What Entrepreneurs Need to Know About Tax Deductions
Oct 24, 2024In the latest episode of "Keep What You Earn," Shannon sheds light on one of the most critical questions for entrepreneurs during tax season: What exactly is deductible? Joined by a guest expert, Shannon explores the intricacies of tax deductions, how to maximize tax savings, and the essential qualifications for business deductions.
Shannon starts by clarifying what a tax deduction is. Simply put, a deduction, or write-off, lowers the profits reported to the IRS, thereby reducing taxable income. It’s vital to understand that a deduction doesn’t mean reimbursal of the expense. Instead, it reduces taxable income, which in turn lowers the amount of tax owed. For example, a $1,000 deduction may save you around $150 to $200 in taxes, depending on your tax bracket.
The IRS defines deductible business expenses as those that are "ordinary" and "necessary.” "Ordinary" refers to common expenses in your line of work, such as advertising for a marketing firm. "Necessary" means the expense should help and be appropriate for your business. Shannon emphasizes that these terms are purposefully vague, allowing for flexibility but requiring robust justification in case of an audit.
To navigate deductions successfully, Shannon introduces "the three Ds": Defendable Business Case, Documentation, and Diverse Categories. First, you must be prepared to justify why an expense qualifies as a business deduction, building a strong defendable case. Assess whether you are more than 50% likely to win if your deduction were challenged in tax court. Proper documentation is also crucial. Keep detailed receipts and records including who, what, when, where, and why. For example, a business meal receipt should document the business purpose and attendees, making it bulletproof in case of an audit.
Shannon advises against lumping many expenses into miscellaneous or other categories. This can raise red flags. Instead, categorize expenses clearly and accurately. For instance, instead of recording all contractor payments under one category, break them down into specific roles such as marketing, operations, or accounting. Shannon likens this to spreading out in different directions if caught in a suspicious situation, thus preventing triggering audits and reducing scrutiny on any single expense type.
It’s important to align deductions with your specific business needs. For example, during the COVID-19 pandemic, fitness professionals could deduct home gym equipment costs as it was ordinary and necessary for their virtual classes. However, a CPA like Shannon couldn’t justify deducting a Peloton bike, as it wasn’t necessary for her accounting business. Shannon also cautions against overly aggressive deductions. Though virtually any expense can technically be deducted, it’s about the risk and defensibility. If unsure, Shannon advises consulting another tax professional to gauge the legitimacy of your deductions.
As tax season approaches, understanding the nuances of deductible expenses is crucial for entrepreneurs aiming to minimize tax liability. Shannon's insights on "Keep What You Earn" serve as a practical guide for navigating the complexities of tax deductions. Ensuring your deductions are defendable, well-documented, and properly categorized not only reduces taxable income but also helps in avoiding potential issues with the IRS.
For more information and practical tips, Shannon recommends checking out their free tax deduction guide, available via a link in the show notes. This resource offers over 150 tax deductions to help entrepreneurs maximize their savings and grow their businesses effectively.
What you'll hear in this episode:
05:20 Defend deductions with confidence, documentation, and preparation.
08:47 Understand risks and defend tax deduction positions effectively.
13:14 Categorize expenses to simplify audits and avoid issues.
14:24 Avoid using 'other' for deductions; be specific.
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The information contained in this podcast is intended for educational purposes only and is not individual tax advice. Please consult a qualified professional before implementing anything you learn.
