Tax rates fluctuate up and down. Deductions come and go. But one thing is ALWAYS true. Business owners will pay less tax than employees. It’s something called the ETS Syndrome.
An employee makes money, pays tax and then spends what’s left. In fact, since 1943 with The Current Tax Payment Act, the feds get their money first. That’s withholding. You hope they withhold enough so you don’t have to pay more later and may “Hurry!” you even get a refund. In fact, so many people celebrate tax refunds without realizing it’s just getting your money back. It’s like getting change at the grocery store.
The government just got to use your money without paying interest. That’s a bad deal for you.
Earn Tax Spend versus Earn Spend Tax
This is the Earn Tax Spend Syndrome.
If you have a business, you earn money, spend money and then pay tax on what is left. As long as the expenses are ordinary and necessary to the production of income, they are legal deductions against the business income.
In fact, you can have a business loss and take that loss as a deduction against other income as long as you have two things: active participation and basis.
Let’s break that down:
1.Take loss against other income. So if you business has $20,000 of income and you have $30,000 of legal deductions, you have a $10,000 loss. That loss can go against your other income from salary, interest, dividends, capital gains, etc. provided you have the next two items.
2.Active participation. In order to have active participation, you need to work in the business for at least 100 hours a year. And you have to ACTIVELY do that.
3.Basis. If there are expenses, you need to either pay for the expenses yourself, the business pays for it and you use a credit card for them that you’re responsible for. (You could also get a bank loan in some cases, but that would depend on the type of business structure you have.)
At some point, if you have multiple years of losses, you may need to prove that you have a business and not just a hobby.
For more information on hobby versus business issues, make sure you check out these articles.
Hobby or Business: 9 Factor Test
Hobby Expenses are ALL Gone Now!
Once you’ve proven you have a true business and that you’re working in it enough with sufficient basis for the write-offs, you need to then figure out WHAT is deductible.
Is Your Expense Ordinary and Necessary to the Production of Income?
The IRS tells us that to be deductible, the expense has to be “ordinary” and “necessary” to the production of income. Depending on your business, just about anything could be deductible.
My CPA business can’t take a deduction for Amazon Prime movies (unless they deal with financial issues) BUT a business that is involved in movie making, documentaries or writing COULD legitimately take that expense as a deduction.
What do you spend money on now that you’d love to take a deduction for? That’s often the sign of something you’re passionate about and I bet there is a way to turn that into a business. That’s the beauty of an online business. You can start an online business in a week, or even a weekend. You can start, stop, grow or change an online business quickly. Flexibility and mobility mean an easy business and even better write offs. Here are some additional articles to read about that:
Write Off Your Shoes
I used to give seminars about tax saving strategies. Once I was asked the question by a very successful blogger about how he could write off his wife’s shoes.
She really liked shoes. If they went on vacation, she had a separate suitcase for her shoes. They weren’t cheap shoes either.
It was one of their biggest non-deductible expenses.
How could they take the shoe expense as a deduction?
Easy. She started a blog about her shoes. She took pictures, talked about special deal, put together outfits showing what to wear them with, when to wear them, and then posted affiliate links to the outfits shown.
Her blog had an income purpose. It was a business. And the business was shoes. Shoes now became a marketing expense.
Could she have done that all with a bricks and mortar business? Of course. But how long would it take and how much money would it take to build out a store and inventory it? The online affiliate marketing model could be done in a weekend.
What do you spend money on right now that you wish was a write off? Leave a comment on the blog and let’s talk about it!
Just about anything can be a deduction in the right circumstances.