In his book, “How to Eat an Elephant: Achieving Financial Success One Bite at a Time” author Frank Wiginton includes interesting thoughts and asides throughout the chapters. One in his section on Tax Deductions vs. Tax Credits had me in full agreement. It was his explanation of why it’s wrong to say that “buying [something] is no big deal as it is a write off.” Being able to deduct something from your income taxes does not make it free!
While Freelancers Can Write Off Many Expenses That Doesn’t Mean They Don’t Have to Pay Anything
As someone working as an independent businessperson, I used to hear this mistake often. Friends and family would say that something wouldn’t cost me anything because I could “write it off on my taxes.”
Although at times it may seem like it, Canadians are not taxed at 100% of their income. If we earn $100, we usually only pay $50 or less in income tax on that money.
Expenses like postage stamps used to mail invoices to customers are claimed on income tax returns to reduce taxable income. They are NOT claimed as a straight reduction in tax owed.
Just Because You Can Claim Something as an Expense or Capital Cost on Your Tax Return Doesn’t Mean It Won’t Cost You Anything
For example, say I earned $100 and was in a tax bracket where I had to pay $20 in income tax on that money. I could claim my $2 in postage stamp costs to reduce my $100 in income to $98. I would then have to pay $19.60 in income tax on my reduced income. I would save $0.40 in income tax owed but not the full $2. I still had to pay $1.60 for those stamps.
(I’ve left the HST out of my example and assumed that the tax bracket stays the same if I earn $100 or $98.)
People seem to think that if I earned $100 and had to pay $20 in income tax, and if I spent $2 on postage stamps for my business that I would only have to pay $20-$2 = $18 in income tax. I wish it were so, but it isn’t.
Consider How Necessary a Business Item Is Before You Pull Out Your Plastic
So don’t just buy whatever amuses you for your personal business: That’s a quick road to bankruptcy.
- whether you really need this item to function,
- whether you can borrow or rent it, and
- whether you can get it at a lower price.
Frank Wiginton and I will approve.
- How to Use StudioTax to Calculate Your Income Taxes for a Sole Proprietorship
- How to Download and Install StudioTax and GenuTax Standard for Free for your 2014 Tax Returns
Do you know someone who fell into the “write off” trap and ended up wasting money that could have been better spent elsewhere in the business? Do you get tired of telling friends that no, you can’t take them out to lunch and “just expense it?” Please share your experiences with a comment.