One common misconception that people have is their understanding of a “tax write off”. Often you will hear someone say “I can write that off…”, in this case they are referring to the ability to write off an expense incurred from their income tax filing.
So what is the misconception? I often hear that people assume it means that the expense becomes free as the person writing off the expense will get the money back at tax time. THIS IS FALSE! (How I wish it were true!)
I think the best way to explain it is with a simplified example: Let’s say Joe Smith is a self-employed salesman. His sales commissions per year are $100,000 and let us assume he pays 50% in tax (again, just to demonstrate the mechanics behind a write off – the tax system is a bit more complex than just a flat rate for everyone!). This means he has to pay $50,000 in tax and is left with $50,000 to spend. BUT the government allows Joe to deduct the COST OF DOING BUSINESS from his income through these tax write offs. Let’s say Joe spends $10,000 on a newspaper ad. This is clearly a cost of doing business for Joe so he can “write this off”. That means that $10,000 can be deducted from his $100,000 in sales commissions leaving a total of $90,000. If we apply the same 50% tax rate to this new amount we have Joe paying $45,000 in tax and taking home $45,000. SO, he spent $10,000 and it only reduced his take home pay by $5,000. His net cost to purchase the newspaper ad is not $10,000 but rather $5,000.
So the next time someone says, “I can write that off” it means they still have to pay for it, but they get some tax money back at the end of the year.