A tax write-off is how businesses account for expenses, losses and liabilities on their taxes. Write-offs are a specialized form of tax deduction. When a business spends money on equipment or operating expenses, it can deduct that spending from its taxes. The same is true when a business loses money on uncollected debts and lost assets. With write-offs, businesses can lower their tax burden and help make their operations more affordable. Here’s how it works.
For more help with how you could use write-offs, consider working with a financial advisor.
What Is a Write-Off?
A write-off is another term for a tax deduction on business income.
When businesses report their taxes they do so, broadly speaking, in two sections. First, the business calculates its operating profits for the year. It reports all income, losses and the resulting total profits. Second, it calculates the taxes that it owes based on those profits.
When a business reports its income, losses and total profits, it does so through the system of revenue and write-offs. Revenue is the amount of money that a business makes from all sources over the course of the year. Losses refer to the money that business spends on all qualified expenses in that same time period.
Those losses are the business’s write-offs, and they reduce its taxable income for the year in the same way that a tax deduction does for individuals.
It’s important to understand that a write-off is a tax deduction, not a tax credit. When a business writes off expenses it lowers its taxable income and, as a result, the taxes it pays. This is not a dollar-for-dollar tax rebate and it only generates a refund if you paid more in estimated taxes than you owe at the end of the year. That said, write-offs can significantly lower a business’ taxes, making them very valuable for anyone who pays taxes on operating profits.
What Can You Claim as a Write-Off?
A business can claim write-offs for all legitimate, qualifying business expenses as defined by the IRS. Generally this includes all spending that is both necessary and relevant to running your specific business.
Understanding exactly which expenses a business can write off can be difficult. This is a complicated area in which the IRS has given precise, but lengthy and dense, instructions. Not every business can claim the same expenses and not every expense can count. Ultimately the best way to know if you’re on solid ground with your write-offs is to hire a qualified tax professional who can guide you through the process of categorizing your income and expenses.
That said, broadly speaking, the IRS allows four main categories of write-offs:
Debt Payment and Other Financial Expenses
If you made payments on debt, contracts or had other expenses for lending and financial products, the IRS often will consider this a qualifying business expense. This can also apply to interest payments on qualifying loans. For example, say your business rents a storefront. Your business may be able to deduct those rent payments from its income as a business write-off.
Business Expenses, Purchases and Operating Costs
This is the biggest category for almost every business.
The money you spend running your business can often be a write-off. This can apply to a wide variety of expenses. The two most common types of expenses are purchases — for example, if you buy desks and computers — and operating costs, for example, payroll and utility bills. These are the costs directly associated with running your business and as a result you can often deduct them from the business’s income.
Uncollected Debts, Liabilities and Losses on the Sale of Investment Property
This practice is known as “writing off a loss.” It applies to when you have assets destroyed or give up on collecting money someone owes you. For example, if your business owns a car worth $10,000 and it gets destroyed, you might write that vehicle off on your taxes. The same is true if someone owes your business $10,000 in payments. If they refuse to pay, you may eventually give up on collecting the debt. In that case you would report the $10,000 on your taxes as a loss.
Selling an investment property at a loss means accepting less than what you initially paid for it. Generally, when a rental or investment property is sold at a loss your losses can be deducted from ordinary income. Again, this is the income most people report on a Form 1040 each year when they file their taxes.
Finally, as with individuals, the IRS allows businesses to deduct money that they donate to qualifying charities. You cannot always deduct charitable donations, and you cannot necessarily deduct all the money you donate, so be sure to check carefully before you plan your taxes around a charitable donation.
How Do You Apply a Write-Off
Write-offs work much the same as when an individual itemizes their taxes. Indeed, as noted above, some financial outlets use the term “write-off” interchangeably as a concept for both business and personal taxes. You apply write-offs when calculating your profit for the year on your taxes. Different entities calculate their income and losses using different forms based on their specific type of business, but all need to make a basic reporting of how much money they took in and spent. For example, self-employed individuals and sole proprietors report their income, losses and profits using the tax form Schedule C.
Wherever you calculate income, losses and profit is where you claim your tax write-offs. In this section, you list all business expenses that qualify as write-offs. It’s best to do this with specificity, attaching an appendix to your taxes if necessary. It’s also absolutely critical to keep the documentation for all write-offs that you intend to claim. This is a complicated area that often breeds confusion. If you make a mistake, receipts can be the difference between a quick check-in from the IRS and a full-blown audit.
Deduct your qualifying expenses from your business’ revenue and report the total as your business’ taxable profit for the year. Note that you can’t always claim all business spending as a write-off. Even if you felt an expense was necessary, you can only claim deductions that the IRS specifically allows.
For a business to claim a write-off it must apply these expenses to its revenue. Write-offs do not apply to third-party income or other revenue streams unrelated to the business itself. This comes up most often for individuals who file taxes as a business. You can only take a tax write-off on earnings related to those expenses.
Say that you have a W-2 job as an accountant and also earn money as a self-employed consultant. When you file your taxes, you would file a Schedule C with the income, losses and profits from your consultancy. There, you could deduct all of the consultancy’s permissible expenses. But you can only deduct those expenses from income that you earned as a consultant. You can’t claim them as deductions from your job as an accountant or from your combined annual income. Business deductions can only apply to business income.
The Bottom Line
A tax write-off is a deduction that applies to business income. It’s when you list all of the expenses and other losses that your business incurred over the year, which reduces your business’s overall taxable income.
Tips on Taxes
- Individuals and the self-employed are the ones most likely to need help calculating their write-offs. Here are some of the most common, and most valuable, tax deductions for the self-employed.
- A financial advisor can help you get tax write-offs right. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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