We’re in the heart of tax season. Probably not your favorite time of year - but an important one for us business owners to navigate successfully.
Is there a simple trick or hack to pay less in taxes?
Sadly, no. There is no quick fix to reduce your tax bill. No quick and easy way that won’t land you in hot water with the IRS, anyway.
The only real trick to pay less in taxes is to understand the rules and then consistently check in with the financials of your business so you can make sure to make the most of those rules.
I subscribe to the theory that you should pay every cent you owe in taxes - and not a penny more.
To help you make sure you do get every deduction you’re entitled to, today I want review what types of expenses you can legally use to reduce your taxable business income. In other words, the rules around what qualifies as business “deductions.”
Of course, keep in mind that none of this information is tax advice - I can’t offer that. This is general educational content to help you better make sense of your situation. (For more information, read the post script below.)
The important rule to know about tax deductions
Our tax “code” (as we call it) can be tricky to understand. It doesn’t like to provide clear rules, telling you what specific business expenses are deductible or not.
Instead, the tax code provides what I like to think of as “standards.”
What’s a standard? It’s a set or qualities or characteristics that your business expenses must meet to be deductible.
So what are those standards for business expenses?
In order to be deductible, a business expense needs to have two characteristics: it needs to be “ordinary” and “necessary”.
What the heck does that even mean?
Whenever possible, I usually find it easiest to go to the actual IRS language to help make clear what the rules are. In this case, Publication 535 provides these instructions:
Admittedly, that language is a little... opaque.
The bottom line is that when you spend money, in order for it to be a business deduction, there needs to be a clear link between you spending that money and your ability to generate revenue in your business.
The expense needs to be “helpful” but it doesn’t need to be “indispensable.” It can also be ineffective and still be deductible. If you spend money on your Psychology Today listing and it doesn’t bring in a single client - that sucks, but you still get to take the deduction for the money spent.
The “ordinary” requirement is a bit more confusing, but I like to think of it as the “eyebrow raise” standard. If what you’re attempting to deduct is so unusual that your colleagues would raise their eyebrows, then it probably isn’t an ordinary expense. For example, spending money on dog food is not an ordinary expense if you’re running a private practice. On the other hand, if you’re running a doggie day care, dog food feels like a pretty ordinary expense. The context matters.
Can you ever deduct personal expenses against your business income?
The answer is often, yes - if they meet the requirements. (The requirements meaning that they meet the "ordinary" and "necessary" standard.)
This is where it’s important to think through the details and get creative. Often, there are expenses that you incur in your personal life (think a mobile phone bill) that you also use in your business. If those expenses are ordinary and necessary - then chances are you can deduct a portion of them. And that will help you pay less in taxes.
Again, the IRS Publication 535 provides us guidance:
Know when the rules gets more complicated!
I wish evaluating every deduction were as simple as applying the ordinary and necessary standard. But it’s not the case.
Here are certain types of expenses that have more specific and nuanced rules:
- Education expenses
- Food & entertainment expenses
- Home office deduction
- Use of personal vehicles
- Expenses when you have an S-Corp (you need to set up an accountable plan!)
You should absolutely take these deductions if you’re entitled to them. AND I want you to make sure you follow the rules and don’t create big headaches for yourself down the road.
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What’s the point of knowing all these boring details?
This tax knowledge isn’t super fun - and yet it can be powerful. Knowing these details will help you make sure you can take all the deductions you’re entitled to. And sometimes that means thinking creatively about what expenses you incur that might be (at least partially) allocated to your business.
I’m all for creative thinking - and not running afoul of the IRS rules and triggering a painful audit.
Helping support clients work through these kinds of details is one of the things I do as a financial planner.
Know the type of professional you need!
Financial planners like me can’t provide that tax advice tailored to your situation (we don’t have the license). But we can help you think through strategy around your taxes. I want to make sure we use the tax rules to provide you the best financial outcomes possible. For me, that means helping you think through things like whether the S-Corp tax election might be a wise tactic to employ — and help you make sure you get every tax deduction you’re entitled to!
If you need tailored tax advice for your situation, you’ll need to seek out the services of a qualified CPA, Enrolled Agent (EA for short) or tax attorney. Any of those licensed professionals can both help you prepare your taxes as well as represent you in front of the IRS.
What I explain above is the same type of tax thinking I offer my clients: I explain the rules, offer my interpretation or “read” of them, and then if it sounds like a good approach - we run it past one of those licensed tax professionals I mentioned above. That ensures we manage taxes effectively without taking on any undue tax risks (which might result in you facing an unpleasant IRS audit).
That's a Wrap 🎬
That's it for this today's post. I know we covered a lot and yet it is but one small part of navigating the entirety of your financial life.
If this all feels a bit much, give me a shout. I work one-on-one with therapists from all over the country helping them address issues just like the ones we talked about today! Learn the different ways you might work with me on my services page.
Turning Point is a registered investment advisor in the state of California. Please visit turningpointhq.com for important information and additional disclosures. This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes financial, legal or tax advice; a recommendation for purchase or sale of any security; or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Read the full Disclaimer here.