Having prepared quite a few tax returns for people, I have seen a large range of incomes, from those barely making it by to those who are absolutely killing it. I have also seen very unique approaches to money management as well. But a common thread I have found throughout my few years helping people with tax returns is that taxes are frustrating and hard to understand.
Taxes Are Complicated
The United States tax system is complicated. I remember the first time I went to prepare my tax return on paper, it felt like I picked up a book written in ancient Greek, and I was only able to get about 1/10th of the way done before having to bring in a translator (my old boss). I didn’t understand all the rules and calculations, and I really dreaded even thinking about doing taxes as the end of the year approached.
Then, tax software became available, and I thought my prayers were answered. Unfortunately, the software asked me a ton of question I didn’t know the answer to, and I even submitted a return that got audited at one point because I forgot to tell them about a bunch of stocks I sold. OOPS! The 1040 forms looked like a hieroglyph, and I didn’t have a clue. So I completely understand when people get frustrated with taxes. But one thing that I try to make clear to everyone I do taxes for is the tax deductions are not something to pursue just to lower your tax bill.
Tax Deductions vs. Math
When I prepare a return, I try to find every possible credit and deduction allowed by law to ensure the tax payer only pays what they owe to the IRS. Far too many people are continually overpaying their taxes because they don’t know all the deductions they are allowed, or possibly don’t keep track of expenses very well. So I am definitely NOT advocating avoiding tax deductions when you legitimately have them. What I am against is spending more money to get a deduction that gets you a bigger refund, or lowers your tax bill. The math just doesn’t add up.
Here’s an example:
You have a small business, and owe the IRS $2,500. Your effective tax rate is 25%. To get rid of that tax bill, you have to spend $10,000 more dollars in business expenses. So you decide to buy a new business car to wipe out your tax bill. WOOOHOOO! You just spent $10,000 to reduce your tax bill by $2,500.
Tax Deduction Are A Bad Investment
When you look at the numbers, you realized how dumb it is to spend money just because something is “tax deductible”. It’s like pulling out a payday loan to invest in your Roth IRA. Wha?! But people do this all the time. I have had people literally ask me how much more money they need to spend so they don’t owe the IRS next year. I always say the same thing, “you are making more money, that’s a GOOD THING! And when you make more, you owe more. But it’s ALWAYS better to make more money than to owe less.” I try to show them that the tax deduction is an incentive to grow business, not an excuse to spend money when you don’t need to.
I’ll ask them the question; “If I asked you for $100 to invest, and could GUARANTEE you that I could turn that $100 into $25, would you invest it? That’s what spending just for the purpose of the tax deduction is doing with your money. So I don’t recommend it.” That usually clears up the point and helps them realize that their money is better kept with them.
Tax Deductions Are An Incentive
Tax deductions and credits are put in place, like a big ON SALE sign, by the IRS to encourage you to invest in your business, education, or wherever they want you to spend money. But it doesn’t mean you SHOULD spend money on those things.
For example; The IRS gives you a tax deduction for buying a new car for your business (you can depreciate the value of the car quicker for a new car). But I would NEVER recommend ANYONE buy a new car. Ever. Screw the “tax incentive”, it’s not worth it. Get a good, used vehicle that has a lot of life left, and that will save you thousands of dollars. You also get a deduction for paying student loan interest. LAME! Don’t do that. I still have student loans and HATE the fact that I’m still paying interest on them. That’s why one of my goals is to kill those loans this year.
Should We Consider Tax Deductions When Making Purchases?
Oh heck yes, you absolutely should consider tax deductions when making purchases. They can be like using a coupon, where you get (whatever your tax rate is) percentage off the purchase. Heck, some things you spend money on might even give you a credit, which is dollar for dollar put right back in your pocket (yes, I know I’m simplifying this, but the concept is the same).
For example; Right now, you can get the first $2,000 you spend on education right back in your pocket! If you’re pursuing a 4-year degree, you can drop a cool $2k on classes, and see that money re-deposited right back into your account when you file your tax return. So, if you were planning on going to school, but weren’t sure, DEFINITELY CONSIDER THIS!
So, What’s The Point?
The point is, don’t spend more than you normally would on ANYTHING just to get a little tax incentive. Not worth it. The math is completely backwards, and you end up spending thousands more on crap you don’t need. You should only make purchases you were planning on making, that fit within your budget, and that make sense for you. If you can make it deductible, then go ahead and make it happen, but DON’T EVER SPEND MONEY JUST TO GET A TAX DEDUCTION, EVER!
If that’s not clear enough, just shoot me an email and I’ll copy/paste that last sentence 10,000 times and paste it into the reply mail. Bolded. In 72 point font. In comic sans.