Welcome to the second half of our two-episode segment on accounting and taxes. This is also the 50th episode of the Coders’ Startup, which is a bit of a milestone!
After discussing the basics of bookkeeping and consulting with accountants in last week’s episode, we found we still had a whole lot to say about claiming deductions on your annual taxes.
As we mentioned last time, about 99% of the tax code pertains to deductions (according to Tom Wheelwright’s book, Tax-Free Wealth). More than anything else, Carter and I want to talk about the kinds of deductions you can claim to save some money for your business.
Remember that neither Carter nor I are tax professionals. You should take everything we say with a grain of salt until you discuss the matter further with a CPA. Putting it another way, our goal is to start conversations you should finish with your accountant.
Let’s begin with the basics.
What Exactly is a Deduction?
If you don’t know much about taxes, then you may be wondering what a deduction (also called a “write-off”) even is.
Simply put, a deduction is an amount of money that is removed from your taxable income, or your total annual income that is eligible for taxation.
I like to think of it this way. There are two types of dollars when it comes to taxation: pre-tax dollars and post-tax dollars.
Consider your paycheck as an example. Suppose your gross pay for one week is $2,000. These are pre-tax dollars–dollars that have not yet been taxed.
The government takes $500 from your paycheck for taxes, and so your net pay is $1,500. These are post-tax dollars–dollars that have already been taxed.
Write-offs for business expenses allow you to retroactively purchase something with pre-tax dollars instead of post-tax dollars.
Suppose you purchase a piece of software for $200 and write it off as a business expense. The government will remove this amount of money from your total taxable income before collecting taxes.
So, in this example, the government will tax a percentage of your $1,800 instead of taxing the same percentage from your $2,000. By lowering your total amount of taxable income, you end up paying less in taxes.
In short, deductions decrease the total amount of tax the government can claim from your income, which means more money in your pocket to reinvest in your business. Sounds great, right?
Some Expenses You Can Deduct
In order to maximize the deductions on your tax return, you should start thinking about things you buy for your business that you can write off.
For starters, many of you have probably purchased or subscribed to tools you use to code, such as Oracle Database or an IntelliJ IDE. You can also include payment for internet hosting on your list of write-offs.
Generally speaking, a business expense is any purchase made to support your business or create revenue. As business owners, you can claim deductions on your business expenses.
So, what are some other types of deductions you should be aware of?
If you work from home like I do, you can deduct a portion of your rent, mortgage payments, insurance, utilities and more. The part of your home you use for business (so long as that part is used only for business and is your principal place of business) can be claimed as a business expense.
The logic behind this is that if you did not work from home, you would likely have to rent out office space, which you would be eligible to deduct as a business expense.
But because I work from home, I can deduct the percentage of my home’s total square footage that my office takes up. This allows me to write off about 20% of my rent as a business expense.
In addition to home office expenses, you can deduct automobile expenses as long as they are related to your business.
The most common type of automobile expense you might write off is travel to business meetings. In this case, be sure you give detailed documentation regarding how far you drove, where you met and with whom you met, why you met, and what you discussed.
You could even deduct the cost of a car wash if you got the wash for a business reason. For example, perhaps you took a client out in your car and wanted to be sure it was clean.
And don’t forget you can write off business travel that takes you further than just across town.
For example, my wife and I traveled to Florida over the holidays to visit my family, and since my father is also my CFO, we spent a lot of time discussing business. Because my trip was in part business-related, I am eligible to write off my plane ticket as well as my baggage fees.
If you want, you can use this as an excuse to travel to places you’ve always wanted to visit. As long as you can find a legitimate business reason for the trip, then you can deduct your travel expenses.
There are all kinds of smaller, random expenses you can write off because they serve to support your business or generate revenue.
Carter recently had to upgrade to a new cellphone because his old one couldn’t perform the social media postings he needed to do for his business. He can write off this expense because his social media postings are an integral part of his business.
Other similar examples include a new power cord or upgraded hardware for your computer, or a new pair of headphones. As for me, I regularly deduct the cost of my internet and cellphone service because they are essential to my business operations.
There are so many possibilities here that it really becomes a question of what you are comfortable deducting. Carter was once at a conference in which someone claimed if you worked from home and owned a dog, you could write off your dog as a security system!
When considering whether to deduct a certain expense, you should ask yourself the following questions: Is this an investment I’m making for my business because I think it will bring in more revenue in the future? Is this going to be beneficial to my business?
If the answer to these questions is yes, then you can probably deduct the expense.
In general, you should stick to deducting the expenses that seem legitimate and ethical to you. It usually isn’t worth it to deduct something questionable, because you may end up being audited.
Which begs the question…
What Happens If You Get Audited?
Getting audited sounds like a scary situation, but what’s really the worst that can happen? The reality seems to be that you may be required to repay some of the money you claimed in deductions.
I was once audited for a personal tax return. My wife and I wrote off the interest on her student loans, but it turned out the type of loan she received was not an accredited loan and was therefore ineligible for deduction.
The CRA audited us, and in the end we had to pay back the portion of our refund we received from the deduction. This wasn’t particularly fun, and we would have liked to keep the money, but it isn’t as if I went to jail or even paid an additional fine.
It’s generally unlikely you’ll be audited, and it if does happen, it’s probably because you messed something up by accident, not because you were purposefully trying to cheat the system. Don’t stress yourself out worrying about the possibility.
If you really want some extra peace of mind, many tax professionals and do-it-yourself tax programs offer audit insurance for an additional (and usually reasonable) fee. This ensures someone experienced will be there to help if the government decides to audit you.
As you advance in your entrepreneurial career, you’ll likely begin to hire professionals to take care of your taxes rather than doing them on your own. One of the biggest benefits of having accountants work for you is they serve as a medium between you and the revenue agency in the event of an audit.
In terms of deductions and their associated risk of audits, look at it from this perspective: Is the money you save worth the potential time you will need to spend backing up your deductions during an audit? Don’t risk the headache over chump change, but if you stand to save a lot of money (such as I did with my loan deduction), then it may we worth taking a chance.
Book and App of the Week
Book: Again this week, we’ll direct you to Tax-Free Wealth, by Tom Wheelwright. If you didn’t check it out after our previous episode, then do so today.
Our second book is unrelated to finances but is nevertheless a classic. Flow: The Psychology of Optimal Experience, by Mihaly Csikszentmihalyi, is all about the experience of being “in the flow” while hard at work. It explains why this phenomenon occurs and how to make it occur more often. It’s a valuable resource for any entrepreneur.
App: HabitBull helps you put into action the “don’t break the chain” mentality we’ve mentioned several times on the podcast. You can enter habits you want to maintain and see visualizations of your progress for each day. The goals are very customizable, including options for yes/no goals, numerical goals, and much more.
This app recommendation comes at a great time with respect to New Year’s resolutions and goal setting, so go download it and start building your chain.
And so we reach the end of our two-part series on accounting and taxes. We hope we’ve given you a lot of great ideas for saving money and growing your business.
We’ll remind you once more that we are NOT tax professionals and are only advising you based on our experience. Always, always, always check with an accountant before taking action on anything we suggested in the show.
As usual, be sure to check out United Business Leaders on Instagram. They currently have 5,900 followers and will soon launch a mini sales funnel coupled with a giveaway. Carter’s team is doing phenomenally on the platform, which shouldn’t be surprising since his nickname is, after all, “The Marketer.”
We may have the opportunity to discuss the results of this sales funnel in a future episode. On the other hand, I would also like to talk about Facebook ads again and share the details of my new marketing strategy for the platform.
Who knows for sure what we’ll cover next week? Things are always very flexible with us, and you’ll have to stay tuned to find out.
Tax-Free Wealth by Tom Wheelwright
Flow by Mihaly Csikszentmihalyi