Want a way to boost your cash flows? Well, look for tax deductions.
Yet entrepreneurs often miss out on this. And hey, this is certainly understandable. Keep in mind that the Tax Code is over 74,000 pages!
Despite this, it is really important to have a basic understanding of how tax deductions work and the main rules.
So let’s get started. Suppose that your business generated $100,000 in revenues last year. But you also have expenses — like meals/entertainment, equipment purchases, travel and so on – that add up to $25,000. As a result, your net profit is $75,000, which is what you owe taxes on. Assuming you are single, the check you need to write to the IRS for federal taxes will be about $14,500 and your tax bracket will come to 25% (for your own situation, you can check out the following simple tax calculator). Note: You will also be able to take these deductions for your state income taxes.
If you have a C-Corporation, then the company itself will have to pay taxes, which can definitely get complicated. But for many entrepreneurs, this is not an issue since the structure will usually be a sole proprietorship, partnership, LLC or S-Corp. In other words, the income and losses will pass-through directly to your 1040 return.
Although, there will be a need to also pay taxes for self-employment, which is the portion set aside for Social Security and Medicare (the exception is for an S-Corp). The combined rate is 15.3%.
So, when you add up all the taxes (federal, state and self-employment), they can easily be over 40%. Thus, for every $1,000 deduction, you would get at least a $400 savings.
Of course, there are many rules about getting tax deductions. For example, you must have a legitimate business not just a hobby. And yes, there must be some legal authority for the deduction.
OK, then what are the available deductions? There are plenty. But to simplify things, you can divide deductions into two main categories. First, there are operating expenses, which are for the normal day-to-day running of the business, such as for rent, insurance, supplies, travel, meals, utilities and so on. When filing your return, you’ll put these items on Schedule C.
Next, there are capital expenses. These are purchases of assets that have a useful life of over 1 year. Some examples include computers, autos, machinery and smartphones. However, you are required to recognize the deduction over a specified period of time (which can range from 3 to 39 years). This process is called depreciation.
Yet there is a valuable exception: Section 179. This allows you to take up to $500,000 of these deductions in the current year!
Regardless of the type of deduction, it does not matter how you make a payment. It can even be with a loan. However, it is critically important to properly document the expense so as to defend yourself if there is an audit. No doubt, if you lose in such a situation, the impact could easily ruin lots of your hard work in putting together your tax deductions.
This article was written by Tom Taulli from Forbes and was legally licensed through the NewsCred publisher network.
The strategies mentioned in this article will often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. This information is provided to you “AS IS”, does not constitute legal advice, is governed by our Terms and Conditions of Use, and we are not acting as your attorney. We make no claims, promises or guarantees about the accuracy, completeness, or adequacy of the information contained here. Clients’ tax and legal affairs are their own responsibility – Clients should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this article.