Hi everyone.
This is the how to lower your tax bill podcast.
I'm your host, Terrence Hutchins.
I'm a financial and tax advisor in the Dallas forward area.
And the goal of this podcast is to help you listeners get educated with different tax
strategies that you can implement to improve your tax situation immediately.
Each episode will break down useful tax tips you can use to save money, no matter what
your personal or business income situation.
Because our motto is, keep more of what you earn.
So let's get into today's episode.
It's good to be back with you.
Today's episode, we are going to be talking to you self-employed listeners out there.
So whether you're a freelancer, a small business owner or running a side hustle, hopefully
you're taking some notes because I'll be breaking down some tax deduction strategies
to help you save on your taxes.
So let's dive into today's topic, the basics for self-employed individuals.
As I'm talking, normally we have to differentiate tax world from the real world.
All right.
And many times people say that they want to start a business.
They will tell me, hey, I need to save money on taxes, so I need to start a business.
Well, the IRS is going to say, okay, why would you want to start a business so you can save
money on taxes?
The point of you starting a business is for you to make money.
And so when they look at it, they say you have to have a profit motive for this business
that you're trying to start.
And so from a planning standpoint, I would say, hey, look, with the business that you're
starting, we're not looking to potentially reduce your overall tax bill.
So the last year you paid 15,000, we're not going to now pay 14,000.
All right.
Now, depending on the business you're in, that might be the case, depending on how much
cost it takes upfront.
But generally, we want you to start making money immediately.
And ideally, you could say, hey, I could go make more money at my job doing maybe work
that I don't enjoy as much, or I can actually do it in this business that I really enjoy.
And the percentage of tax that I pay on my next dollar will actually be less.
In fact, there's a story Ronald Reagan, one of the things that led him to help change
the tax code was he was an actor and he realized, okay, if I make another movie this year, I'm
only going to be able to keep 8% of my income.
He was at the top tax bracket at the time.
So he said, hey, I'm only going to make another $8,000 for every $100,000 I make extra.
So that's not very motivating.
So if you can now say, hey, instead of me making 8% of my income on the next dollar
I make, if I can make 80 or 90%, which is more than what I would have otherwise, then
that can be a great thought on how you're going to look at your tax situation once you
have this business.
But anyway, as it relates to the actual definition, the IRS says a business is something that
you're participating in regularly with the primary persons of earning a profit.
So if it's a hobby or it's just something you're doing sporadically, it's not considered
a business for tax purposes.
So you're not going to just be claiming tax deductions for expenses that didn't have any
business purpose.
Now you can, I'm not saying that you will get caught, but if you weren't get audited,
you're just not going to prove that unless you had some type of business purpose behind
what you were doing.
So when it comes to the actual expenses of what you can deduct, you're going to now have
to justify them as being considered ordinary and necessary.
That's in section 162 of the tax code.
If you want to have some good late night reading, then anything that you spend that's ordinary,
necessary, and generally it can't be lavish or extravagant.
All right, that lavish and extravagant is going to be facts of circumstances dependent.
But if it's something that's out of the ordinary for you to normally do, then you could probably
pretty seriously think about is this going to be considered a deductible expense or will
that expense be reduced?
Okay, so when it comes to being ordinary, they're looking at some of that as common
and accepted in your industry.
A landscaper, it's ordinary for you to buy equipment.
Graphic designer, it's ordinary for you to buy a computer for you to work on.
Also necessary is something that is appropriate and helpful in carrying out your business
activity.
So it doesn't have to be absolutely essential, but it should contribute to the success and
functioning of your business.
Things like office supplies or your internet, those are things that would be considered
necessary.
And it doesn't have to be frequent.
It might be a one time purchase, but it was necessary in that moment for the activity
that you were trying to get accomplished.
So I need to always be able to say, okay, is this ordinary?
Is it necessary for my business?
And then the three, I would say main questions I get asked about as it relates to specific
business expenses are going to be around business travel, business mills, and automobiles.
So we're going to kind of dive through those three.
Then I'll kind of give you a interesting tax court case and then we'll wrap up for this
week.
When it comes to travel, we have to start with is my travel ordinary necessary?
Is it not lavish or extravagant?
Lavish and extravagant is also going to be at scale because I might normally go on trips
to Europe or Dubai in my personal life.
But if I run an office supply store, I probably need to go to Dubai in order to meet a client.
Or if I'm doing a marketing event and my average sale is $5 per item, I probably don't need
to spend $50,000 on a party to invite people for my business.
So the yacht party that you saw on Tic Tac that you could deduct may or may not be the
case for your business.
So facts and circumstances is always going to be important.
That's why it's important to work through things with whoever you're working with that
does your taxes.
For one, to see if they're going to actually do it because some frustrations I hear from
clients is that their CPA won't even entertain what they're doing.
If you had had the conversation with them ahead of time, you're either now saying, okay,
I'm going to either do it myself.
I'm going to fire my CPA because they don't want to go along with whatever scheme I had
or I'm just going to lose out on the deduction and I've already spent money on whatever it
was that I'm not getting a tax benefit for.
But when it comes to business travel, the IRS says that your business trip must take
you away from your tax home.
I live in Dallas, Fort Worth.
If I'm traveling out of the area and I'm traveling long enough for it to require sleep or rest,
then I can now deduct my lodging expenses and my other travel expenses while I'm away
from my tax home.
So for example, if I'm going to Austin in the morning, this is three, three and a half
hours and I'm done by two o'clock, it would be natural for me to get back home before
dinner if I left immediately.
But if I got wrapped up around seven, eight o'clock and I could probably justify, hey,
look, it was already late.
I don't want to drive in the middle of the night.
I'm going to grab a hotel and I can deduct that hotel for my current stay so that I'm
not having to disrupt my sleep pattern so I could justify the lodging for that expense
and that would be considered my business travel.
All right, now when it comes to the actual specific expenses you could deduct on business
travel, so you're going to look at airfare, train, bus tickets, rental cars, even your
personal vehicle.
You have the operation of that vehicle, so gas, repairs, tolls, things like that, that
you could deduct.
And then if you're doing ride share, so if you're going out of town or you're catching
an Uber or Lyft, you can deduct that.
You also have baggage charges.
So if you don't fly Southwest, then you're paying for bags potentially.
So you can deduct that cost.
And then any meals that you have.
This is something that's often overlooked, but if you're away from your tax home, you
can deduct pretty much any expense that is normal for you to operate in your daily life.
So it would be natural for you to eat.
So if I eat out of town over my tax home, I can deduct that cost.
And then incidentals, if you're actually out of town long enough where you had to dry clean
or do laundry, if you tipped your bellhop or whatnot, you can deduct those things.
Okay.
Now, in order to substantiate your expenses, you're going to need to keep track of the
amount of each expense.
So if there is a receipt that's available, normally if it's over $75, you're going to
want to keep that receipt.
You're going to want to have the date and you're going to also document the business
purpose and where it happened, which can truly be a calendar entry.
So I'm going to make an entry in my calendar.
I met with Jane Doe at this restaurant.
We talked about XYZ business.
It's pretty customary for me to record all of my meetings so I could just prove a business
purpose from the transcript that I created.
Now one thing when it comes to travel, if you don't want to keep track of all of your
expenses, you do have what's called a per diem rate.
The IRS said, okay, based on your area for things like mills and lodging, you can actually
have a rate that you could automatically take.
So for example, in Oklahoma, I had a client, their daily rate was like $160.
So if you had a full day of travel in Oklahoma for meals and lodging, you would get like
$160 without having to track all the expenses from it.
You just have to document the fact that you still had a business purpose with the destination
and all that, but you can just do a flat 160 based on the per diem rate.
Then that leads me into a strategy that you can actually think about if you run an LLC
or a corporation, it is customary in that business for you to actually keep a corporate
book or a corporate ledger.
That corporate book was going to essentially say, how do you govern this entity?
How do we know this is a legitimate business versus something you're just kind of operating
as a side hustle that's not really serious?
One way to do that is to have a board of advisors and to keep corporate minutes.
And so your board of advisors are going to be people you trust.
And most people, they trust their families, their spouses, their kids, their loved ones.
And so one thing that I help my clients with is say, hey, okay, let's go into the year
and we're thinking about where is our travel going to be and can we incorporate a business
function in that travel?
So for example, if we're going on a four day trip down to the Smoky Mountains, I'm looking
at it as a corporate retreat.
I have a travel day getting there and then we're going to have a business meeting while
we're there.
And during that meeting, we're going to have an agenda.
So I'm going to have items that we discussed.
I'm going to be teaching my kids how to do business, talking about things like income,
expenses, operations, marketing, helping them understand, hey, if you eventually want to
take this business over, what does that entail?
Just giving them principles on, okay, let's review some of the tasks that I have you guys
do that I pay you.
So those are all things we can do review and then we can plan ahead and set goals for the
future.
We can document that as our corporate meeting.
So that's kind of be our business function for that day.
And then I have maybe a personal day the following day and then I have my travel day back.
All right.
So I get my travel day, I get my business day and then I get my travel day back.
That's three business days on a four day trip.
If you can coordinate it with the weekend, your weekends will also count as business
days.
So now I might be able to deduct 50, 75, even 100% of my trip, depending on how long it
was and the time that I took.
So I'd say, hey, plan ahead, do your corporate meetings out of town, have them have a business
function, document it properly is actually going to be a body exercise for you and your
family and you get the tax benefits as a result.
Let's dive into business meals.
So when it comes to a business meal, they're going to be deductible at 50% of the cost
of the meal.
It doesn't matter if you pay for them or you just pay for yourself.
50% of the cost of that meal is going to be deductible.
So we're still going to have to go through the filter of is it an ordinary, is it necessary,
is it not lavish or extravagant, did it have a business purpose?
All right.
And you're actually have to separate the meal costs from the entertainment.
So when it comes to entertainment, that is no longer deductible.
The most common I would see is your sporting event.
Hey, we go to a sporting event, the cost of that ticket is no longer deductible.
But if I order hot dogs, drinks, whatever, I can deduct 50% of the cost of that food.
I just need to document the fact that, hey, I was with an employee, a client, a consultant.
I was with someone that had a business purpose behind it.
And I was able to prove that there was a profit motive behind my actions whenever I pay for
a meal at that type of event.
All right.
Now, a few other specific things to know.
If it's under 75 dollars, you don't have to keep your seat.
You just need to keep the amount, the designation and the business purpose.
A few other nuances, if I have working lunches for myself, let's say, then those are going
to be deductible unless I add it to my salary, which can actually be beneficial because like
during tax season, for example, I might be working 12 hours a day and it's hard for me
to actually take an hour lunch out of the office so I can order Uber Eats, eat at my
desk and I just need to document, hey, I spent 100 hours last week on food.
I'm going to increase my salary by a hundred dollars.
The business gets to write that off.
Now I do pay tax on a hundred dollars, but I can write a hundred percent of it off to
the business.
So I do get some type of benefit outside of not getting any at all.
You also could pay for your employees.
If you could prove that meal cost is for the business of the business, meaning it helps
you save time, it allows you to be more efficient.
You could deduct the cost of the meal for your employees.
You also can deduct a hundred percent of the cost for things like employee appreciation events,
holiday parties, or for realtor, you can have an open house and say, hey, if this food is
open to the public, I can deduct a hundred percent of that cost because at that point
it's considered more like a marketing expense as a result.
So that's kind of the high level with meals.
And then if you do have a spouse that works in the business, you can deduct meals with
them.
I would just make it less frequent, make sure it has a business purpose, make sure you
document what you did so that you can properly deduct those expenses.
If not, then you can increase the salary of yourself or your spouse in that case.
So at least you are paying tax on the meal cost, but you are getting the deduction for
it through the business.
So lastly, let's jump into automobile.
So this is probably the biggest one that I get the most questions about because everyone
wants to buy that big, massive car and get that big depreciation deduction upfront.
Okay.
So let's actually dive into that, but going back to my theme, if the use of your vehicle
is ordinary necessary for your business, then you can deduct it.
So there's just going to be two different ways that you're going to be able to deduct
it.
You're either going to take what's called the standard mileage rate, or you're going
to just add up your actual expenses.
So the simple, the simpler of the two is the standard mileage rate.
So with that standard mileage rate, you are essentially taking all your business miles
and you are deducting for 2024, 67 cents of those miles.
So if I drive a thousand miles for business, I'm going to deduct $670 on my tax return.
Okay.
Simple as that.
Now, when you're tracking your business miles, you can just do all of your miles and take
the percentage of business that they are or the actual running total.
Okay.
So I'm going to just total all my miles for the year, and then I'm going to total up how
many of those are business.
Secondly, I could take the same week of every month.
So for example, the first week of the month, I track all of my miles and I add that up
and I basically extrapolated out.
So I say, Hey, look, I had 12 weeks of data in those four weeks.
My average miles were 50 miles.
So I'm going to do 50 times 52.
That's going to be my miles for the year as far as my average, or I can take a 12 month
consecutive time period and extrapolate that out over the year.
So I take three months record all my miles and just multiply by four.
Now when it comes to your actual expenses, you're going to now look at, okay, what did
the car cost me?
What is the percentage of business use for that vehicle?
And I'm going to deduct all the expenses it takes to maintain the car.
So for example, if I have a $20,000 vehicle and I've been tracking my miles and 50% of
those are for business, I now have a $10,000 car for tax purposes.
So it costs $20,000, but I was only using it half for business.
So 10,000.
And then I'm going to actually depreciate the car over five years for easy math.
That's $2,000.
Then I'm going to add in my gas, my car insurance, my repairs, my registration.
And let's say that's another $5,000 for the year.
Well, 50% of that is $1,200.
So now I get another $1,200 tax deduction.
Okay.
So you're going to add all that up and you're going to really compare.
So I say, Hey, do I have more miles at 67 cents per mile or do my actual expenses?
Are they higher?
And I can take the higher of the two, but I need to decide that in the first year, which
one did I do?
So generally, if you have a high priced vehicle that the business use is high, you're probably
better off taking the actual expenses.
If you have a lower cost vehicle and you drive a lot of miles, you probably want to take
the actual mileage rate.
One thing that kind of threw a wrench into things was this EV tax credit.
So what I do with an EV, I will actually subtract out the EV credit that I take first from the
price of the car.
So if I had a $30,000 car and my tax credit was $7,500, I'm going to subtract that $7,500
out, take that as my credit or my personal tax return.
And then now my tax basis is $20,500.
So I'm going to say, okay, I have a $20,500 car.
And then if I'm depreciating that, it's going to be based on that $20,500, or I'm just going
to go ahead and take the miles as far as my business use.
Now the biggest thing you probably see on social media is going to be this whole depreciation
aspect.
So when it comes to depreciation, you can actually take a big deduction on the front
end.
So always remember when it comes to depreciation, you're either spreading it out over the
time that the IRS says that you should have the vehicle, or you're going to take most
of it upfront.
And so for 2024, they allow you to take up to $20,400 upfront on a business vehicle.
Okay.
So if you have a passenger vehicle, which means it's under 6,000 pounds, the first year
the max you could take is $20,000.
If it's over 6,000 pounds, you can actually take the cost of the vehicle at 60%.
So if I have an $80,000 car, I can take 60% of the cost of the vehicle in the first year.
All right.
So that's how a lot of people will try to buy their cars and then take that big deduction
upfront.
But the IRS says they have to be placed in service.
So if I buy a car, it has to be used in business by the end of the year for me to be able to
claim it.
Okay.
So that's important to know when you're looking at planning things out.
Number one, does this have a business purpose?
Number two, is this something that I would already have purchased anyway?
I don't want to buy things that I don't need to get tax savings because I'm left spending
more money out of pocket.
So my actual net worth goes down even if my tax bill goes down as well.
All right.
So to recap, we had travel expenses, we had meal expenses, and we had automobile expenses.
So we need to make sure that they have a business purpose.
And that business purpose is in a activity that has a profit motive.
And then those expenses must be ordinary and necessary with the proper documentation, which
is generally going to be amount, business purpose, destination, and when it occurred.
Now one of the things that I did leave out, if you lease a vehicle, you're going to actually
take the percentage of the lease payment.
So if I use my car 80% of the time, that lease payment, I'm going to take 80% of that as
my deduction.
So each week we will go into some kind of unique tax situation.
So I want to talk about the Elvis Presley estate case in 1981.
One of the things that the estate was trying to deduct were gratuities paid to his bodyguards,
chauffeurs, and other employees, because they said that that was part of his lavish lifestyle
to maintain his public image.
So you know, obviously I don't need a bodyguard for my situation, so I couldn't even make
that argument.
The estate was trying to say, hey, look, obviously Elvis Presley, he's a public figure.
He needs to have these people around and we should be able to deduct all these expenses.
The IRS disallowed the cost.
The estate took them to tax court because the IRS is the fire authority.
It's actually the tax court and they tried to get these deductions in, but ultimately
the IRS won.
And so they essentially said, hey, these expenses aren't ordinary and necessary for what he's
trying to do.
They're personal in nature.
So they actually threw it out.
Whenever you're doing something, it's important to look at your facts and circumstances.
See one, is it properly documented?
How can I justify its ordinary and necessary nature so that if I did get called to the
carpet, I'd have a good explanation.
And if I felt like it was worth it enough, I could actually go to a tax court and win
and outdo the IRS.
So thanks for hanging in there with me.
We'll talk in the future about some more business specific tax deductions, but until then, go
be great.