What Is a Tax Write-Off, and How Does It Work?
If you work for yourself, then tax write-offs are your best friend. Whether you're a freelancer, gig worker, or small business owner, taking advantage of them can help you save big at tax time.
What is a tax write-off?
A tax write-off — also known as a tax deduction — is an expense you can subtract from your taxable income.
With a lower taxable income, you'll end up paying less in taxes. That's why tax deductions are such a powerful financial tool for self-employed people, whose tax bills can be uncomfortably high without them.
Who can write off expenses?
There are actually two kinds of tax write-offs: deductible business expenses and personal itemized deductions. Only self-employed people are eligible to deduct business expenses, while all taxpayers can claim personal itemized deductions.
Here's how the two types of write-offs work.
Deductible business expenses
Self-employed people, like independent contractors and business owners, can deduct their business expenses from their gross income to lower their tax bills.
This is true whether you have a sole proprietorship or an LLC — you don't need to have a particular type of business entity to deduct expenses. (W-2 employees, however, can't write off what they spend on work, even if they’re paying out of pocket. They'll have to get reimbursed by their employers.)
Deductible business expenses are, simply put, the day-to-day costs associated with doing your work. You deduct them by filling out your Schedule C.
Common write-offs in this category include:
- Your computer
- Your phone
- Supplies you use for work
- Fees paid to contractors
- The home office deduction, which can include your rent, utilities, and even home insurance
- Car-related expenses, if you drive for work (outside of your commute)
- Meals, if you use them to meet with clients or talk shop
- Travel expenses, if you go on business trips
At Keeper Tax, we've built a deduction tracker that finds these qualifying business expenses for you. Sign up for the app, and you'll be paired with a Keeper (short for bookkeeper) who uses our software to scan your purchases for write-offs like these.
One important thing to keep in mind about these business expenses: you can write them off even if you take the standard deduction. More on that later!
How to find deductible business expenses
Depending on what you do for work, lots of other purchases might be tax-deductible.
For example, an Uber driver can write off passenger freebies like water bottles, gum, and even barf bags. Meanwhile, an actor can deduct the occasional movie or show ticket. But if an Uber driver tried to deduct movie tickets? Unless they could prove they were treating passengers to a matinee, that would be a problem.
To find write-offs for your job, take a look at our free tool for identifying qualifying business deductions. If you use our app, you can also just text your Keeper!
Capitalizing and depreciating business expenses
If you have business assets costing more than $2,500 — think office furniture, equipment, or even buildings — they won't be recorded in the app. Instead, if you file taxes with us, we'll capitalize and depreciate them: that is, spread their cost over multiple tax years, according to IRS guidelines.
Why $2,500? That's the de miminis safe harbor limit for deducting "tangible property" used for your business.
There’s a couple of caveats here. One: This is only true of items with a "useful life" of one year or more. Things like contractor payments don't count, since their useful life is less than a year. You can write off a contractor payment of $3,000, of example, just like any other business expense.
Also, Section 179 deductions and bonus depreciation will actually allow a lot of small business owners to deduct the full cost of a business asset in the year it’s purchased — even if it costs more than $2,500. (For an example, check out our post on how this works for car depreciation.) We can handle these special cases when you file.
Personal itemized deductions
Only self-employed people can write off business deductions. But there are other, personal deductions that all individual taxpayers can take. You'll fill these out on your Schedule A.
Common itemized deductions include:
- Charitable donations
- Medical expenses
- Mortgage interest
- Mortgage points on your home loan
- Health savings account (HSA) contributions
Keep in mind: Unlike business expenses, these itemized personal deductions trade off with the standard deduction, a set dollar-amount that all American taxpayers can choose to write off. (The amount depends on your filing status. In 2021, it's $12,550 for single filers, $25,100 if you're married filing jointly, and $18,800 if you're a head of household.)
You'll have to choose between taking these write-offs individually — itemizing them — or taking the standard $12,550. (Needless to say, itemizing only makes sense if the amount you spent on charitable contributions, medical bills, and the like ends up exceeding than the standard deduction.)
The Keeper Tax app won't keep track of these personal deductions for you. But if you file your taxes through us, we'll still be able to deduct them on your tax return.
How much are tax write-offs worth?
The actual value of the write-offs you claim can be confusing. A 100% tax deduction, after all, doesn't mean that the purchase was free.
The actual dollar value of your write-off depends on your tax rate. If you use the Keeper Tax app, you can find your tax rate on the ⓘ icon by "Estimated Tax Savings" on the app's main page. You can also estimate it using our free self-employment tax rate calculator.
To calculate how much you're saving from a write-off, just take the amount of the expense and multiply it by your tax rate.
Here's an example. Say your tax rate is 25%, and you just bought $100's worth of work supplies, which are fully tax deductible. $100 x 25% = $25, so that's the amount you're saving on your taxes.
How tax deductions compare to tax credits
It's easy to confuse tax deductions with tax credits. Instead of lowering your taxable income, tax credits directly reduce the amount you're paying in tax, dollar-for-dollar.
For example, the American Opportunity Tax Credit is a credit for certain education expenses, worth up to $2,500. So if you had a tax bill of $5,500 but then qualified for the maximum amount of the credit, your tax liability will fall to $3,000.
What if your write-offs result in a net loss?
Reduce your taxable income with write-offs, and you'll end up with a lower tax bill. But what if you wind up with so many business expenses that your profit falls down to nothing?
When your expenses exceed your income, that's called a net operating loss (NOL). In general, it's nothing to worry about — especially if you're just starting out. It’s normal for new freelancers not to make a lot of money in their first few years at it. (Even experienced freelancers may find themselves with extremely limited net income from time to time.)
Let's talk about when these losses can save you money, and when too many losses can hurt you.
When losses can help
Sometimes, losses can help you reduce your tax bill without any negative impact on you.
For people who freelance as a side hustle
For example, let's say you work a full-time job, where you make $50,000 a year. You also drive for Uber on weekends. But your ridesharing side gig cost you more money than you got paid. After deducting all your expenses, you ended up with a loss of $1,000.
On your tax return, you can take this $1,000 NOL and subtract it from your W-2 salary. Now, your overall income for the year is $49,000.
For people who freelance full-time
What if your only income is from freelancing? In that case, you may not be able to benefit from your loss the year you incur it. But if you include them on your tax return, you can carry it forward to future years.
Here's how that works. Say you had a NOL of $1,000 the first year you went freelance. The year after, you start to hit your stride: your income, after expenses, is $10,000.
You can carry your loss from the previous year forward, reducing your income to $9,000 for the year.
When losses might hurt
The IRS does expect self-employed people to earn a profit eventually. If you fail to earn one in at least three of the last five years, it may end up treating your business as a hobby.
Why does it matter? Unfortunately, if your business ends up being classified as a hobby, you can't deduct your business expenses anymore. (Your “hobby” income, though, will still be taxed. It really is the worst of both worlds!)
At the end of the day, losses are no big deal when you first start working for yourself. Don't let the fear of them stop you from taking legitimate business deductions. After all, you're investing in your ability to work smarter in the future.
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At Keeper Tax, we’re on a mission to help freelancers overcome the complexity of their taxes. That sometimes leads us to generalize tax advice. Please email firstname.lastname@example.org if you have questions.