Last week the New York Times published a story about Donald Trump’s tax avoidance over the years. I heard a collective groan from tax preparers expecting related questions from their (less wealthy) clients.
I’m not here to get into the merits of the story or the tactics described there. Social media will debate that enough. But reading through the article did make me think about legal tax strategies you should consider. Even if you’re not a billionaire with several businesses and properties.
Tax Avoidance vs. Tax Evasion
First, remember that tax avoidance is allowable when done legally. There are plenty of legal tax avoidance techniques right in the black and white letters of the tax law. Supreme Court judges have said it is within our rights to arrange our affairs to pay the least amount of taxes possible.
Tax evasion is illegal. Evasion can take many forms. Underreporting income, inflating deductions, or even hiding money in offshore accounts. These are all an effort to misrepresent income to the IRS. In short, don’t do it.
The following opportunities represent legal tax avoidance techniques. And they are strategies I help clients with all the time.
Of course, I hope your business is profitable and you don’t have to worry about this one. Losses from a pass-through business can be deductible against ordinary income on your tax return. There are limitations here depending on how the business is taxed. The Tax Cuts and Jobs Act (TCJA) also put a limit on how big these losses could be in a given year. That TCJA provision was suspended as part of the CARES Act in 2020, but will return in 2021. That said, there are plenty of ways to show a profit and pay less taxes. So please don’t spend more just to save tax. Most of the time it doesn’t make sense.
Real Estate Tax Provisions
The tax law is very generous to real estate investors and developers. But you don’t have to be a mogul to use them. One provision you can use is the ability to depreciate certain parts of your property faster. Structural components of a commercial building get depreciated over 39 years. But your property is not made up of structural components alone. There are removable items like floor coverings, furnishings, lighting, landscaping, and so on. Most of these components depreciate between 5 and 15 years instead of four decades. Which means bigger deductions for you now. This can free more cash for you now to invest, use in current operations, or increase your profit distribution. If you own your office building, this technique is worth looking into.
Hiring Your Kids
You don’t have to pay your child $700,000 in “consulting fees”. In fact, don’t pay them consulting fees at all. Most small business owners should hire their kids as legitimate employees of the business for this strategy. Of course, legitimate means they are on the payroll and they do real work for their paycheck. Do it the right way and you could shift up to $12,400 per child, per year to a lower tax bracket. You could even pay zero tax on that money, depending on your business structure! (Note: $12,400 is the 2020 standard deduction for an unmarried individual. That number changes every year.)
What About Those Haircuts?
The tax law is always strict on expenses that could be either personal or business expenses. And this one is no different. Most of us do not have reality TV shows or another need for this to make the cut (pun intended) as a business deduction. And no, just because you have to appear well-groomed for your customers does not make haircuts and styling a business deduction.
There are plenty of other personal expenses you can convert to business deductions. Clothing, vehicles, cell phones, and your home are a few. The key here is to follow the many rules and document everything well.
I have only discussed the opportunities here. Not the tactical steps of how to implement these strategies. You’ll want a good tax strategist for that. And remember, if you take these ideas to your tax pro and they groan at you, that’s a clear sign it may be time for a change.
If you liked this post, check out our Independent Optometrist’s Guide To Financial Freedom.
Eric Levenhagen, CPA CTS is the only financial consultant who helps private practice optometrists improve the financial health of their practice with a simple, proven process called Financial Harmony which will reduce their taxes and increase their after-tax profits by at least $10,000 in the first year, guaranteed.