What Are Business Tax Write-Offs and How Do They Work?
Every business must file and pay taxes, but understanding how to properly report financial information can help lessen the burden. By taking advantage of business tax write-offs, expenses incurred in the course of running a company can be deducted from income, which ultimately lowers your tax liability. Careful tax planning and consistent recordkeeping will result in the proper calculation and reporting of business tax write-offs.
Tax Write-Off Meaning: What Is a Business Write-Off?
A tax write-off refers to any business deduction allowed by the IRS for the purpose of lowering taxable income. To qualify for a write-off, the IRS uses the terms "ordinary" and "necessary;" that is, an expense must be regarded as necessary and appropriate to the operation of your type of business. Generally, tax write-offs fit into specific reporting categories such as business travel, advertising, or home office expenses.
When the times comes for tax preparation, you should be familiar with the types of costs the IRS allows businesses to write off. Due to their ability to reduce taxable income, tax write-offs may play a part in everyday business decisions throughout the year. For example, traveling to attend an industry conference may seem cost-prohibitive, but if you can deduct all or part of the conference fees, lodging, and mileage for tax purposes, the benefit of the additional write-off may lead you to a different decision.
Tax Deduction vs. Tax Write-Off
When seeking tax advice, you may hear tax professionals or accountants use the term tax deduction or tax write-off. The terms are used interchangeably and there is no real difference between them, as they both refer to an amount that reduces taxable income.
Tax Credit vs. Tax Write-Off
Unlike a tax deduction, a tax credit is not the same as a tax write-off. While tax write-offs reduce business income, a tax credit lowers the actual tax liability. If a company generates $10,000 in income and deducts the $1,000 cost of a business insurance policy, their net taxable income will become $9,000. The cost of the business insurance would be a tax write-off.
A business tax rate will then be applied to the $9,000 to determine the amount of taxes owed. Given a 10% tax rate, the resulting tax liability would be $900.
Using a business tax credit, companies may further reduce the amount of taxes owed. Tax credits are allowed for a variety of purposes, such as small businesses funding a pension or health care plan. Continuing the example above, if a company qualifies for a $500 tax credit, they would then pay $400 in taxes, rather than $900.
How Do Business Tax Write-Offs Work?
Tax write-offs for your business are calculated using expense tracking reports. Throughout the year, it's important to keep records for business-related expenses paid. When compiling year-end tax reports, it may help to devise a system that groups expenses into categories that match the IRS forms. This will ensure that you do not miss any potential write-offs. If you use tax software, you may be prompted to enter common expenses that qualify as a tax write-off.
What Can You Write Off? Common Tax Deductions for Small Businesses
The IRS Publication 535 provides comprehensive guidance on which business expenses can be written off. If you have an expense that does not fit into a general category, it pays to research if the cost may be deductible for tax purposes. Here's a list of some of the most common tax deductions for business owners.
Advertising and Marketing Expenses
Costs related to marketing your business and finding new customers can be deducted as advertising expenses. This may include developing and printing promotional materials, the cost of a social media campaign, website creation and maintenance, or any ads used to draw in new business.
Legal and Professional Fees
If you pay an accountant, lawyer, or other financial professional to help run your business, their fees may be deductible for tax purposes.
The cost of insurance policies purchased for your business may be written off against taxable income.
Income taxes paid during the year to state, local, or foreign entities may be deductible against federal taxes. You may also be able to deduct other taxes, such as real estate taxes, employment taxes, or sales taxes.
Bank Fees and Interest Expense
Bank fees and interest on commercial loans or lines of credit may also be deductible for tax purposes, under certain limitations. A write-off for business interest expense may be restricted by certain IRS stipulations, such as the amount of business interest income or to 30% of adjustable taxable income.
Costs related to assets with an extended life, such as office equipment, furniture, or a company-owned vehicle, must be written off over a set number of years. The annual deductible amount is reported as a depreciation expense. The rules for depreciation can be complex, but a tax software program will calculate the allowable deduction each year, and allows you to track the write-off in future tax reporting periods.
Expenses related to the business use of a vehicle may also be written off. You may choose to write off actual expenses such as maintenance and gas, or you can elect to use the standard mileage rate as determined each year by the IRS. For the 2022 tax year, this standard rate is 58.5 cents per mile.
Compensation paid to employees, along with contractor charges, qualify as tax write-offs for business owners.
The costs to maintain office space and storage are also deductible. This includes rent for office space as well as expenses associated with a home office. Telephone, internet, and utilities are examples of office expenses that may be written off.
Business Travel, Meals, and Entertainment
If you travel for work, you can write off a portion of the costs for tax purposes. If you combine both personal and business travel, you must write off only the costs related to business travel. When traveling for business, transportation costs are fully deductible.
Business meals are 50% deductible in most cases, according to the IRS, but a temporary exemption for restaurant meals allows a 100% deduction through the end of 2022, when an employee or the owner of the business is present and the meals are not considered lavish.
Entertainment costs are generally not deductible.
The costs of providing health insurance for yourself and your employees can also be written off for tax purposes in most cases. Small businesses that provide health care may also be eligible for an additional tax credit.
Conference Attendance or Educational Seminars
Along with business travel, the costs for attending an industry conference are also deductible. Self-employed individuals who incur job-related educational costs may also take a deduction for tax purposes.
Which Deductions for Small Businesses Are Not Tax-Deductible?
Some business expenses may be limited or restricted when it comes to tax write-offs. You should be aware of these types of expenses and refrain from including them in your tax filings.
Certain Legal Costs, Fines, or Penalties
Legal costs for defending yourself when you've broken a law are not deductible. Any fines or penalties assessed by the government are also not deductible expenses.
Mileage Related to One's Normal Commute
An individual's normal daily commute is not considered a deductible expense. Any transportation costs including the standard mileage deduction cannot be written off for travel to and from work each day. However, business travel outside of one's normal commute is generally deductible.
Personal expenses are not deductible. If an expense is split between personal and business use, you must only deduct the portion of the costs related to your business. Additionally, if you partake in an activity without the intention of making a profit, you can't write off related expenses. This includes situations such as a sport, hobby, or recreational activity.
Contributions to support political candidates can't be written off for tax purposes.
Understanding Business Tax Write-Offs and Deductions
Business tax write-offs can help reduce your taxable income. Setting up a process to track deductible expenses throughout the year will help streamline tax preparation at year-end. For assistance with expense tracking and tax preparation, Paychex offers tax services including user-friendly automated solutions as well guided tax preparation to ensure that you don't miss vital business deductions or available tax credits.