What Is A Tax Write-Off And How Does It Work?

The term “tax write-off” gets thrown around a lot. But what exactly does it mean? 

For many, understanding tax write-offs is the trickiest part of doing taxes.

There’s a fine line between expenses you can write off and those you can’t.

And missing a single tax write-off could result in overpaying your taxes.

That’s why it’s crucial to understand the rules.

This post fully defines tax write-offs, what generally qualifies, and how to properly claim them.

What is a Tax Write-Off?

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Tax write-offs are eligible expenses that you can deduct from your income for tax purposes.

For individuals, the most common tax write-offs are:

• The standard deduction: which provides a predetermined tax write-off to taxpayers each year
• The itemized deduction: which allows taxpayers to write-off certain individual expenses on their tax return

As an individual, your tax write-offs are generally limited to one of the above deductions.

However, self-employed individuals and business owners are able to take many more tax write-offs.

The tax law allows business owners to write-off almost any business expense they incur as a tax deduction.

The IRS allows you to deduct business expenses that are “ordinary” and “necessary” to run your business.

Ordinary means that it is common and accepted in your line of work. 

Necessary means that it is helpful and needed to run your business.

Generally, any business expense that meets these two requirements can be written off.

For example, a car repair shop may write-off repair tools because it is ordinary and necessary for their business. But an accounting firm may not be able to write-off car repairs if it is not necessary for their work.

What is the Benefit of a Tax Write-Off?

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The primary advantage of a tax write-off lies in its ability to reduce your taxable income, ultimately resulting in a lower tax obligation.

Your taxes are based on your income. The more income you report, the more taxes you will pay.

Tax write-offs reduce the income you report on your tax return. Therefore, the more tax write-offs you claim, the less income you will report.

And the less income you report, the less taxes you will be assessed.

For example, someone with a 30% tax rate and $100,000 in tax write-offs would save $30,000 in taxes.

Tax Deduction vs. Tax Write-Off

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The terms “tax deduction” and “tax write-off” are used interchangeably. Both terms refer to the same thing.

Whether it is referred to as a deduction or a write-off, both terms describe an expense that can be subtracted from your total income when calculating your taxable income. 

Therefore, both deductions and write-offs ultimately serve to reduce the amount of income that is subject to taxation.

Tax Write-Offs: How Do They Work?

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Tax write-offs reduce the reported income on your tax return.

After subtracting all of your tax write-offs from your income, you would have your Adjusted Gross Income.

Income minus Tax Write-offs = Taxable Income.

This number is then used to compute your tax liability according to individual and/or business tax rates.

Your tax liability reflects how much you need to pay in taxes to the government, including federal, state, and local taxes.  

And the more tax write-offs you claim, the less income you will report subject to taxes.

Common Misconceptions About Tax Write-Offs

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Many people think that tax write-offs are applied directly against your tax liability.

They think that if you owe $15,000 in taxes and have $15,000 in tax deductions, they would owe $0 tax.

This is incorrect. Tax write-offs do not directly reduce the taxes you owe.

It directly reduces your income, which is subject to taxes. Therefore, tax write-offs indirectly reduce your tax liability.

Tax credits, on the other hand, do directly reduce the taxes you owe.

There is a distinct difference between the two.

Tax credits reduce your taxes. Tax write-offs reduce your income.

Here’s a simple example:

If you had $10 in income and claimed $2 as a tax deduction, then your remaining income would be $8. If we assume your tax rate is 25%, then you would owe $2 in taxes.

On the other hand, if you had $10 in income, and your tax rate is 25%, you would owe $2.50 in taxes. However, if you had a $2 tax credit, then you would only owe $0.50 in taxes..

What are Individuals Tax Write-Offs?

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Individuals have the option to take the standard or itemized deduction on their tax return.

In 2024, the standard deduction is $14,600 for single individuals and $29,200 for married taxpayers filing jointly.

However, when individuals have itemized deductions that exceed these amounts, it is more beneficial to itemize instead.

The itemized deduction allows you to write-off:

• Medical and Dental Expenses that exceed 7.5% of your income
• State and local taxes up to $10,000
• Mortgage interest expenses
• Gifts to charity
• Casualty and theft losses

What are Business Tax Write-offs?

Because the IRS allows business owners to write-off any ordinary and necessary expense, there are over 100 business tax write-offs.

The most popular deductible expenses include writing off a portion of the following:

• The business use of your car
• The business use of your home
• Travel expenses
• Advertising expenses
• Repairs and maintenance
• Tax preparation fees

To learn the most valuable business tax deductions, read our post on the 34 best business tax write-offs.

How to Take Advantage of Tax Write-Offs

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To avoid missing tax write-offs you qualify for, it is recommended to follow the 3 simple steps below.

#1 Make sure you have a business bank account

Keep your business finances completely separate from your personal expenses by having a dedicated business bank account. 

This makes it crystal clear which transactions are for your business. 

If the IRS ever audits you, having a distinct business account lets you easily show all your business income and expenses without any personal purchases getting mixed in and complicating things.

#2 Make sure your business bookkeeping is done

Writing off your business expenses should be a very simple process during tax time.

Regularly track and categorize your business expenses throughout the year. 

Your expenses should be nicely organized into reports that clearly list out categories like advertising costs, overhead expenses, etc.

That way, your accountant can quickly and easily prepare your tax return to ensure you take advantage of all tax deductions you’re eligible for.

#3 Retain Proper Documentation of Expenses

Save every receipt, invoice, bill – anything that documents legit business expenses you’ll want to write off.

Having this paper trail proves the expenses were real if you ever get audited by the IRS.

Now, an IRS audit shouldn’t scare you from writing off valid expenses that you incurred to run your business. Their job is to make sure you are complying with the rules and regulations that exist.

And having complete documentation makes this process much easier.

Also, don’t forget to secure W-9 forms from vendors and W-4 forms from employees. 

If you do these three things, you should be able to take full advantage of tax deductions and save big on taxes.

Bottom Line

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At the end of the day, we all want to keep more money in our pockets.

And understanding tax write-offs is all about being strategic with your money.

As a business owner, every dollar counts, and those write-offs can really add up to some sweet savings come tax time. But you’ve got to play by the rules.

The key is keeping things nice and organized all year round. Remember to keep those receipts and documents, too—they’re your proof if the IRS ever comes knocking. 

There’s no need to stress though, as long as you’re claiming valid write-offs and following the guidelines.

Using write-offs properly is just good business practice. So take advantage of the write-offs you qualify for – that’s more cash you can reinvest into growing your business.

If you want a tax plan that is guaranteed to put more money back into your pockets, schedule a free consultation with a tax advisor now.