Self-employed professionals and business owners may be tempted to spend generously and take as many deductions as possible in any given year, yet there are circumstances where it makes more sense to be more careful or defer deductions, tax and financial experts say.
It is important for the self-employed to know the rules. Businesses must report all earned income and expenses. There are instances where businesses claim items that are not truly legitimately deductible.
The assumptions are that a personal mobile phone that is used for a few business calls, home internet, their only car which they claim 100 percent for business, and other personal expenses can be business deductions
Not only does that cause a problem if they are audited by the IRS, it could also hurt their cause when it comes to a sale, qualifying for a loan or making a retirement contribution based on taxable income.
There are times where it makes sense to defer making purchases and be a high-roller in any given year.
Consider the following
When you want to amp up retirement savings
Retirement plan contributions for the self-employed are based on the amount of profit or income in the business. The less taxable income you have, the less you can take advantage of the plans.
When you want to boost your income
You may choose to be frugal in your business or defer deductions if in the next three years you plan to either sell or obtain long-term financing.
When you sell your business, you will likely be asked to give the buyer at least three years of tax returns. Many buyers rely on these net income numbers more than your accounting books, because so many expenses can be claimed in a sole proprietor business when you are doing your end-of-year accounting.
Loan officers also will look to your tax returns to assess your ability to repay a loan. Less income may translate to a smaller loan. Lower taxable income could also hurt a business owner's personal goals.
Small-business owners should be wary of their personal finances. Deductions lower business income, but that also hurts a business owner's ability to qualify for family needs like a mortgage or loan for a new car.
If you are just starting out
Timing — and matching expenses with income — is perhaps the most important reason to defer deductions.
You may want to defer expenses to the next reporting period because you are anticipating a large income item which will come in. The important thing when it comes to tax decisions and opportunities is keeping good records. Many business owners claim they deduct everything. The problem with that line of thinking is that they will never survive an IRS audit.
For those who are smarter, they will learn that lesson early.