This is something that I hear every year. I’ve been hearing it for years and I have no doubt that I will continue hearing it in the future. Of course when people say it that’s not the actual words they’re using, but it’s what actually happened. Deductions are great. They lower your taxable income and, in turn, lower the amount of taxes that you owe. Who doesn’t love a bigger refund? But was that deduction really worth it?
Let’s say you’re shopping for supplies for your business. As you turn the corner and enter the next aisle there’s a big display of shiny new widgets. They’re on sale for just $100. You don’t need any widgets but, you’ve been having a good year and you want to buy it so you can get the extra deduction and not pay as much in taxes. So you bought something you don’t need, and what happens when you buy something you don’t need? You use it maybe once and then it gets placed in the back of a closet to never be thought about ever again. But it was a deduction, so who cares if you never really use it or not?
Let’s take a look at the numbers. Let’s say you’re either a Sole Proprietor or a Single Member LLC. Between income and self-employment tax you’re probably looking at having to pay about 30% in taxes on your business profit. So that means buying that $100 widget saved you about $30 in taxes. You just spent $100 on something you didn’t need and won’t use so that you could save $30. In other words, what seemed like a great idea turned out to be you just wasting $70.
Some people view having to pay taxes as a fate worse than death. Pay taxes means that at the end of the year, you had a profit. That’s great, that’s something you should be proud of. A lot of companies are having a very hard time doing that these days. Don’t get me wrong, I’m not saying everyone should be happy about paying taxes and should want to pay as much as possible. I’m all for finding ways to reduce your tax liability as much as possible, but in ways that make the most sense. There are ways that you can save on your taxes without throwing money out the window.