As discussed in the first two parts of “How to Reduce Your Taxes,” working to lower your AGI, as well as finding a great accountant who diligently works to lower your taxes, were two great ways to reduce taxes overall.
But, did you know that starting a small business can actually help reduce your taxes as well?
By owning a business, it allows you to write off all related expenses. However, even more powerfully, it allows you to deduct portions of what you already spend on now – like your home utilities, travel, cars and part of your actual home expenses.
Be sure to select a business that does not add to your cost structure. Here are some clients who started a business based upon their skills and interests:
Sam and Elizabeth recently retired. When they built their dream home, it was with the longstanding plan that Elizabeth would have an art studio in the home. For years, these plans had taken a backseat to Sam’s career while raising the kids.
They added a separate studio, office and classroom. During the week, Elizabeth teaches art, works on commercial graphic design, and paints original paintings to sell at local art fairs. They set up a Limited Liability corporation for the art business.
They were able to write off all costs related to the building and furnishing of the studio and office as well as the prorated share of their home utilities. They used IRS Section 179 of the tax code to expense up to $125,000 of their tangible personal property expenses for computers, etc., each year.
They write off all materials and business advertising. They write off part of their automotive expenses. Lastly, they write off any other travel-related expenses in selling the art in fairs and exhibits. The write-off allows them to reduce Sam’s income tax so their Social Security was not taxed. This led to a reduction of their overall tax percentage.
The art business is beginning to make money. Elizabeth is happy painting and they are living their dream retirement, while saving in income taxes along the way.
Because their overall AGI dropped, they were able to write off a greater percentage of their other deductible expenses.
Is your home office small?
By moving your office to a more spacious location within your home, you might be able to deduct the remodeling of a room or part of your basement simply by moving your office there. Then the increased home office percentage will help increase the write-off relating to home utilities, maintenance and other nondeductible expenses.
Here are some common business-related write-offs you may not have known about:
- Write off the costs of starting a business
- Maximize your IRS Section 179 deduction which, according to CPA, Jim DuPont, you can expense tangible personal property up to $125,000 per year
- Expense travel related to the business
- Take a home office deduction, as well as a part of your utilities
- Write off part of your car if you use it for business
- Buying something you can write for your business that will improve its income prospects while reducing income tax
- Remodel a basement, have a tax deductible home office, and deduct 100 percent of all costs related to the office
- Buy a computer
- Write off some of your insurance costs
- Deduct interest related to the business
Steve had a terrific life. Living in a sunny oceanfront community in southern New Jersey, young, healthy and wealthy, he did not have to work. Then Steve had an idea. Using sophisticated personality profiling, he built a software program that could predict which salespeople would be able to perform and what underachievers needed to do to improve their effectiveness. If his company could predict which employees will do well, firms that use his services can do a better job hiring and training their people. Steve created the profiling business on a shoestring budget by using the expertise of former colleagues.
By working at home, Steve’s business added to his quality of life. It gave him tax savings by writing off a prorated share of his home, utilities, business travel, direct development costs, and all the direct costs of making his home capable of operating this fledgling business.
During this time, Steve had very little income, so he was able to withdraw funds from his IRA and pay remarkably little in taxes. The company should start making money in the next year or two, but in the meantime Steve’s tax savings have already made the business worthwhile.
Be careful not to create a “hobby business” as it might be disqualified by the IRS. According to Jim Chase, a former IRS agent, unless permitted under other Internal Revenue Code Sections, IRC Section 183, commonly referred to Hobby Losses and Expenses, denies deductions from gross income for activities deemed to be entered into not for profit.
Treasury regulations under IRC Section 183 provide some 20 factors, not inclusive, to weight when making a determination whether the activity has the intent to turn a profit. For example, business losses may not be a hobby if there has been profit in three out of the last five years.
The IRS does not require businesses to make a profit. The intent to make a profit is the determining factor of whether or not the business is legitimate or not.
If you didn’t already have a small business, hopefully this information helped you to see how starting one up can help lower your taxes. Thinking a small business may be the right choice for you? Check out Part IV of “How to Reduce Your Taxes” where we will discuss choosing the best entity for your company!
What type of company are you thinking of starting? Send me an email with your ideas at firstname.lastname@example.org!
Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Please consult with your accountant or tax advisor for specific guidance.