What Write offs Are
- Write-offs and deductions represent the method the federal government uses to give tax exemptions to businesses and individuals that meet certain criteria. As tax filings are prepared, both companies and private citizens go through their forms and answer whether they fall into specific economic categories. If so, then the federal government allows some of the category expense or cost to be credited against taxes owed, mathematically reducing the net taxes that have to be paid for the year.
Types of Deductions
- On the business side of the picture, write offs include business expenses that are allowed to reduce the value of business income reported. So if a business has $100,000 in gross profits but $60,000 in expenses, then the taxable income for the year is really only $40,000. This is a bit of a simplistic example, since various business write-offs are handled differently. Some may result in a 100 percent credit while others may only be partial.
For instance, capital expenses are usually not credited 100 percent in the first tax year they are bought. Instead, such write-offs or deductions are depreciated over a number of years. So the tax impact is felt only partially each tax year.
Personal Write offs
- Many taxpayers---about 46 million or so---identify their write-offs on IRS Form 1040 or 1040A in the form of itemized deductions. These deductions calculate out to somewhere near $1 trillion in lost revenue for the government.
However, for still many more, the process of itemizing deductions may be laborious, and opting for standard deductions is easier. These 85 million filers take a default, lump sum write-off allowed per individual filer, which adds up to another $0.5 trillion of lost revenue. These filers often use a 1040EZ rather than the more complicated forms.
- Specific write-offs only allowed in business include costs associated with production and manufacturing of services and goods. The common term that reflects this deduction is the "cost of goods sold." To obtain such deductions, the business must keep detailed documentation showing expenses paid for manufacturing or producing products and/or services. Depending on the industry and type of manufacturing, the specific tax rules vary.
Accounting Methods for Business
- The federal government relies on businesses to keep documentation and good records of their own activities. As a result, businesses have to choose which accounting methods they use to determine their write-off amounts. Many choose a cash basis or accrual basis of accounting. The cash basis counts only the money actually received to date or spent while the accrual basis counts expected receipts and expenses yet to occur. For larger businesses, these approaches are incorporated within Generally Accepted Accounting Principles or GAAP.
Don't Avoid Filing or Cheat on Your Taxes
- When considering write-offs, the best approach tends to be reporting those that make sense. The Internal Revenue Service frequently flags exotic or oddball deductions for further review and audits. If the IRS finds a deduction that smells bad, the results can be penalties as well as loss of the deduction.