A common question I get from business owners is “Should I buy ‘this’ since it will save me on taxes?”. “This” is usually anything from computers to cars. The reason this question arises is because, as business owners, client know that expenditures in the course of business are deductible from business income.
The Straight Answer
The straight answer in general is “yes”. This decreases their business income, and as a result, their taxable income on their personal tax return.But do you want to? That depends.
The Effect of the Buy
As an example, think of your tax as a flat percentage of your taxable income. For ease, let’s say your tax is 10% of your taxable income. That means for every $1 of business of expense, you save .10 cents in tax (10% of $1)*. You have to keep in mind that each business expense dollar does not in turn reduce your taxes by a dollar also. Each dollar reduces taxable income, and your taxable income is then subjected to the tax bracket percentages to determine your tax (for more on tax brackets, see “What’s My Tax Bracket”).
So What Should I Do?
The decision is between whether you want to save .10 cents in tax, or whether you would rather conserve cash of $1. My answer to people is typically, “if it is something you will need to buy in the course of your business anyway, then make the purchase; however, if you’re intent is to decrease tax, be aware of what that decrease actually is”.
*To demonstrate this example differently, let’s say you have $1,000 in taxable income, which at 10% is of course $100. If you spend an additional $1 in business expense, your taxable income is then $999, and your tax is then $99.90–a difference of .10 cents.
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