Tax write-offs: What they are and what they do
A “write-off” is a colloquial term that means tax deduction. Tax deductions reduce your taxable income.
Back up a moment: what is taxable income? Good question. Your taxable income is the amount of your income the government can tax. The lower your taxable income, the less income tax you pay.
All business owners want to increase their gross income — it’s the whole point of business. But you also want to pay less in income tax. To do that, you write off deductible expenses, which lowers the amount the government recognizes as income.
When you lower the income you report, you don’t just reduce the dollar amount you pay — you even have the chance to move into a more favorable tax bracket. That could decrease the percentage you pay, too.
If you don’t know your current tax bracket, you’re not alone. Financial experts at CNBC report that 22% of small business taxpayers don’t know their 2021 tax rate. That’s where Ignite Spot can help. Call an outsourced certified public accountant (CPA) at Ignite Spot today for a free 30-minute consultation. Our corporate finance experts will help you get an idea for how much taxable income you’re reporting on your current tax return and ways you could pay less in taxes.
WHAT A TAX DEDUCTION IS NOT
Don’t confuse tax write-offs with tax credits. Tax credits are another way to reduce the amount of taxes you pay for the year. But unlike itemized deductions, tax credits reduce taxes paid dollar for dollar.
By contrast, qualifying tax write-offs take your entire income and reduce it in the hopes of moving into a lower tax bracket and lowering the rate you pay. Tax credits are rare, and it can be difficult to qualify for them. Tax deductions are far more common.
To clarify the difference, let’s look at an example. The Plug-In Electric Drive Vehicle Credit reimburses business owners between $2,500 and $7,500 for new electric vehicles purchased to conduct business. The credit is a government incentive. But if you were to buy a diesel vehicle instead, you could simply deduct 100% of the cost of the vehicle from your gross income, lowering your taxable income for the year. It’s a write-off.
How a small business can write off expenses
As a business owner, you benefit when you take tax deductions by writing off business expenses. These expenses include operational costs.
Let’s take self-employed Sally, for example. Sally sells seashells (naturally). She spends a lot of time driving so she can operate her business away from the seashore. If her car is also for personal use, she can split the expenses based on mileage and deduct a portion of that cost. Sally also rents out a storefront in the big city, so she can deduct that rent as well. She can also deduct the money she pays in sales tax.
But that’s just the beginning. There are plenty of things a small business owner can deduct.
EXAMPLES OF SMALL BUSINESS TAX WRITE-OFFS YOU CAN TAKE
The list of deductible expenses allowed is as unique as every business. But in general, the tax law allows all businesses to write off...
• Marketing. All your advertising costs are tax-deductible. This includes everything, from the talent you hire to design your brand’s logo and aesthetic to your website hosting and local radio air time. When Sally rents a billboard to sell her seashells, she can write off that expense.
• Business insurance. The coverage you carry can be deducted to lower your taxable income. You can write off workers’ comp, professional liability, business vehicle coverage, property insurance premiums, health insurance, disability, life insurance for your employees, and even your business interruption policy.
• Banking and payment processing fees. Think about your financial institution’s service charges, maintenance fees, credit card processing expenses, and bank account transfer costs. Those all can and should be helpful tax write-offs each year.
• Office space and vehicle usage. Your home office can be written off, and so can the business portion of your vehicle use. Again, a vehicle and home office deduction must be done correctly, so it's best to call an expert for help.
• Employee and contractor compensation. When you pay others for their talent, plan to deduct those wages from your taxable income. If Sally’s sales grow, she may hire her sister Sharon, and that expenditure would be tax-deductible. This tax benefit includes wages and employee perks like your team’s retirement plan and health savings account.
• Charitable contributions. Sally’s small business donates regularly to Save the Whales. She can write off these charitable donations to lower her adjusted gross income (AGI), directly decreasing her tax bill.
• Educational materials. Continuing accreditation may be important to your business. Thankfully, costs associated with your ongoing learning can be deducted.
• Equipment and supplies. Do you use a laptop to conduct business? What about your phone? Desk? Printer? These may all be used to offset your taxable income.
• Business services. Your virtual assistant, internet bill, computer repair person, customer relationship management (CRM) subscription, and even your outsourced accounting services are all helpful tax write-offs.
Remember that the combination of tax breaks is unique to each business. Only a tax expert can tell you whether you’ve taken advantage of all the tax deductions you’re entitled to.
Are tax write-offs worth it?
Getting all the tax write-offs you deserve requires diligent record keeping. Plus, some tax write-offs increase your chances of being audited. Are your deductions worth the trouble and risk? As accountants, we say tax write-offs are definitely worth it. Here’s why.
LAWFUL TAX WRITE-OFFS DON'T RAISE YOUR AUDIT RISK
We’ve helped hundreds of businesses take the deductions that the government encourages them to take. In our 12 years of experience, we’ve seen no evidence that tax write-offs — when done correctly — really increase your risk of being audited by the IRS.
What does increase the risk of an audit is the deductions that can be argued either way. Sally might operate her business at the seashore, but does her whole family need to go to Disney World on the business account?
Every day, taxpayers struggle to understand what can be written off.
Don’t wrestle needlessly. Call a tax expert to help and rest easy.
SUSTAINING CLAIMS DOESN'T HAVE TO INVOLVE TEDIOUS WORK
The other reason it’s worth it to get all the deductions you can is that productivity tools have changed. These days, good recordkeeping is a lot easier than it used to be.
In the past, you used to have to hire an in-house accountant or download complicated, clunky software to try to keep your books straight. Today, you can hire an outsourced accountant who only does the work you want them to do. And if that partner is Ignite Spot, then you know you’re getting an accountant who uses the best automation tools to streamline the process, making it a cinch for everyone involved.
How to know what’s a legitimate deduction — and what isn’t
The tricky nature of certain expenses often leads to a lot of questions. For instance, if Sally were to buy $50 in seashell-printed pens on a family shopping trip but then take them to her office, would that be an appropriate write-off?
Generally, a deduction has to pass a five-point test to pass muster.
• Ordinary and necessary. This means you absolutely need the product or service in order to conduct business. “Ordinary” describes an expense that’s commonly incurred by similar businesses in the industry. Necessary doesn’t mean essential. In this case, it means appropriate.
• Reasonable. The expense shouldn’t be exorbitant. If you can prove it’s a reasonable amount for the ordinary and necessary expense, then it passes this legitimacy test.
• Proof of an exchange. You also must be able to substantiate goods or services received for your deductible expense. If it’s a valid business cost, this shouldn’t be difficult to do.
• Evidence of outflow. The fourth test is whether monies have actually gone out of your account. Obviously, you can’t claim a deduction if you haven’t yet paid for the expense.
• Timely. Performance bonuses must be paid out to employees, shareholders, and owners within specific time frames in order to be written off for that specific tax year.
Write off: Right on!
As a small business owner, you know that stakes are high during tax season. Write-offs, deductibles, expenses, exemptions, and other strange accounting terms can confuse non-accountants.
Again, the best policy is to engage an experienced business finance expert, like a team member at Ignite Spot. Getting into trouble with the IRS can be disastrous. Get your questions answered now and prevent costly issues in the future.
Our online, outsourced bookkeeping firm is highly experienced in small-business tax preparation, so contact us today with tax questions regarding your C-corp, S-corp, LLC, or sole proprietorship.