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Listen to the Podcast Here: 10. The Truth About Tax Write-Offs

People love to talk about tax ‘write-offs”. It seems like social media has made many people view tax write-offs as a magical solution or a cheat code to save money on their taxes. However, the reality is that a tax write-off isn’t a cheat code or a guaranteed shortcut to financial success.

Have you ever seen someone talk about the Holy Grail of tax write-offs on social media? Or maybe you’ve heard someone you personally know brag about something they purchased with the intent to write it off on their taxes?

The truth is (fair warning – I’m sorry because I know this is going to come off too strong) they probably don’t understand how a write-off works.

Take this trade, for instance: If you give me $100, then I’ll give you $20 in return. What do you think – deal or no deal?

No deal, right?

This is the trade people make all the time when they purchase something through their business just because it’s a write-off.

The Myth of the Tax ‘Write-Off’ Cheat Code

First, we need to set the stage with some technicalities of tax write-offs. A “write-off” is technically referred to as a “deduction” in the tax world.

Most of the deductions that are spoken about on social media are not available to individuals. The deductions that you often hear about on social media are only available if you own a business.

(No, you cannot open an LLC to claim deductions if it is not a legitimate business that earns income, but that’s an entirely different story that we’re not talking about today.)

Contrary to popular belief, when you claim a tax deduction, you don’t get to pocket the entire amount of your purchase as tax savings – a write-off simply reduces your taxable income, which, in turn, affects the amount of tax you owe. Spending a dollar does not save you a dollar.

The Basics of Tax Deductions

To better understand what that means and how tax write-offs work, let’s take a look at a simple example.

Let’s assume that you’re a business owner and you pay for an office for your business that costs $2,500 per month ($30,000 per year).

(It could be any expense other than an office, this is just what I chose for this example.)

While you may think that this office expense counts as a write-off that automatically saves you $30,000 in taxes, that’s not the case.

In reality, the benefit you receive from a deduction is determined by multiplying the amount spent by your tax rate. If we assume that you’re in the 24% Federal tax bracket, the actual deduction would be $7,200 ($30,000 x 24%). This doesn’t factor in self-employment tax or state and local taxes.

You still had to pay for the office, and you only saved a percentage of that expense in taxes. Your cash balance still decreased by the amount of the office expense.

(It’s important to note that the calculation can be more complex than this example suggests, as various factors can impact the final deduction amount. However, this simplified scenario helps illustrate the concept that tax deductions don’t equate to a dollar-for-dollar reduction in taxes owed.)

Don’t Let the Tax Tail Wag the Dog

“Don’t let the tax tail wag the dog” is a favorite saying among financial planners. What does it mean?

While tax deductions are beneficial and can make business purchases less painful, it’s important to not let the pursuit of write-offs dictate your spending decisions. Your spending decisions in your business (and in your personal finances) should be made based on your cash balance, your cash flow, and your needs.

Don’t step over dollars to pick up dimes. (I had to throw that saying in here, too.) What do I mean? Yes, you should take the deduction if you were going to pay for the office anyways, but you shouldn’t let the deduction lead you to paying for the office.

In our example of the $30,000 per year office, you only saved 24 cents in taxes for every dollar you spent. So, in this case, I guess you’re stepping over dollars to pick up quarters, not dimes.

Overall, I hope I’ve made it clear that purchasing things solely for the sake of deducting them on your taxes is not a good financial strategy. The primary driver behind your purchases should be their value and necessity, not the potential tax benefits they might provide.