Many would be entrepreneurs hesitate to start their own business because they think it is too risky from a monetary perspective. In fact, most people don’t think starting a business is even worth trying unless they can come up with a grand slam profitable idea. Of course profitability is an extremely important factor with any business, but what if I were to tell you that you could save a decent amount of money every year with your business while only making a small profit or none at all?
That’s right! Most people don’t consider the tax savings involved in running a business. Most people don’t realize that having a day job is one of the worst ways to save on taxes because Uncle Sam takes a huge chunk out of your paycheck BEFORE you pay for anything. On the other hand with a business, you can effectively pay for everything using pre-tax dollars which can save you up to 35%. So while on paper your business may not be making any money, in reality you could be saving big bucks by purchasing goods with money that is not taxed at all.
But talk is cheap! I thought that it would be interesting to throw some numbers into the mix by calculating how much the average American could save by starting their own business.
The Average American
First off, the average American makes roughly $63,091 before taxes. If we assume that they fall under the 25% tax bracket, the average American is also getting reamed up the wazoo by Uncle Sam to the tune of about $11960 before they can even use this money leaving themselves with only $51131. Even worse, the average American spends roughly $49638 a year which doesn’t leave much savings. It’s no wonder that the average American household is just barely scraping by!
In order to calculate the tax savings associated with running a business, we must break down each and every expense of the average American to see what can possibly be written off with a business and assume a certain percentage of savings. Below is my analysis.
Transportation – Gasoline And Oil Costs
The average American spends roughly $2384 on gasoline and oil related products. If we assume that gas is $3 a gallon and that the average car gets 20 miles per gallon, the average American drives roughly 15893 miles per year. We’ll round this number to 16000 for simplicity.
Currently with my business, I’m able to expense roughly 22% of the miles I drive on my car for business purposes. How do I do this? Whenever I need to drive some place or run some errands, I make sure that I try to take care of something business related along the way. For example, if I need to go to the grocery store, I also make a trip to the office store or other related establishment where I need to pick up something for the business. It takes a bit of planning and excellent documentation but you’d be surprised by how easily you can find ways to use your car for business.
For the average American, 22% of 16000 miles is roughly 3520 miles. For 2009, the IRS mileage tax deduction is 55 cents. 3520 * $.55 equals a tax writeoff of $1936.
Housing And Shelter
The average American spends $10,023 on housing or shelter every year. Currently, my wife and I expense 20% of our rent for business related purposes. In actuality, we use more than 20% of dedicated business space in our home but we keep things at 20% to prevent the likelihood of an audit. In any case, 20% of $10023 equals $2004.60 of tax writeoffs for the average American.
Food – Eating Out
The average American spends roughly $2668 a year eating out. For my wife and I, we love discussing business over dinner. In fact, we make many of our key business decisions at restaurants because it’s a more relaxed environment and easier for us to concentrate.
As a result, we are able to expense some of our meals every month. For this analysis, let’s assume that the average American can expense 10% of their meals. Because meals and entertainment can only be deducted at 50%, this effectively equals a 5% writeoff. $2668 * .05 equals $133.40.
The average American spends roughly $1600 on summer vacations every year. While travel expenses purely for pleasure can not be expensed, any vacation can be made to be business related with the proper planning. So what my wife and I usually do every year is plan our vacations around our business travel.
For example, a few years ago my wife and I had to meet with linen and textile vendors in Japan so we made a vacation out of it. We purposely planned our meetings every other day and used our free days to relax and pamper ourselves. If you do things right, you can pretty much expense almost the entire vacation!
Because I’m not sure how the $1600 a year is broken down in terms of airfare vs food/entertainment costs, I’m going to assume that 75% of this cost is deductible for the average American. Total tax deduction $1200.
Since we use 20% of our house for business, it’s only fair that we deduct the same percentage for utilities. In addition to water, gas and electricity, we also have a dedicated phone line for the business which can all be expensed.
The average American spends $3477 on utilities every year. Once again, the exact breakdown of this number is unclear so we need to make some assumptions. For example, a business probably wouldn’t be able to expense the cable tv bill. However, most other items are fair game. To be conservative, I’m going to assume that at least 10% of this amount is deductible which puts the deduction at $347.70.
Computer Equipment And Household Furnishings
Unfortunately, this category is extremely vague. Computer equipment and household furnishings covers everything from furniture all the way to decorative items and computers but excludes major appliances. Because this category is so broad, I’m going to be conservative here and assume only 15% of this amount is deductible.
Thanks to section 179, computer equipment and other furnishings can be expensed 100% up to a six figure dollar amount every year. Chances are, if you have a business and purchase a computer, it can be written off in its entirety in the same tax year. The average American spends $1797 in this category. 15% of $1797 is $269.55.
Adding It All Up
Obviously, I have not included every possible business expense in my analysis, only the common items. If you really want to get nit picky, in reality you could probably expense far more than what I’ve mentioned in this article.
In any case, if we total all of the categories mentioned above, this comes out to $1936 + $2004.60 + $133.40 + $1200 + $347.70 + $269.55 = $5891.25.
Based on an income of $63091, this represents almost a 10% writeoff on the average American’s taxes! Putting all of the numbers together at a 25% tax bracket, this is a savings of $1472.81 every year. Keep in mind that most of the deductions I calculated above were on the conservative side. In practice, my wife and I actually deduct a good amount more especially under the computer and equipment category.
If you are worried about getting audited, the best thing to do is to arm yourself with an accountant and document every expense carefully. Your accountant should be able to tell you with high confidence whether or not an expense is actually deductible. This is free money folks, but only available if you have a business. Stop giving your money away to the government now!
Disclaimer: As one reader pointed out, this article is not meant to encourage people to haphazardly make tax deductions for their business. In fact, I discuss the flip side in depth in my article on Is Your Business Just A Hobby In The Eyes Of The IRS. However that being said, the deductions mentioned in this article are not exaggerated. In fact, I believe that the majority of people don’t take tax deductions that are rightfully theirs because they are afraid of the IRS. Talk to your accountant! They will know how to help you figure out how to make the most out of your deductions.
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