Another Year End Tax Planning Tip to Avoid
Another Year End Tax Planning Tip to Avoid
This time of year, the media starts to focus on taxes and what "you" can do to reduce your taxes before the end of the year. This tax advice is geared toward the general population.Last week I went through the example of maximizing a retirement plan contribution and how that was tax advice for the general population and not for business owners and investors. There are better ways for business owners and investors to reduce their taxes.Making it a habit to avoid tax advice that is for the general population is so important that I'll share another example this week.Spend Money before the End of the Year Have you heard the following advice?Pay your January mortgage payment before the end of the year Pay your state taxes before the end of the year Buy equipment before the end of the yearThis advice can have harmful consequences and while the first two are geared towards the general population, the last one is geared toward business owners and some investors.This advice is based on deferring tax. The expenses are claimed one year early because they are paid in December rather than in January which results in tax savings now and paying the tax next year (or some future year).The problem with this advice is that 2 key pieces of information are often not mentioned:Key #1: Are you going to spend the money anyways? I've heard too many business owners tell me they have to buy equipment before the end of the year for the tax write-off.In many countries, a large portion (if not all) of the purchase price can be deducted in the year of purchase. In the U.S., this is the Section 179 deduction.While there may be tax savings that come with the purchase of equipment, making a purchase of this size should never be based solely on the tax benefits.And, you may be surprised at who is giving the advice - it is often the vendors giving the advice! It's a great tactic for them to use to close the deal on a piece of equipment.Yes, this type of deduction can be fantastic but buying equipment for the sole reason of getting a tax deduction can result in bad tax planning that conflicts with business and wealth goals.It never makes sense to buy something for the sole purpose of getting a tax deduction!Let's say you are in a 40% tax bracket and you buy business equipment for $10,000 to lower your taxes. Indeed, you will save $4,000 in taxes. But, you had to spend $10,000 to get this $4,000 savings.If you don't really need the equipment and are purchasing it solely for the tax savings, this is a terrible financial situation. You would be better off paying the taxes of $4,000 and not spending $10,000 (or even better would be to take advantage of the many other tax saving opportunities that are available to business owners and investors).If you are planning on buying equipment in January, then moving your purchase up to December may make sense because you can enjoy this tax savings sooner. But, there is one more item to consider, this leads to the second key.Key #2: What is your tax bracket this year compared to next year? Let's say you are in a 15% tax bracket this year, and next year you will be in a 40% tax bracket.If you make your $10,000 equipment purchase this year, your tax savings are $1,500 ($10,000 purchase x 15% tax bracket).If you make your $10,000 equipment purchase next year, your tax savings will be $4,000. ($10,000 purchase x 40% tax bracket).You save $2,500 more by waiting to make that purchase!This second key is particularly important to business owners and investors because their tax brackets tend to vary year to year whereas the general population tends to be in the same tax bracket year to year.Good News for Business Owners and Investors Too many taxpayers hear the advice to buy equipment (or a car or a house) before the end of the year, get caught up in the tax savings and forget to consider if it makes sense in their big picture tax and wealth planning.This is just one way for business owners and investors to reduce their taxes. There are many more opportunities available to business owners and investors in the tax law to reduce their taxes.Make it a habit to scrutinize the general tax advice you hear or read. Is it the best advice for your specific wealth and tax strategy or are there better opportunities available to you because you are a business owner or an investor?Get Started Now As I have been sharing, the government wants you to reduce your taxes! The tax law is a series of stimulus packages for real estate investors and business owners.
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