The short answer: Is you can deduct “ordinary & necessary business expenses.”
Listen to the episode and read the transcript below for all the details.
If you really want to dig into write-offs, I’d also love for you to join the Tax Challenge happening next month to help you get all your docs ready for tax season. It’s totally free! And you’ll get my free small biz tax deduction guide.
Hello and welcome to episode 26 of the unfuck your biz podcast. This is your host, Brayden and I'd like to thank you so much for tuning in as we always do here on the podcast. It is Tuesday so we will be tackling a question from the Breedens besties Facebook group if you'd like, you can join the group and drop your own question once you get prompted to do so, you join all a ask you three questions in order to get into the group. The first one is what is illegal or tax question that you have for me. I collect those and then we pick one to chat about each Tuesday here on the podcast. So this week's question is how do I know what I can ride off on my taxes? Short and sweet question, not a super short and sweet answer, but we are going to work through it.
Before I dive into the answer though, I want to remind you all that I do have a super fun briefing for you all to join in the next couple of weeks. It is going to, it's called the tax challenge. Very simple. Just like our question today and we will be starting on January 13th so you can sign up between now and then it's a free four day challenge that's going to prepare you to get all of your documents and your bookkeeping organized so then you can take those documents to your tax preparer to get your tax return done or you will just have it all organized for yourself to make your own tax filing process a little less stressful. So you can go to Braden drake.com that's my website forward slash tax challenge to join. If you don't want to remember that, you can also just go to the podcast website, which is unfuck your biz.com and you'll find all the information there as well.
So let's dive in. Again, our question was how do I know what I can write off on my taxes and in this lesson or in this lesson in this podcast? I thought it would be fun or helpful if we just went through one of the lessons in my course. Totally attacks. So this is a course that I have that covers all of the tax topics that you need to know about. And module two, lesson one is on the general rule for tax deductions. Let's start with the basics. What is a deduction? A business deduction reduces or deducts from your income. It does not reduce your tax. That's what credits do. So important distinction. Here's an example. If you have $10,000 in business income and a $5,000 deduction, now you have taxable income of $5,000 so let's say client a pays you $10,000 then you hire someone else to do work on your business for $5,000 now you have $5,000 in profit, or we call that taxable income.
That's the way tax deductions work. We now calculate a tax on the taxable income. So let's assume that your tax bracket is an effective tax rate of 20% before the deduction, you would owe 20% tax on $10,000 which is $2,000 and then after the deduction, you owe 20% on $5,000 which is a thousand right? Yes, I think. Yeah. Okay. Sorry. It's half of the normal AWC. Sorry. Now I'm just thinking out loud guys. I should've done the math beforehand, but your $5,000 tax deduction is saving you $1,000 in tax. That's the way you can look at that. All right, let's move on. Why do we care about deductions? Well, they help you pay less than taxes, so that's probably why most of you care about deductions, but they also help you figure out your profitability. It's part of your bookkeeping, all that good stuff as well.
Here's the general rule. This is a lot our questions really getting at. You are able to deduct quote unquote ordinary and necessary business expenses. That's the rule. Super helpful. I know. So let's dig into what that actually means. A ordinary is defined as in a case called deputy deputy, the DuPont from 1940 I know you guys are probably getting a real excited about this episode. Now that we're referencing cases ordinary. It has the connotation of normal, usual or customary to be sure and expense. Maybe ordinary though it happens, but once in a taxpayer's lifetime. Yet the transaction which gives rise to it must be common or a frequent occurrence and the type of business involved. So we're not looking at is this a recurring expense, is it something you're going to have all the time, but rather is this thing you're trying to deduct something that would be common or frequent in your industry.
If you're a social media manager that's paying for a premium plan only account, that's going to be something that's very common or frequent for other social media managers. Um, buying a new computer is something that's common or frequent for pretty much anyone who owns it. Anyone who owns a business needs a computer. So you can look at that conferences, same type of thing. You get the picture. The second part of our definition, so remember it was ordinary and necessary business expenses is a necessary. So we get from a case called a Welsh the hell Vering. The definition of necessary means appropriate and helpful to the business. I always find this one pretty odd because to me, the way they define it, this is almost the opposite of the way I would think of necessary that they say necessary means helpful or appropriate. So it doesn't mean that you have to have the thing you're deducting.
We could all operate our businesses without fancy tools and gadgets and software, but that doesn't mean that we can't take a deduction. If the deduction of what we're deducting is appropriate and helpful to our business, then it's deductible. So it must be ordinary and a must be necessary or in translation. It must be common and frequent in the type of business we have and it also must be appropriate and helpful to our business. That's the general rule. You must have also paid for that deductible item during the taxable year. So if you are a cash based tax taxpayer, which is going to be pretty much all of us, I'm assuming that most of my listeners or all of you, none of you are paying or filing taxes on an accrual basis. If you are attacks you guys, I apparently need to take a break from podcasting today.
This is episode number seven and I think I'm going a little little loopy. Let me back up. Let me start again. If you are a cash based tax payer, you take deductions and report income in the year, you pay the expense or receive the money not in the year that it's owed to you or the year that you a incurrent invoice. It's when you pay it. So if you pay something, if you get a bill for something that's due on January 2nd but you pay it on December 31st you deduct it in that tax year before the tax year ends. That's how it operates. So that is a, I have a few more slides in this lesson, but I think I want to keep it nice and simple, not overcomplicate things here. I know I did not get into the specifics like a list of every single thing you can deduct. I like to give a more theoretical approach just so you know how to think about it.
When you go to buy stuff, when it comes to what category do I deduct that in? That's not as important. It is important, but mostly you need to understand what types of things you can deduct in your business. Good news is if you want more specific rules on common deductions for creative and online business owners, I have all of that information available to you. Actually, in the tax challenge, I have a small business tax deduction guy that's about 10 pages. You're going to get that for free when you're doing the challenge. I have a list of all the most common deductions and the rules so that you can see them. So again, uh, go to the website, unfuck your biz.com to sign up for the challenge. Hopefully you enjoyed this episode. Despite all of my stumbles, I'm hoping to have still gotten across some good information. If you enjoyed it, I would love for you to subscribe and leave a review and I am super happy that you turn tuned in today. I will be back in your ear buds on Thursday. Have a good one.
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