What Is a Tax Write-Off and How Do They Work?
Tax write-offs can create a lot of confusion. This guide explains how tax write-offs work and how deductions can save you money on your taxes.
November 15, 2021
You’ve probably heard the phrase “well, it’s a write-off!” when someone mentions a major purchase or an upcoming trip. But what does this term mean, exactly, and how do tax write-offs work?
There tends to be some confusion surrounding what tax write-offs really are. Some people think of a write-off as “complimentary money,” while others might not understand deductions and could be leaving valuable tax breaks on the table.
This guide will set the record straight and explain everything you need to know about tax write-offs.
What is a tax write-off?
A tax write-off is another way to say tax deduction.
Essentially, a write-off is any legitimate expense that can be claimed as a deduction to lower your taxable income.
What can you write off on taxes? The IRS allows dozens of deductions and credits for individuals, and even more for businesses.
Tax write-off examples include:
To put it into practice, let’s say a taxpayer paid $2,000 in mortgage interest, $5,000 in property taxes and $3,000 in charitable contributions in a given tax year. This taxpayer could deduct $10,000 from their taxable income for that year.
The term “tax write-off” is also used by business owners to refer to legitimate business expenses. A tax write-off can therefore be used to lower the business’ profits and tax liability.
Business tax write-offs are a bit broader, and can include the cost of goods sold, employee salaries, transportation expenses and even dining and travel expenses for business trips.
How do tax write-offs work?
When you file your federal income tax return each year, you tally up all your income and calculate your tax owed. You are also able to deduct certain expenses, which lower your taxable income.
Taxpayers are able to choose between two options:
A standard deduction, which lets you deduct a flat $12,550 regardless of your deductible expenses or $25,100 if you’re married and filing jointly
Itemized deductions, which let you deduct the total amount of your qualifying expenses with no limitations
Most Americans use the standard deduction, because it ends up saving them more money. That said, some taxpayers (particularly higher-income households) choose to itemize their deductions in order to save more.
It’s wise to speak to a tax advisor if you’re not sure which approach to take.
If your deductions exceed $12,550 (or $25,100 for married filers), it’s wise to itemize
If your deductions are less than $12,550/$25,100, it’s wise to take the standard deduction
Tax deduction examples
To demonstrate how tax deductions work, it’s helpful to look at some examples:
Single filer, standard deduction
A single filer earns $50,000 per year. She has student loan interest and has paid state income taxes, both of which are deductible. However, her qualified deductions total just $6,000.
Taking the standard deduction of $12,550 will lower her taxable income far more than the $6,000 in qualified deductions would.
Married filer, itemized deductions
A married couple earns a combined $185,000 per year. They own a home, are paying off student loans and pay state income taxes. Their qualified deductions total $29,000.
It makes sense for the couple to itemize their deductions, as their qualified expenses exceed the $25,100 standard deduction they could take.
A tax write-off does NOT equal “complimentary money”
When it comes to the question of “how do tax write-offs work,” there’s a common misconception that a tax write-off means an expense doesn’t really matter; that the IRS is picking up the bill.
This is false.
A tax write-off lowers your taxable income, not your tax owed. The deduction will slightly lower your tax liability, but not by the full amount of the deduction.
For example, let’s say you are single and earn $65,000 per year, which puts you in the 22% tax bracket.
In this case, a tax write-off of $1,000 would lower your taxable income by $1,000 — but it will only lower your tax due by approximately $220 (22% of the $1,000 deduction).
Deduction vs. credit
A deduction lowers your taxable income, while a tax credit lowers your tax owed dollar-for-dollar.
A tax credit is substantially more valuable than a tax deduction. However, it is more rare.
Examples of tax credits include:
Earned Income Tax Credit (for lower-income taxpayers)
Saver’s Tax Credit (for lower-income taxpayers who save for retirement)
The Child Tax Credit (for families with children)
Tax credits are limited in scope and often difficult to qualify for. For this reason, when you hear someone talk about a “write-off,” they’re usually talking about a tax deduction.
Business deductions are different from personal deductions
Another factor that creates confusion is that businesses are allowed to deduct a wider range of expenses from their profits.
You may hear your friend who owns a business discussing a write-off for an extravagant meal with a client or a business trip to a conference in Las Vegas. But, for individuals, neither of these expenses would be deductible.
So, how do tax write-offs work when it comes to business? Businesses are only allowed to deduct legitimate business expenses. They can deduct a portion of the cost of a restaurant meal if they are eating with a client or potential client, but they cannot deduct personal expenses. Likewise, travel expenses are only deductible if the travel was required for business operations.
Wrapping up tax write-offs
In closing, here are a few key takeaways about tax write-offs:
A tax write-off is another term for a tax deduction
Write-offs can reduce your taxable income and therefore lower your tax bill
Expenses like mortgage interest, student loan interest and state income taxes paid can all qualify as tax write-offs
Write-offs only benefit you if you choose to itemize your deductions
Most people take the standard deduction ($12,550 for single filers; $25,100 for married filers)
You cannot take both the standard deduction and itemized deductions
Unless your qualified expenses exceed $12,550/$25,100, you’re better off taking the standard deduction
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