We will talk in the month of August about different tools, tips and tactics that can help business owners and the self-employed keep more of the money they make. If you own a business and are committed to building it, then you may be putting all your money back into it. This is considered a good practice not only because it helps grow the business with the capital you reinvest, but also because it turns into a tax deduction.
I thought about sharing some of my thoughts on tax deductions today. I have been working with many people who are looking to reduce the amount of money they pay on taxes by taking deductions for the things they do. This can be a good thing, of course, because one gets to use the money for the things they need and also pay less in taxes at the same time. The only issue I see with this strategy is when one makes purchases or spends money on unneeded stuff for the sake of the tax deductions.
I have always believed that the most important money one should keep in their money instead of spending is the money paid on interest to other people or companies. I have come across people who don't want to pay their mortgage down faster and save the interest because they want to use the mortgage interest as a tax deduction. Well, here is the challenge with that strategy: one pays $100 in mortgage interest to save $25 in taxes (for someone in the 25% tax bracket). In this case they would be better off keeping the $75 in their pocket instead of giving it to the mortgage company.
As a strategy to save money on taxes, many people contribute to pre-tax retirement plans, such as 401K or IRA. This is a great strategy to keep more money for the present time. For most people, it can be a good strategy long-term, given that most Americans have less money in retirement than they do while they work. However, if you plan right and build your wealth to have a worry-free retirement, you may be better off paying taxes on your current income and then receiving your retirement money tax free. This would mean a Roth account - IRA or 401K. The wisdom of this strategy comes from a popular saying that states that it is better to be tax on the seed than on the crop.
These tips and strategies don't work for every single person or every single situation. Everyone is different and their strategies need to be adapted to their situation. For this very reason, it is important to sit down with financial professionals - financial planner, CPA, tax attorney, estate attorney.