What Does Write Off Mean in Business?

A business write-off is an accounting adjustment that allows a company to reduce its reported income or the value of its assets. This adjustment accounts for expenses, losses, or the diminishing value of assets over time. Understanding write-offs is a significant component of financial management for businesses. It reflects how businesses recognize costs and asset changes on their financial statements, impacting profitability and tax obligations.

Core Meaning of a Business Write-Off

A write-off functions as an accounting entry that decreases the reported value of an asset or the amount of taxable income. It often applies to costs or losses that have already occurred or to assets that have depreciated in value. This differs from a direct cash payment made at the time of the write-off, as the actual cash outlay might have happened much earlier. For instance, if a piece of equipment loses value due to wear and tear, a write-off acknowledges this decline.

Common Categories of Business Write-Offs

Businesses regularly use various types of write-offs to accurately reflect their financial position. Many ordinary and necessary costs incurred in daily operations qualify as business expenses. These include items like office supplies, rent, utility bills, salaries paid to employees, and marketing expenditures. The Internal Revenue Service (IRS) defines “ordinary” expenses as those common and accepted in a specific industry, while “necessary” expenses are considered helpful and appropriate for the business. These expenses are subtracted from revenue to determine taxable income.

Another common write-off is depreciation of assets, which accounts for the gradual decrease in the value of long-term assets such as equipment, vehicles, and buildings over their useful life. This accounting practice spreads the cost of an asset over the years it is expected to generate revenue, rather than expensing the entire cost in the year of purchase. For example, a business vehicle’s value decreases with mileage and age, and depreciation allows the business to recognize this decline annually.

Businesses also encounter bad debts, which are uncollectible customer invoices or loans. When it becomes clear that an amount owed will not be paid, businesses can write off this amount as a loss. For a business to claim a bad debt deduction, the amount owed must have been previously included in its gross income.

How Write-Offs Reduce Taxable Income

The primary benefit of a write-off for a business is its effect on taxable income. By recognizing expenses, losses, or depreciation, write-offs reduce a company’s reported net income. A lower net income means a smaller amount of income is subject to taxation, which can lead to a reduced tax bill.

For example, if a business earns $100,000 in revenue and has $20,000 in qualifying write-offs, its taxable income is reduced to $80,000. This reduction directly impacts the amount of tax owed, as taxes are calculated on the lower, adjusted income figure. While write-offs decrease taxable income, it is important to note they are distinct from tax credits, which directly reduce the amount of tax owed dollar-for-dollar. Write-offs simply lower the base upon which the tax rate is applied.

Essential Documentation for Write-Offs

Maintaining thorough and accurate records is necessary for all claimed write-offs. Businesses must possess proper documentation to substantiate their claims, which can include receipts, invoices, bank statements, and detailed asset records. The IRS requires that records support the amount, date, place, and business purpose of each expense. For instance, a receipt for a business meal should indicate who attended, the business relationship, and the discussion that took place.

These records are important for compliance with financial regulations and are critical in the event of an audit. Without adequate documentation, a business risks losing potential deductions and may face penalties. Generally, businesses should retain tax records for at least three years from the date the tax return was filed or due, whichever is later, though some advisors recommend keeping them longer, up to seven to ten years. For bad debt deductions, specifically, records should be kept for seven years.