Having an understanding of our tax system can put money in your pocket by maximizing opportunities allowed by the Tax Code. This includes those in real estate businesses. In the following, we highlight seven issues regarding common business expenses that may cause dramatic differences in how much you pay in taxes.
Example 1: Choice of vehicle purchase. Buying a business vehicle for $50,000 may provide a first year 179 deduction somewhere between $3,200 to $25,000, depending on the vehicle chosen. Some vehicles take more than twenty years to write off! Knowing this BEFORE you buy one may add much to your real estate profits.
Example 2: Increased deductions using two vehicles. If you own two vehicles, but use only one in business, you may be able to convert money you’re already spending into additional tax savings by driving some business miles using the second vehicle.
For example: You drive one car 32,000 miles during the year (28,000 business and 4,000 personal). Your spouse drives the other car 7,000 miles (all personal). If instead, you and your spouse switch cars every other week (splitting business and personal), each car would have 72% business use (14,000 business and 5,500 personal miles), possibly increasing your deductions up to $16,000 using Sec. 179 and accelerated depreciation ($44,000 max compared to $28,000 max, had you used only one car).
Example 3: Alter ego. Alter ego is a very costly mistake made by many owners of small corporations and LLCs. One of the most common is when personally-owned vehicles are deducted on the tax returns of corporations or LLCs. The IRS argues alter ego to deny tax deductions, reclassify corporation tax structures (into less favorable ones) and to eliminate pretax fringe benefits for business owners and their families.
Example 4: Accountable reimbursement plans (AP). One of the best tax strategies is for corporations to reimburse working owners for expenses when using their personal vehicles for company business. Reimbursements made through APs are:
- Exempt from income and payroll taxes;
- Not subject to AMT, reductions or phase-outs as when deducted on 1040s; and
- Reduce the chance of audit, since deductions aren’t taken on 1040s.
Caution: Reimbursements not made through APs are taxable to employees and subject to payroll taxes for both employees and companies.
Example 5: Convert charitable miles to business for tax savings. Many business owners are active on Boards of charitable organizations (such as school boards or fraternal organizations) and involved in charitable fundraising and other activities. Unfortunately, the tax deduction for charitable mileage is only 14 cents per mile (2016). If instead, you used the activity to promote your business (and kept records), your tax benefit could nearly quadruple to 54 cents per mile (2016) [IRS Rev Ruling 59-316].
Example 6: An administrative home office reduces taxes in two ways:
- Allows a deduction for a business pro-rata share of your home expenses, reducing both income and employment taxes; and
- Increases vehicle deductions by converting non-deductible commuting into business miles.
Administrative home offices also simplify recordkeeping, since you don’t need to track the first and last business trip each day (which isn’t deductible without the home office).
Example 7: Maximizing meals and entertainment (M&E) expenses. Ordinarily M&E expenses are limited to a deduction for 50% of the cost, but some may qualify for 100%.
For example: You participate in a charitable fund-raiser golf tournament and pay $400 for yourself and a business prospect. You have four possible ways to deduct the $400:
- As a charitable contribution
- As business M&E
- As business charitable M&E
- As business promotion
Which method allows the greatest tax benefit?
- If deducted as a charitable contribution, it would be limited to the amount over any personal benefit received. The face value of the tournament tickets ($250) would be subtracted from the $400 purchase, leaving a charitable deduction of $150.
- If deducted as business M&E, it would get a deduction for 50% of the cost. The $400 purchase would get a deduction of $200.
- If deducted as business charitable M&E, it would get the full deduction of $400. To qualify the charity event must:
- Be organized for the primary purpose of benefiting 501(c)(3) charities,
- Give all its net proceeds to these charities, and
- Use volunteers for most all the work performed in carrying out the event.
- If deducted as business promotion, it would get a full deduction for the tournament cost, as well as any associated M&E. If, for example, you met for breakfast to discuss business before the tournament and followed up after with a business discussion over lunch, the $100 cost for the two associated meals would be 100% deductible (instead of the usual 50%), allowing you a total deduction of $500.
The four examples allow a range of tax deductions from $150 to $500 for the same out-of-pocket expenses. The highest is 330% more than the lowest.
Having an understanding of the tax system can put money in your pocket by maximizing opportunities allowed by the Tax Code. Let us help.