Maximize your Tax Benefits by following the Rules
Operating a business can create significant tax benefits for you and your family if you’re willing to comply with the rules. The Tax Code is complex and filled with variable tax outcomes. Some rules allow expenses to be deductible, while others provide greater benefits for the same dollars. Knowing the Rules can put money in your pocket.
When business owners purchase something for business, they generally get a tax deduction for the expense. A purchase for $100 may generate $40 in tax savings (when income and employment taxes are considered) resulting in an out-of-pocket cost of about $60. Contrast that with an employee who must earn about $150 to net $100 in bring-home pay to buy the item (when income and employment taxes are considered).
What a contrast! The employee had to earn $150 to buy the same item that the business owner was able to acquire for about $60. This example illustrates a significant difference when pretax dollars are used versus after-tax dollars. Imagine the benefit for you and your family when this concept is duplicated dozens of times.
In addition to the pre-tax concept, some tax rules allow for more than just the ordinary tax deduction that most others get. Some of the rules allow for double or triple the benefit when structured properly. We’ll illustrate a few examples below, but there are hundreds of possibilities. Let’s begin with one of the largest purchases: the automobile.
Certain automobiles allow bigger deductions. Let’s say you buy a $50,000 vehicle for business. The kind of vehicle you buy has a major effect on how much you can deduct each and every year. A $50,000 auto may allow the entire purchase to be written off in the first year or as little as $3,200 or less. What a difference! Some autos could take twenty years or more to write off! You can see why tax planning should be done BEFORE you buy a new vehicle for business.
Converting charitable mileage to business. Many business owners are active on boards of charitable organizations (such as school boards or fraternal organizations) and involved in fundraising and other activities. Unfortunately, the tax deduction for charitable mileage is only 14 cents per mile. If instead, you promoted your business while volunteering, your deduction would nearly quadruple to 56 cents per mile (2014).
Get reimbursed when driving your car for the company. One of the best tax strategies requires you to be an “employee”. An accountable reimbursement plan allows your corporation (or LLC if taxed as a corporation) to reimburse you for driving your automobile in business. This type of reimbursement:
- Is tax free to you and deductible by the company;
- Is exempt from employment taxes for both you and the company;
- Isn’t subject to AMT, reductions or phase-outs, as when deducted on 1040 and;
- Lowers your chance of an audit, since deductions aren’t taken on your 1040.
The right kind of home office increases auto deductions. A home office that qualifies as an administrative office increases your deductible auto miles by converting non-deductible commuting to business. It also simplifies record keeping because you won’t need to track your first and last trip each day. When home office expenses are reimbursed by the company, the reimbursement is tax-free and reduces the chance of audit, because it eliminates the home office form on your 1040.
Increasing the meals and entertainment (M&E) deduction. Ordinarily qualified M&E expenses are limited to a 50% deduction, but some are allowed a 100% deduction, such as M&E costs for promoting your business, when provided to employees or for certain charitable fundraising events.
Hiring your spouse may allow your household to maximize its pretax fringe benefits with such things as additional retirement plan contributions, medical benefits, pretax daycare, education, life ins, long-term care ins, tax-free reimbursements and more.
Hiring your dependent children allows your company to get a tax deduction for their wages. Everyone wins, the kids learn about money, expenses, investments and you still claim them as dependents. A Roth IRA could be funded for them with some of the wages, which would allow the contributions to be withdrawn tax and penalty free for any purpose, such as to pay for college or trade school, buy a car, put down on a home and more (beginning five years after the first contribution is made).
Corporations can implement tax saving strategies that other entities cannot.
Different tax and legal structures provide different tax outcomes, fringe benefits and asset protection capabilities. S corps are ideal for most small businesses, since they’re not subject to double taxation or employment taxes when profits are distributed and can provide tax-free fringe benefits for owners (who work in the business) and their families. LLCs can often save on taxes when they elect to be taxed as corporations, which can eliminate SE taxes and the California gross receipts tax.