"They just write it off!"

Taking a closer look at what a business can/can't or should/shouldn't write off

In one of the most popular comedy shows of all-time (and one of my old roommates’ favorites), Jerry Seinfeld and Kramer go back and forth on the merits of a write-off when talking about Jerry’s package with the United States Postal Service. Though the scene gets a bit ridiculous (as most of the scenes where Kramer is considered the “expert” do), there’s a lot of truth in it as it pertains to how people often see business write-offs. Kramer smashes Jerry’s package so that he gets a refund for it, and the scene commences as follows:

(Kramer) “It’s a write-off for them”

(Seinfeld) “How is it a write-off?”

“They just write it off”

“Write it off what?”

“Jerry, all these big companies, they write off everything.”

“You don’t even know what a write-off is.”

“Do you?”

“No, I don’t.”

“But they do. And they’re the ones writing it off.”

Growing up in a rural farming community, I became familiar with the concept of the write-off at a young age. Quite a few farmers went to my church growing up, and it seemed like they had new pickups every year, if not every other year. After I bought my first car with the cold, hard cash that I earned from mowing lawns, I thought of how nice it must have been to just write that off instead of handing over a cashiers’ check for the 2003 Cadillac CTS that I bought. That’s how write-offs worked in my 16-year-old brain. And other people seemed to confirm this! When I asked about write-offs, many people said “it’s confusing. But they can just write it off and that’s how they get new stuff all the time”. I mean, sure, but where is the money coming from?? This can’t all just be free. If so, I was greatly questioning my dad’s decision to leave dairy farming behind and broadcast games on the radio instead.

When I took Principles of Accounting during my freshman year of college, I got a taste of what a write-off was. Section 162 of the United States Internal Revenue Code loosely defines a business expense as “a deduction of all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business”. Following that line, the code dives into the nitty gritty of what can and can’t be counted as deductions against the taxable income of a business, what can be deducted for business purposes but not for tax purposes, and a myriad of other things (side note: illegal bribes are not allowable deductions, and be sure that you count all of the money that you made dealing drugs in your taxable income. Section 162 is explicit in these instructions). It also outlines what is required for a business vs. a hobby (with horse racing being a unique exception—you can lose money in 5 out of the first 7 years of the business and still call it a business with profit motive!), and defines write-offs and tax deductions and all of the fun stuff that people typically call their accountants about.

Generally speaking, if you use something solely for business purposes, it’s a write-off. That’s great! This code section incentivizes the American entrepreneurial spirit that the country was built on, and utilizing deductions as a means of lowering your taxable income is a great tool to stimulate economic growth. Business owners incur quite a bit of risk when they begin a business, so these tax breaks are important ways to ensure that not everyone becomes a standard employee. A general rule of thumb that I typically advise people on is that if you’re trying to bend and twist to make something seem like a write-off, it probably isn’t. That isn’t always the case, but “creative accounting” isn’t something that most accountants will typically toe the line with, and the more convincing that a client has to do to justify their Tik Tok tax position, the less likely it is that the deduction is allowable under the Internal Revenue Code.

However, the term “write-off” can be a bit misleading, especially for people who have never used them. You don’t just get these things for free, as my 16-year-old brain had previously hypothesized. The business still has to pay for them, either using a loan or straight cash. By doing this, a business is making an important investment in their future or simply paying a necessary expense that keeps the lights on for whatever trade they are conducting at the time. “There’s no such thing as a free lunch” rings quite true here.

Another area that can get business owners in trouble (and specifically frugal farmers, in the cases that I’ve dealt with) is that people hate paying taxes. This isn’t new—we love to use the benefits of the tax system (roads, schools, medical care, social programs, etc.), but it sure would be nicer if we didn’t have to pay for those ourselves! So what some farmers like to do (and what Section 179 expensing and bonus depreciation laws have amplified) is make big purchases near the end of the tax year (November and December) so that they lower their tax bill and get an asset for their business instead of paying Uncle Sam. On its face, it’s foolproof. Who wouldn’t want to get something instead of paying their tax liability?

The issue that I’ve most commonly seen people run into with this strategy is that they purchase something that they don’t necessarily need, and they purchase it with a large loan from the bank rather than paying in cash. By stretching this loan over a 3-, 5-, or 7-year period, the business owner is strapping themselves to a long-term debt for a (typically) one-year tax benefit. By using Section 179 or bonus depreciation, the entire cost of the tractor, combine, etc. is depreciated in the year that it was purchased (with some bleeding over to the subsequent year in some cases). This is great when a farmer doesn’t have to pay taxes in the current year, but it doesn’t feel quite as good when the next year isn’t as profitable and that same farmer is stuck with some large principal and interest payments on the shiny new tractor that they didn’t necessarily need at the time.

One phrase that rings true for most businesses: you won’t (or shouldn’t) go broke paying taxes. You don’t pay taxes when you don’t make money, and making money means that you should have cash on hand to pay what you owe to the Internal Revenue Service. In cases where cash management and tax planning isn’t a priority, businesses run into problems. This is the exception, and not the norm. The standard is that well-run businesses are paying their taxes on a quarterly basis as long as they are working in conjunction with their accountant and accurately forecasting cash flow, revenue, expenses, and any other services that an accountant, CPA, or EA may provide their clients.

Finally, there is no nobility in paying more tax than what you owe. An interesting trend that I’ve seen from a few owners (Warren Buffett in particular) is a certain sense of pride in paying taxes. I get that taxes are a necessity, and I’m grateful for a taxation system that seems to do an okay job in providing general needs for society in the best way possible. But the pride and sense of superiority that some owners get from paying taxes is weird to me. The taxation system is set up in a way that business owners, general population, and all Americans can find ways to legally reduce their tax liability. That is their right, and there is no sense (to me) in paying any more or any less than that in a given year. Simply figure the tax, take advantage of your legal deductions, and pay the bill. Easy peasey, really.

*NOTE: The information provided is for general informational purposes only and should not be considered tax, legal, or financial advice. While every effort has been made to ensure the accuracy of this content, tax laws and regulations are subject to change. Always consult with a qualified tax professional or CPA regarding your specific situation. I am not liable for any decisions made based on this information.