Lowering Taxes

[inquisitive]

I have seen several books (Lower Your Taxes!, Asset Protection 101, all books on small business taxes) claim that anyone who is serious about lowering their taxes must start a home-based business. What is the rationale behind this? I think they are advocating starting a part-time business in addition to a person's current employment? How does it reduce taxes?

 

[SteveL]

Theoretically, a home-based business would allow you to deduct a portion of the expenses of your home against the income from the business. Potentially, this could include a portion of your utilities, taxes, depreciation.

The devil is in the details. To be a real business instead of a hobby, (and thus deductible) your venture needs to make a profit ($1) at least two years out of every five. Generally, start-ups will lose money for a number of years, so you need some kind of business which will actually make enough to produce a profit before you can deduct expenses of your home. Also, the IRS sees these as scams and will audit much more frequently.

 

[TromboneAl]

I agree with Steve. But if you can run a successful small business:

You can deduct all medical, vision and dental expenses (by implementing a company reimbursement plan).

You can contribute to a SEP-IRA (probably you can contribute more than to an IRA).

You can legitimately hire your family members, and deduct their medical etc.

------------

I wouldn't recommend starting a small business just for the tax benefits.

 

[ziggy29]

You can legitimately hire your family members, and deduct their medical etc.

This is true, but it's also another potential audit red flag. You want to make sure you're not paying them much more than the prevailing wage for what they do, particularly if they are your kids in a lower tax bracket than you.

Let's say you hire your teenage daughter to do some stuff for your business. If you pay her $60 per hour to perform 100 hours of administrative work when the going rate is $10-15 per hour -- taxed at her very low earned income tax rate instead of your higher rate -- it can get the IRS sniffing at your door. They may see it as an attempt to get more of your business income taxed at her lower rate by paying her a ridiculously high wage that you'd never pay outside the family.

 

[LOL!]

I work for an employer. All my contributions to the health care plan are already deducted. I also participate in the flexible spending account (FSA) so that all my out-of-pocket health care expenses are also with tax-free money.

I do a small amount of consulting outside of my normal work. If I spent all the money on expenses then I would pay no taxes on that money. Of course, I would have no money to spend on anything else. The trick is to make "expenses" things that you would have to pay for anyways. I always deduct all my professional subscriptions and books ... until I decided that I didn't even need these so those expenses went away. I could take "clients" out to dinner and deduct a portion of those meals.

You see folks that do this all the time: They are the ones who have their kids in their TV and print ads (doctors, dentists, lawyers, car salepeople, furniture salespeople, real estate people, etc.). They drive vehicles with their business name plastered on them. I imagine that these folks are generous when pro-rating the use of their vehicles and home between business and non-business use.

 

[ERD50]

There is a very simple way to lower your taxes, if that is the goal. Give money to charity. It becomes an 'expense' that is deductible, and if properly documented will cause no red flags. And the money might do some good for someone.

That's really all these plans are, just wrapped up in details so they can charge you for their advice. Getting a tax deduction on an expense can't happen w/o the expense. Spend $100 to save $25? I can do that on the sale items in stores

Like others have said, you can get creative and shift regular expenses to business expenses, but creative = read flag.

-ERD50

 

[ziggy29]

There is a very simple way to lower your taxes, if that is the goal. Give money to charity. It becomes an 'expense' that is deductible, and if properly documented will cause no red flags. And the money might do some good for someone.

True -- if you itemize. Those of us with small, paid-off homes (or who rent) are unlikely to be able to do so -- especially in states with no income tax.

 

[ERD50]

True -- if you itemize. Those of us with small, paid-off homes (or who rent) are unlikely to be able to do so -- especially in states with no income tax.

Another example of how screwed up our tax system is. If they want to 'subsidize' charitable contributions, then just do it. But no, they need to wrap it up in complex rules.

Why should a dollar of charitable contribution be subsidized more when a high tax bracket person donates it, than when a low tax bracket person donates it? To the charity, a dollar is a dollar.

Come to think of it, if you want to complicate it, the complication is backwards. Seems to me a low income person needs more incentive to donate than high income person. It is the high income person that should be getting a lesser deduction (%-wise).

< Before posting, I deleted the following comments that I typed after realizing we are not in the soap box - I'm sure you can fill in the blanks, rant, rant, rant, congress, rant, rant, rant >

-ERD50

 

[ejman]

A small farm is also a great way to lower taxes. The rules are a little more liberal (2 years out of 7 for profit requirements) and its much easier to deduct expenses because just about everything you do is related to the farm.

 

[Bimmerbill]

Don't forget flexible spending accounts for medical expenses. Also, dependent care flexible spending accounts (for kids or adults). $5K each, for a total of $10K. Plus the 401K deductions (if elegible), property taxes, mortgage interest. Heck, my plan allows us to deduct our health care premiums "pre tax."

 

[frayne]

All depends on your situation, the easiest and probably the best way to lower your tax liability is to contribute to an IRA, 401K, 403B, etc. If you own your home and are paying it off, the interest is a deductible expense and in most cases you can come up with more itemized deductions which should beat your standard deduction amount, thus lowering your taxable income.

As far as a home office or business, there is a catch phrase in IRS Pub 17, that uses the language, "used regularly and exclusively for the business." A home office/business in and off itself for the sole purpose of reducing your tax liability will probably cause you more grief with the IRS than it is worth if you ever get audited. Just my two cents and I wouldn't chance it or recommend it unless you have a legit need and use for a home office/business.

 

[Alan]

As far as a home office or business, there is a catch phrase in IRS Pub 17, the uses the language, "used regularly and exclusively for the business." A home office/business in and off itself for the sole purpose of reducing your tax liability will probably cause you more grief with the IRS than it is worth if you ever get audited. Just my two cents and I wouldn't chance it or recommend it unless you have a legit need and use for a home office/business.

This is what put us off taking deductions for a home office when DW spent 2 years as an independant computer programmer, working herself back into the job market after 13 years as a stay at home mom. She worked primarily on small projects for a couple of companies. Most of the work was done at home plus some trips to the work sites. She was able to claim mileage expenses, plus costs for postage, stationery, new computer, printer/fax. We maintained an auditable record of all work and trips.

The big payback of course was being hired on by one of the firms she did work for

 

[inquisitive]

Theoretically, a home-based business would allow you to deduct a portion of the expenses of your home against the income from the business. Potentially, this could include a portion of your utilities, taxes, depreciation.

As far as a home office or business, there is a catch phrase in IRS Pub 17, that uses the language, "used regularly and exclusively for the business."

It sounds like I wouldn't be able to qualify for the first quotation due to the wording in the second quotation.

Another small business idea: With a small business, taxes can be reported on an accrual basis instead of as a cash basis. If business purchases can be made one year and not paid for until the next year, it can be deducted on the current year's taxes. This could provide quite a savings (Obviously it wouldn't make sense to start a business just for this reason, but if going to start a small business anyway this could really help).

Can business and personal taxes be filed together? That is, a small business deduction be taken from my non-small business income?

Another idea I just thought of to lower taxes is to get an interest free loan on the purchase of a house, as that would provide tremendous tax benefits over the long run (I'm assuming there's no limit to interest deductions) The assumptions are that I would hold onto the property and had investments that would appreciate faster than the increased payments I am making over the long run in an interest-free loan.

 

[SteveL]

If you are a sole proprietor (as opposed to a corporation or LLC) you will file your business taxes using sched C with your 1040. If your C shows a loss, this will carry over to your regular income and reduce it. However, your business must produce a profit at least two years out of every five!

I think you mean interest-only rather than interest-free. There would be no interest paid on an interest free loan.

I would like to repeat what others have said. You are thinking about this in reverse. What is your business idea? What will you make or sell, or do? How will you do enough of this to make it worthwhile? Tax planning is just one element of business planning, and far from the most important, or even something to consider in the early stages of planning a business.

Suggest you visit SCORE | Counselors to America's Small Business | SCORE and read up on small business planning.

 

[Gone4Good]

I have seen several books (Lower Your Taxes!, Asset Protection 101, all books on small business taxes) claim that anyone who is serious about lowering their taxes must start a home-based business. What is the rationale behind this? I think they are advocating starting a part-time business in addition to a person's current employment? How does it reduce taxes?

If you have a business idea that you wan't to pursue, start a business. If you're just looking for a way to reduce your taxes, you're likely heading for trouble.

 

[inquisitive]

I think you mean interest-only rather than interest-free. There would be no interest paid on an interest free loan.

Right.

I would like to repeat what others have said. You are thinking about this in reverse. What is your business idea? What will you make or sell, or do? How will you do enough of this to make it worthwhile? Tax planning is just one element of business planning, and far from the most important, or even something to consider in the early stages of planning a business.

I have actually wanted to start a business for some time now, but I've been independently reading about taxes and wanted to see if I could combine the 2. Any tax benefits will probably be minimal since the business I am planning will not allow me to shift expenses I already have to a business, or use a home office, or hire others (since I will be a sole proprietor), rather it's just going to be a second source of income. I'm going to continue looking at other ways of reducing taxes since it's just a huge expense every year.

 

[samclem]

Right.
. . . rather it's just going to be a second source of income. I'm going to continue looking at other ways of reducing taxes since it's just a huge expense every year.

That's probably smart. A small business dreamed up solely as a means to reduce taxes is unlikely to be worth the trouble. But if you are trying to earn money, this can be a good way to save on taxes and also put some money into a more favorable tax category.
- The Medical Savings Accounts (or whatever they are now called) can save you some money.
As a sole proprietor, you can start a solo 401k (or a Roth Solo 401K). This allows you to put away more $$ into a tax-deferred retirement account than you can with a SEP IRA (which is also not a bad way to do this). Here's a link to a site comparing the two plans. Basically, as SEP IRA allows you to save 25% of the earnings from the side business (up to contribution cap of $45,000). The Solo 401K allows you to make this same contribution plus another fixed contribution of up to $15,500 (increased to $20,500 if you are over 50 YO). So, depending on how much this side business earns, you might be able to put every penny into a tax-deferred retirement account. If you did this, you might reduce the amount of after-tax savings you are presently doing from your primary job.

(Subsequent edit: These are 2008 figures)