7 Secrets to Paying Less Tax


7 Secrets to Paying Less Tax… for the One-Owner Business

by Conrad Oertwig

There is only one secret to paying less tax: knowledge.

One hard fact of life is that taxes are cash.  It’s a mistake to think of taxes as taxes.  If you want to create more net worth, you need to think of taxes as cash.

How much tax cash are you leaving on the table?  Thousands?  Tens of thousands?

So, let’s explore 7 secrets (great pieces of knowledge) that will enable you to pay less tax, have more cash, and build net worth. I know that’s why you are here, so let’s get started.

Secret 1: Dutch-treat entertainment

Start with a question: If you go to a qualifying business entertainment, but you do not pay for your business prospect and you pay only for yourself (you go Dutch treat), can you deduct the cost of the entertainment that applies to you only?

How did you answer?

The correct answer is that Dutch-treat business entertainment is just as deductible as paying for the other person.

We find that many owners of corporations and proprietorships do not know this rule.  They miss thousands in deductions.

Example.  Henry Miller goes to a baseball game with a fellow business owner.  After the game, they go to dinner together and discuss how to find and hire a great assistant.  Mr. Miller does not pay for his fellow business owner.  He pays for himself only.  His costs of the baseball game and dinner are deductible as Dutch-treat entertainment.

You might say prove it!  I say, “Sure.”  Here’s what IRS Regulation Section 1.274-2(b)(1) has to say about this type of entertainment:

1)    The taxpayer may deduct business entertainment even though the expenditure relates to the taxpayer alone.
2)    The objective test precludes arguments that business entertainment means only entertainment of others.
3 )   Deductible business entertainment may include an activity that satisfies a personal, family, or living expense.
4 )   An individual in business may deduct the entertainment cost, including his personal benefit, as a business expense.

You can see that knowledge of the Dutch-treat entertainment deduction is worth money to one-owner and husband-and-wife owned businesses, regardless of business form: proprietorship, corporation, or LLC.

Secret 2: Second office in the home

Have you been told that because you have an office outside your home that you may not have an office in the home?  That’s wrong!

IRS publication 463 states, “You can have more than one business location, including your home, for a single trade or business.”

So far, so good: The IRS follows the tax law and says that you can have two offices for your business, one downtown and one in your home.

As a one-owner business, you want your office in the home to qualify as an administrative office.  The IRS in publication 587 says:

Your home office will qualify as your principal place of business for deducting expenses for its use if you meet the following requirements:

1)    You use it exclusively and regularly for administrative or management activities of your trade or business.
2)    You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.

Note the italics. This is an exact quote from the IRS. Also, note the word “substantial” because that gives you the strategy:  Do your administration at home and don’t do it in your downtown office.

In publication 587, the IRS goes on to say:

There are many activities that are administrative or managerial in nature.  The following are a few examples:

•    Billing customers, clients, or patients.
•    Keeping books and records.
•    Ordering supplies.
•    Setting up appointments.
•    Forwarding orders or writing reports.

You can see that knowledge shows you how you can claim the home-office deduction even when you have a downtown office.

Secret 3: Eliminate commuting

Secret 2 contained a magic word: “principal”— as in principal office.

Why is that important?

IRS publication 463 says:  If you have an office in your home that qualifies as a principal place of business, you can deduct your daily transportation costs between your home and another work location in the same trade or business.

I know you are going to like this:  Step 1: Establish an office in your home that you regularly and exclusive use for administration. That’s it. This is so easy that I don’t have a Step 2.

You have done it: The proper establishment of an administrative office in the home eliminates commuting.  Now, all your trips from your home to your downtown office are deductible.  This could be huge.

John Wilson owns a $50,000 vehicle, but he has only 10% business mileage on it because he commutes from home to office.  Now, with that home-to-office mileage converted to business mileage, his business percentage jumps to 83%.

Do the math.  From a possible $5,000 depreciation deduction (10% times $50,000) to a whopping $41,500 (83% times $50,000).

I know that your vehicle may cost more or less than Mr. Wilson’s vehicle.  That’s okay.  This concept works for everyone.  Apply your newly improved business percentage to your vehicle and see the increase in deductions, not only for this year but for every year you are in business.

Knowledge is the power and the secret.

Secret 4: Charity Sporting Event

Ask yourself this: Could a $300 charitable sporting event ticket produce a bigger tax deduction than a $300 business meal with a client?

In both cases, you spend $300.

Here’s the answer and it’s a stunner: the charity sporting event produces double the deduction of the business meal.  Double!

Are you capturing your double deductions?  Do you have the following line items set out in your chart of accounts?

1)    100% business entertainment deductions
2)    Regular 50% business entertainment deductions

If not, and if you attend or participate in charitable sporting events, you are missing valuable deductions because you are giving your tax preparer only one category for entertainment. Worse yet, you might be deducting the charity events as charitable deductions. Yikes!

Example 1.  You buy two tickets to the local American Cancer Society chapter’s golf outing.  On the day of the golf outing, you collect your business colleague and the two of you have breakfast at the outing.  Over breakfast, you and the colleague discuss new ways of getting more prospects for your businesses.  This gives you a business meeting, and now the golf outing qualifies as business entertainment associated with the breakfast discussion.  With proper documentation of the cost and business discussion, the entertainment cost of this golf outing qualifies for the 100% deduction.

Example 2.  Everything is the same as in example 1—breakfast discussion and all—but you go as a spectator to a PGA TOUR event that gives 100% of its net proceeds to 501(c)(3) charities.  Your cost of the PGA TOUR event is 100% deductible.

Example 3.  Everything is the same as in example 1.  The charity sends you a note saying that the fair value of your golf, food, etc., is equal to the amount you paid and you have no charity tax deduction.  Smile.  You have no problem.  The fair value limitation does not apply to business entertainment.  Thus, like in example 1, you deduct everything.

You might ask me: Where does the law say that I can do this?  Internal Revenue Code Section 274(l)(1)(B) says that the 50% cut in a business entertainment deduction shall not apply to any ticket for any sports event.

1)    which is organized for the primary purpose of benefiting an organization which is described in section 501(c)(3) and exempt from tax under section 501(a),
2)    all of the net proceeds of which are contributed to such organization, and
3)    which utilizes volunteers for substantially all of the work performed in carrying out such event.

Events that use volunteers for substantially all the work and donate the net proceeds to charity include, among others:

•    Golf
•    Tennis
•    Skeet shoots
•    Pheasant hunts
•    Fishing tournaments
•    Bowling
•    Marathons
•    Triathlons
•    Ski tournaments

Here’s another case where tax knowledge produces cash.

Secret 5: Antiques Make the Best Business Assets

Let’s say that you have narrowed the purchase of your business desk to either an antique or a regular desk.  Each desk sells for $5,000.  Which desk gives you the best business result? Is the difference worth thinking about?

First, you should know that some relatively recent appeals court decisions allow you to depreciate and expense the desk, regardless of its antique status.  Thus, you can deduct the $5,000, antique or not, but that’s where the similarity ends.

There can be a huge difference in financial results at the time of resale.

For example, in 10 years, the antique desk might increase in value to $15,000, whereas the regular desk could decline in value to $500.  But to see the true financial results, you need to look at the after-tax numbers.

Let’s say you are in the 35% income tax bracket and the 15% capital gain bracket at the time of sale. On the $15,000 proceeds from the sale of the antique desk, your federal taxes would be:

•    $1,500 on the $10,000 capital gain part of the profits ($15,000 selling price minus $5,000 original basis times 15%);
•    $1,750 on the $5,000 of depreciation recapture ($5,000 depreciated in full, taxed at the ordinary income tax rate of 35%).

After taxes, you pocket $11,750 on this sale of your antique desk ($15,000 minus $1,500 minus $1,750).

On the sale of your regular desk, you pocket only $325 after taxes ($500 sales proceeds minus $175 in recapture taxes).

The antique desk gives you 36 times more cash ($11,750 compared with $325). Imagine an entire office full of antiques!

Tax knowledge says to you: If you can buy an antique car, clock, rug, desk, cabinet, bookcase, paperweight, conference table, chair, umbrella stand, coatrack, library table, or other asset that will function just as well as a new purchase, take the antique.

Secret 6: Use Two Vehicles for Business

In the past, your tax adviser likely told you to drive one vehicle for business and the other vehicle for personal purposes. T his old advice made it easier to claim the one car as a business car because no business mileage log was required back then.  But that’s no longer true.

Today, tax law requires you to keep a mileage log to prove business use.  That changes the game.  With today’s rules, you gain nothing by using only one car. But the new mileage log rule gives you a possible opportunity to increase your tax deductions.

First, you might ask: Will the IRS allow me to use more than one vehicle for business?

Yes!  The IRS official method for computing business use of a single vehicle is to divide business miles by total miles driven.  IRS Form 4562, which is filed by proprietorships and corporations, contains spaces for up to six vehicles. In other words, yes, the IRS recognizes that you can drive more than one vehicle.

Here are the two basics that make the two-vehicle strategy work:

1)    You drive more miles than your spouse, and
2)    Both vehicles are somewhat close in adjusted basis.

To see if you can benefit from this two-vehicle strategy, and by how much (the minimum amount, really), apply the arithmetic from the before-and-after example below to your vehicles.

Before.  You drive 2,000 personal and 28,000 business miles on your vehicle (93% business).  Your spouse drives 8,000 personal miles on vehicle 2.  Each vehicle has an adjusted basis of $24,000.  Your maximum depreciation and/or Section 179 deduction is $22,400 (93% times $24,000) on the one vehicle you currently drive for business.

After.  You switch vehicles with your spouse every week. You now have 73.7% business use of vehicle 1 and 73.7% business use of vehicle 2.  This produces $35,376 in maximum depreciation and/or Section 179 deductions (73.7% x 2 x $24,000).

You gain $12,976 in new deductions ($35,376 minus $22,400).  You did not have to drive one mile further or spend one additional penny.  You simply had to know (as you learned here) that this strategy could work for you.

Secret 7: Travel by Cruise Ship

When you know the rules, it’s easy to travel to a business meeting by cruise ship rather than by airplane or other mode of transportation.

The law provides various ways for you to deduct a cruise.  Let’s examine just one: a trip to St. Thomas in the Virgin Islands and let’s say you live in California or New York.

IRS Regulation 1.274-4 gives us two one-owner business friendly rules that we can use to our benefit:

1)    The United States means the 50 states and the District of Columbia
2)    Transportation cost to a foreign destination for seven days or less, excluding the day of departure, is not subject to an allocation between business and personal days

St. Thomas is outside the 50 states; accordingly, it’s a foreign destination. You are subject to the foreign travel rules on your trip to the business meeting or convention in St. Thomas.

You plan to fly to Miami, Florida, and then board a cruise ship that will take five days to arrive at St. Thomas.

Once you arrive at St. Thomas on day five of your trip, you will:

1)    Depart the ship
2)    Check in for a two-night stay at the hotel where the convention or meeting is being held
3)    Attend the convention or meeting after sleeping at the hotel for the first night
4)    Depart by airplane for Miami on the day after the convention or meeting

Your business tax deductions include the cost of:

1)    Travel to Miami
2)    Cruise ship fare to St. Thomas (not to exceed tax law’s luxury boat limits that range in 2014 from a low of $566 to $680 per day, depending on the dates of travel)
3)    Food and lodging in St. Thomas
4)    Airfare to Miami
5 )   Travel from Miami to home

Note that you have no personal, nondeductible expenses for this trip to St. Thomas. You have to admit, tax knowledge can be fun!

A Few Thoughts

I specialize in “nuts and bolts” tax strategies that bring tax law to life so that business taxpayers and professional tax advisers can put the law to work for them. In fact, my mission is to clarify taxes so that you take control of your money.

Frankly, plucking common sense from the tax law is time consuming and difficult work.  Yet, after more than 25 years, I still get great satisfaction when I can clarify and extract tax dollars from the tax law not only for your pockets but also to add to your net worth.  In fact I have extracted over 400 tax savings tips and would like to share the most important lessons with you so am creating a course that will share seven tax secrets each month for the next year.

October 17-18,  I will be speaking at Gary & Merri Scott’s Value Investing Seminar about tax secrets that may create cash for you.  I invite you to attend this seminar.

Get seminar details here.

If you are interested in a year long course on how to save tax, enroll for more information here. Sign up for more information here.

Sincerely,

Conrad Oertwig