Toph Sheldon CPA for the Self-Employed ® - April 2020

APRIL/MAY 2020 VOLUME 4, ISSUE 4

T O P H ’ S TAX RESOLUT ION T I M E S

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Don’t Spend a Dollar to Save a Quarter

Tax season is in full swing. We’ve been hard at work for the past few months helping clients get things squared away for the dreaded day: Tax Day, April 15. As I sit down with clients to talk about their tax situation, they often come to me with questions about how they can save on their taxes. They might have a big tax bill coming and want to get it down before the deadline. Unfortunately, I see many people who are using the wrong strategies to try to get their tax liability down or to eliminate it completely.

You also have to consider the type of retirement accounts you’re putting money into. Are they tax-deferred like a traditional IRA or 401(k) or do you pay tax upfront, as you do with Roth IRAs? These are just more potential costs to think about in addition to what you may or may not be saving on your current income tax bill. If you’re self-employed, you might think about how you can use that $10,000 to invest in yourself and your business. Does that $10,000 make more sense in your retirement accounts? Or can you get more out of it today by investing in advertising, equipment, staff, etc.?

I hear questions like “Should I contribute to my retirement accounts?” or “Should I buy a car?”Many of the questions often involve major expenses. Many people think that buying a car or other large item for their business will help them save big on their taxes. The reality of the situation is very different. The problem stems from misinformation about how tax deductions (aka “writing it off”) work. While investing in your retirement is always a good thing, when you put money into your retirement account with the intention of lowering your tax liability, the end result might not be what you expect. I had one client who wanted to put $10,000 into their retirement accounts. They thought by doing that, they would lower their tax liability by $10,000. In reality, they might only be lowering their tax liability by $2,500, meaning they still owe $7,500 in taxes. But there’s more to it than that. This $10,000 is now locked away in retirement accounts. If you’re putting that money into something like an IRA, you can’t touch it until you’re 59 1/2 or you’ll face penalties and be out more money.

Here’s another example. I spoke with a client who wanted to buy a car so they could write it off through her business. If they were looking at a $10,000 used car, they might see a tax saving of $2,500. In the end, they would have to spend $10,000 to buy the car to see the $2,500 write-off savings at a later date. They would still be out a net $7,500. Plus, they have to come up with the cash to pay their taxes (since the $10,000 is now locked in the car). And with a car, you also have to factor in the cost of maintenance, upkeep, and fuel. Suddenly, that tax write-off doesn’t seemworth it. It really pays to look at your tax situation and potential deductions carefully. You don’t want to end up spending a dollar to save a quarter when it simply doesn’t make sense. If you find yourself in this situation and you have questions, don’t hesitate to ask. We’re here to help you navigate this often confusing maze of taxes, deductions, and IRS rules.

–Toph Sheldon

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