Karla Dennis, EA, MST & CEO of The Award Winning Tax Accounting Firm Karla Dennis and Associates Inc. — Specializing In Tax Planning
The tax code broadly applies to two types of individuals: W-2 wage earners (employees) and business owners. When you are a business owner, you qualify for more tax write-offs based on the investments your business makes throughout the year.
Why is that? The tax code favors those who are contributing more to the economy through their business in addition to making business investments that stimulate the economy. Often, business owners also make additional money from investing in other business ventures, oil, real estate, etc. Not only that, but many entrepreneurs have a tax strategy in place to protect their wallets from putting more money in the hands of Uncle Sam. If you are a business owner, you may be in for tax savings if you become knowledgeable in understanding tax strategy and increasing write-offs through strategic investments.
Tax Compliance Versus Tax Strategy
Tax compliance happens from January through April 15 when taxpayers receive their year-end statements in the mail and rush to get their taxes done, often expecting a tax return. This differs from tax strategy, which involves tax planning all year long, keeping sufficient records, making smart investments and utilizing the tax code to save money. In other words, tax strategy involves looking for everything you can do to reduce your tax bill according to tax codes and working with tax professionals and accountants who can help you strategically plan where to invest your money to receive more write-offs.
If you are a business owner looking to create a tax strategy, start by taking a holistic look at where your finances are and where you want them to be. Next, consider your most common expenses, and ask yourself whether those expenses were made in the pursuit of income. Expenses that were made in the pursuit of income can most likely be used toward a tax write-off, such as for a home office, business vehicle, or even meals and entertainment.
To keep things simple, consult Internal Revenue Code Section 162(a), which allows business owners to deduct expenses that are considered ordinary and necessary and are paid or incurred in the taxable year in carrying on any trade or business. This code is one of the most neglected from a tax planning standpoint, yet it can enable your business entity to receive tax deductions for everything other than personal, living and family expenses.
Increasing Your Write-Offs Through Investments
Investing is another way business owners can reduce their taxable income. When thinking of investing, one may often think of putting money in the stock market or in a mutual fund. These investments would not be considered a tax write-off.
However, if a business owner were to invest in real estate or a building owned by the business, then that investment would become a write-off. The business would be allowed to take a write-off to recover its costs of the investment. That cost recovery is called depreciation. Depreciation allows for the expensing or write-off the cost of the investment over time. This is also true if an entrepreneur invests in new equipment for their business. In some taxable years, depending on the law, the business may be able to write off the majority of the costs in the year of acquisition.
If the business owner reports their business income on their individual income tax return, they may be able to benefit from investing in real estate that is not owned by their business. This is because on the individual return, all income and expenses are aggregated to determine taxable income. For example, if my sandwich shop makes $90,000 and I invest in real estate that produces a loss on paper using depreciation of $10,000, my adjusted gross income would only be $80,000. The investment in real estate and the use of depreciation helped increase my write-offs, lowering my income by $10,000.
In addition to real estate, a business owner may decide to invest money in a retirement account. This type of investment will also give the business owner a write-off in the year the investment is made. The key to investing and tax write-offs is to have investments that will provide some duality. These means they afford future benefit (e.g., money at retirement) or fill a need (e.g., owning the building your business occupies) while still providing tax incentives.
Understand there is more to taxes than just tax compliance. Ask yourself, “What can I do that will allow me to reduce my taxes?” Find out what the tax codes can do for you if you make smart investments into real estate or starting a business.
In the end, one of the beauties of being a business owner is the tax write-offs you’ll receive. Speak with your financial planner to find out what is best for you.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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