The Truth About "Write-Offs"

How much can you really save when you “write something off” on your taxes?

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It seems that every tax season we hear more and more about write-offs! Dinner with friends? Write it off! New Car? Write if off! Need a new computer? Write it off! Family Vacation? Write if off!

Social media seems to be causing a growing belief among entrepreneurs that you can eliminate your tax burden simply by writing-off as many expenses as possible. We recently saw a highly respected and widely followed real estate agent bragging on Instagram that he once SAVED $50,000 IN TAXES by writing off the purchase of a new Ford Explorer. And since this experience apparently made him an expert in the US tax code, he went on to encourage his followers (thousands of them) to do the same.

But how much do you really save when you “write something off?” This is probably the most misunderstood tax concept out there and it seems to be getting worse every tax season when everyone and their mom suddenly feels the need to start giving out tax advice like they are a CPA on Facebook, Twitter, TikTok, and Insta!

We’ve all seen the Seinfeld episode where Jerry and Kramer discuss what “writing it off” actually means and more recently we’ve seen this covered in an episode of Schitt’s Creek. While both cover “write-offs” in a hilarious manner, not understanding how write-offs actually work can be detrimental to your small business.

So What Exactly Is A “Write-Off” Anyways?

Good question! Technically speaking a “write off” doesn’t really exist in actual IRS tax code. What does exist in the tax code are “ordinary” and “necessary” expenses incurred as the cost of owning a business or carrying on a trade. These expenses are generally considered tax deductible in the year they are incurred.

Before we dive into how much you really save from a write-off it is important to understand the difference between tax credits and tax deductions (aka write-offs).

Tax Credits vs Tax Deductions

Tax credits like the Child Tax Credit and the Electric Vehicle Credit give you a dollar-for-dollar reduction of your income tax liability. In other words, this means that a $1,000 tax credit will save you $1,000 in taxes.

Write-offs on the other hand reduce your taxable income (assuming they qualify as being ordinary and necessary expenses). Contrary to popular belief, a write-off does not give you a dollar-for-dollar tax break simply because you decided to write it off!

Example: Let’s say you were the braggadocios real estate agent that spent $50,000 on the Ford Explorer. Your taxable income before the purchase of the Explorer was $200,000 but after deducting the $50,000 your taxable income is now down to $150,000. That doesn’t mean you saved $50,000 in taxes though. What it means is that you don’t have to pay taxes on that $50,000.

Calculating Your Tax Savings

So how much did our real estate agent turned write-off expert actually save by writing off the $50,000 Explorer? In order to calculate his savings, we need to figure out his marginal tax rate. Assuming he is single he would have a marginal tax rate of 32% so we would take the $50,000 deduction and multiply that by 32% and viola, his tax savings from “writing off” that Ford Explorer would be $16,000 – a good chunk of savings but nowhere near the $50,000 he was bragging about on Insta!

Either he was completely off in understanding write-offs or he paid over $156,000 for a Ford Explorer ($156,000 x 32% = 50,000 tax savings). He either needs to fire his accountant or Google Kelly Blue Book and find out the actual market value of an Explorer because either way he got hosed!

So there you have it – figure out what your marginal tax rate is and multiply that by the cost of the shinny new object you are about to buy and you can figure out what your “write off” will actually save you from paying to Uncle Sam.

Keep in mind that this is sort of a general rule though. It can get tricky because the marginal tax rate is more of an estimate than an exact number. Why? Because in America, we use a progressive tax system meaning you pay a higher percentage on each bracket of income. On top of that, not all expenses are treated equally – some expenses do not qualify to be deducted 100% in the year they are incurred. But a simple calculation of cost of new write-off times your marginal tax rate will give you a pretty good idea of how much you can save in taxes.

Is There Such A Thing As Too Many Write-Offs?

The important thing to remember when working with “write-offs” is that they must be ordinary and necessary. Not only will a large number of “write-offs” raise a red flag, but simply deducting something on an expense that has nothing to do with your particular industry can also expose you for a potential audit. Make sure you are working with a professional tax accountant that can help you maximize your write offs without setting you up for a costly audit.

Not only do you need to work with a professional to fully understand the legality of your write-offs, but they also need to be discussing your long-term goals before they give you the green light to go out spending just to save on taxes.

Work With A Professional Advisor

We recently came across an accounting firm that is offering a course called “Write Off Your Life.” We haven’t personally taken this course, but we did some further digging and this firm promises to teach you how to “live the CEO lifestyle by writing off your PERSONAL expenses.”

While we would all love to hop on our private jet to go island hopping, this type of approach is probably going to get you into some hot water with the IRS. Don’t get us wrong, at ZanderFi we will do everything we can to help you take an aggressive approach in reducing your tax burden as much as legally possible. There are some very creative ways that one can legally reduce taxes and we make sure we explore all those possibilities.

With that said, taking too many deductions can not only raise your risk of an audit but it can also negatively impact other goals you may have. For example, if you are planning on getting a loan to buy a house or invest in your business did you know that having too many write-offs could impact your ability to get those funds?

Lenders often use a debt-to-income ratio when they decide whether or not to finance you. The more tax deductions you take, the less you pay in taxes, which obviously saves you money. However, when you take those deductions, you also reduce your profit. The less profit you have, the lower the income factor will be in your debt-to-income ratio, and the harder it will be to qualify for a loan. How many bankers out there like to lend money to businesses with no profits?

Conclusion

Write-Offs are a great way to legally reduce your tax burden as a self-employed individual. With that said, you really need to take some time to understand just how they work. Contrary to the popular narrative, write-offs do not reduce your taxes dollar-for-dollar.

Just because the tax code and your CPA give you the green light to write-off that shiny new object, make sure you also factor in your other goals before you go on that shopping spree! You might get the short-term advantage a tax savings, but it could prevent you from getting a loan or having the funds available to reinvest in your business. Make sure you are not simply meeting with a tax professional once a year to do your taxes but instead take a more active approach to working with your advisor throughout the year so you can factor in all your short-term and long-term goals.

And once you have those dialed in... happy spending!