What is a Tax Write-Off?
It has happened to all of us. We hear that word that people have thrown around our entire lives but never truly understood what they were talking about. We stand there listening and nodding in agreement, maybe even dropping a few words to sound like you know what they are talking about. An “ohhhh” here, a “mhmmm” there. In an effort to show you know what they are talking about, you decide to not ask them what it means, and you let the conversation die.
I have been in your shoes and have had my fair share of those moments. So for those who are still confused about the word “write-off” you have come to the right place.
When someone says write-off it could actually mean a variety of things. In today’s world, people seem to relate the term write-off to anything that will reduce your income on your taxes. That is the gist of the word. Naturally, your next question is “how/what things reduce your income on your taxes?”
Let’s dive right into a few things that can reduce your tax burden.
This type of write-off will be your bread and butter as freelancers. Learning what things you can “write-off” from your business income can lead to thousands of dollars of tax savings, so no matter how bored you may be right now just bear with me for just a couple more paragraphs! (or if you are yawning, you can use a 1099 expense tracker app to do it all for you).
If you are running a “trade or business” - as the IRS would call it - you are allowed to deduct expenses from your business income. These expenses have to be expenses that would ordinarily be incurred in whatever business venture you are involved in.
For example, let’s assume that Fred is a handyman. Fred works as a handyman doing freelance jobs nearly every day. He buys tools and equipment to be able to fix the things that are broken. He travels to and from different homes for service calls.
He has a business telephone that he fields calls on. Whatever Fred pays for those things are business expenses and can be used to “write-off” business income. Common synonyms for these are expenses or deductions. There are many things you can claim as deductions on your taxes.
Some common ones are:
- Cost of materials
- Business equipment
- Track miles for taxes or automobile expenses (you have to choose one or the other)
The list could go on and on. Basically, if you incurred an expense in the ordinary course of business more than likely it is eligible to be taken as a write-off. Here’s Keeper Tax’s guide if you want to get acquainted with more common types of business expenses.
Are There Disallowed Expenses?
I know it’s hard to believe but I’m about to tell you something that is a little tough to swallow. Some people abuse the system and deduct more than they should. I know that you are all shaking your heads in utter disbelief right now but it’s absolutely true. And why do we have to be concerned with that? Because since the IRS has caught many people abusing deductions, they have made some expenses “nondeductible” as a punishment for the widespread abuse they have uncovered. The most common of these non-deductible expenses is entertainment.
Say you are trying to schmooze a potential client and you pay for you and the client to go to a baseball game. You have a great time; you two eat hot dogs, sing “Take Me Out to the Ballgame,” and end up landing the potential client! That’s great!
Talk about money well spent. Fast forward to tax time. Let’s analyze that expense. Yes, it was a well-intended expense incurred by you to acquire new business, but since the activity itself was a form of entertainment you technically can’t deduct that expense. Don’t shoot me, I’m just the messenger! You can blame whoever has tried to deduct season passes to skyboxes every year in the past and happened to get caught by the IRS.
Another common nondeductible expense is meals. Meals have a special rule where only 50% of the cost of the meal is nondeductible. So come tax time make sure you dig deep into your expenditures and exclude the nondeductible expenses.
What Else Can Be A Write Off?
Tax write-offs are a completely legal thing that every freelancer should use to help offset some tax burden that they may have. If you are still wanting more after this article, I encourage you to read our guide to independent contractor taxes.
Now that you are an expert in the field of business expenses let’s move onto what someone else might mean when they say that magic word. Some people relate losses to write-offs, especially investment losses. Say that Fred the handyman also liked to invest in real estate on the side. Well after a couple of years of owning this investment property Fred decides to sell it to free up some cash. When Fred puts it on the market, he discovers that it has lost value! Since Fred needs money now he decides to sell and take the loss on the property.
In instances like these, the IRS magically finds some pity in its soulless coffers and allows Fred to reduce a portion of his income from his handyman by the loss that he had. It’s nice to know that the IRS has a smidge of a soul (disclaimer: I’m sure many nice people work at the IRS, it’s just part of my job as a CPA to bash them on a regular basis). Again, we recommend you use a 1099 expense tracker to do it all for you (you know, Keeper Tax has great reviews.
So next time you hear someone try to justify their loss by saying “well at least it’ll be a good write-off!” you can nod your head proudly and say “oh yeah, definitely” with a confident smile on your face.