How Do Business Write-Offs Work?
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You’ve heard the phrase in television and movies countless times, about the unwarranted purchase of expensive items...
“Tax write-off.” For those starting in the business world the phrase may appear to be corporate lingo that’s thrown around often, but what exactly are tax write-offs and what can be ‘written-off’?
In layman's terms, a tax write-off is an accounting tactic that helps businesses decrease the cost of their annual taxes, but before you run and start writing off everything you’ve ever purchased for your small business, watch this ‘educational’ clip from the hit TV show Schitt’s Creek.
A business trying to get out of paying taxes? Shocker, I know, but when a business has an expense that is necessary to the function of the business and one that is common for competing businesses in the industry, it can be ‘written-off.’
In layman's terms, this means that at the end of the year businesses don’t need to pay taxes on these items.
For simplicity purposes let’s assume that a company has $1,000 in revenue for the year. That company will be taxed for that revenue amount; However, if the company has $100 worth of items that can be written off, then the company will only be taxed as if they earned $900 in revenue, thus decreasing the total amount of taxes paid.
While we just moved past the thick of tax season, it is important to mention that a given business expense does not need to be classified as indispensable to be ‘necessary’ for tax purposes.
What items can be written off
Common expenses that can be written off are travel and transportation costs, supply costs, meals during business hours, and employee training costs.
Another classic example is inventory. If a production company experiences a shipment that spoils then that shipment would be able to be written-off due to the loss of assets.
If you happen to run your own home-based company, then expenses such as internet and additional phone lines could potentially be written-off as they are crucial to the function of your office (home).
One of the more interesting expenses that can be write-offs is research materials used to become more knowledgeable about one’s industry or specific job. This means that conferences, books, and online courses can potentially be written-off and give you immediate benefit to help your business.
Even office furniture can be written-off after age and decay take its toll, with the depreciated amount being written-off In some variation, most business expenses are deductible and can be written-off in some fashion.
Small business owners take on a high amount of risk generally speaking. Financial forecasting can be overwhelming, especially in the infancy years of a business when success has yet to be established.
To give themselves a bit of breathing room, some risk in the form of business expenses can be planned to be written off when looking at the cost-benefit analysis of a particular action.
It is essentially a surefire way of ensuring that not all the money spent on a decision will be paid for in full. For example, if a small business owner is considering buying a new office space he or she can plan on writing off purchased business computers into the cost-benefit analysis when determining if a new office space is financially viable.
The grey area
As mentioned earlier, a business owner can expect to write off items that are commonly used within their company’s industry, but the grey area can become even murkier when considering each expense.
Health and life insurance are items that can be written off, as they are paid for by the employer and are deemed essential to have qualified employees working at the company. Uniforms and required clothing can also be written off, but clothing other than the bare minimum cannot be used as a tax write-off.
Travel costs are a common example of costs that can be written off for tax purposes. If you are the owner of a manufacturing business in Texas and you need to visit the owners of prospective retail companies in California for example, the flight costs can be considered essential.
With this being said, that doesn’t mean you can write off that family trip to Disneyland. Even though the airfare for you, the business owner, can be written off, airfare for anyone other than an employee cannot be written off, including spouses or children, even if the tickets are jointly purchased.
In this scenario, when determining costs that can be written off you would take the cost of your single airline ticket and use that as a deductible cost, leaving your family’s airfare out of the equation.
One key thing to mention is that manufacturing and distribution businesses are not able to write off items that are purchased, whether as a material or a finished product. Items incorporated into the cost of goods sold cannot be written off because they are being sold for profit.
According to the IRS, less intangible items such as freight, storage, and factory overhead are all items that are included under the cost of goods sold.
The equation is simple. The more tax write-offs a business has for its purchases, the fewer taxes are paid; however, this is only possible if accurate records are kept throughout the fiscal year.
Recurrent costs are easy to spot through receipts and can then be planned for when doing financial preparation of expenses and write-offs for the following year. Over time these costs may change depending on economic changes, business location, or scalability, but no matter the case they will still be deductible.
Write-offs aren’t just corporate lingo used by business owners to determine how much money they can save, they are realistically applied in the personal finance realm as well.
Many items can be written off when doing your yearly personal taxes, but we will save that for another article.
So the next time you’re knee dip in chip dip and god forbid the topic of taxes comes up at your neighbor’s dinner party, you can use the term “tax write-off” in confidence.