Small Business Taxes & ManagementTM--Copyright 2015, A/N Group, Inc.
We've often heard taxpayers say "it doesn't matter how much it costs, it's deductible". It may be deductible, but that doesn't mean you won't be out-of-pocket. The government (federal and state) is picking up some of the cost, but not all. How much? It depends on your tax bracket. And, the higher your bracket, the more the government pays.
For example, assume you're buying a $30,000 truck and, for simplicity, assume you can write the whole thing off in the year of purchase. That $30,000 purchase will reduce your taxable income by $30,000. Here's what your out-of-pocket expense will be at various tax rates on a $1 purchase. (We're using individual tax rates because that's what counts if you're doing business as a sole proprietorship, S corporation, partnership, or LLC.) The last column (M&E Out-of-Pocket) is for meal and entertainment expenses. For these expenses, only 50% of the cost is generally deductible. That means you'll be picking up a larger share of the costs. And you might want to think twice about adding some of those options to the truck if you're paying for most of the cost.
For 2016--Some points. First, we've added state taxes to the table to make it a little more realistic. We've assumed a flat 5% rate for the state rate. It's obviously more complicated. Rates are often graduated based on income, and they vary from state to state. Many state rates are higher. Moreover, you could get a deduction for state taxes on your federal return. The impact on you may be off a little, but not enough to really affect the analysis. Second, this table really only applies to individuals without a business and S corporation shareholders, since partners, sole proprietors and most members of LLCs are subject to the self-employment tax (we'll deal with that in a minute). Third, the tax brackets shown for individuals apply to 2016; the brackets are adjusted annually for inflation. Fourth, we haven't taken into account the alternative minimum tax or the Medicare tax on earned income. Finally, a business deduction will affect your AGI which can have other tax effects. For example, a $30,000 deduction by your S corporation for an equipment purchase will reduce AGI which could allow you to deduct rental losses that were denied because your AGI exceeded the threshold. Or the deduction could keep you out of the 39.6% bracket, resulting in capital gains being taxed at 18.8% (including the net investment income tax) rather than 23.8%. Or put you into a lower bracket. There's no easy way to account for that. And it can be important. As a result of benefit phasedouts that $30,000 truck deduction could allow you to claim the American Opportunity Tax Credit of $2,000. If you're curious about the exact impact, you've got to put the numbers in tax software. Despite the cautions, the tables will give you a pretty close approximation of the cost you're picking up.
Taxable Income Your State Pays M&E Out-of- (Married, Joint) Tax Rate Out-of-Pocket Fed Pays (5% rate) Pocket Over But not over $ 0 $ 18,550 10% $0.85 $0.10 $0.05 $0.93 18,550 75,300 15% .80 .15 .05 .90 75,300 151,900 25% .70 .25 .05 .85 151,900 231,450 28% .67 .28 .05 .84 231,450 413,350 33% .62 .33 .05 .81 413,350 466,950 35% .60 .35 .05 .80 466,950 ...... 39.6% .55 .40* .05 .78 * rounded to nearest whole percentage
Since the table is based on $1, you can use it to figure your out-of-pocket cash for any outlay by simply multiplying the decimal amount by the expenditure. It's clear from the table that if you're in the 15% bracket, you'll be paying for 80% of the cost of the truck. Thus, your out-of-pocket cost for a $30,000 truck would be $24,000. On the other hand, if you're in the highest bracket, your cash outlay will be only $16,500 ($30,000 value less $13,500 in tax savings). In the case of meal and entertainment expenses that are subject to the 50% disallowance rule, you'll be picking up 85% of the expense if you're in the 25% federal bracket--more in lower brackets, less in higher brackets.
The approach is the same for regular corporations. The only difference is the tax rates.
Tax Your Out- State Pays M&E Out-of- Income Over Not Over Tax Rate of-Pocket Fed Pays (5% rate) Pocket $ 0 $ 50,000 15% $0.80 $0.15 $0.05 $0.90 50,000 75,000 25% .70 .25 .05 .85 75,000 100,000 34% .61 .34 .05 .81 100,000 335,000 39% .56 .39 .05 .78 335,000 10,000,000 34% .61 .34 .05 .81 10,000,000 15,000,000 35% .60 .35 .05 .80 15,000,000 18,333,333 38% .57 .38 .05 .79 18,333,333 .......... 35% .60 .35 .05 .80Since the corporate tax rates can be higher (than those for individuals) in the lower income ranges, a deduction can be worth more (state rates can approach 10%). If your corporation's taxable income is between $100,000 and $335,000, your out-of-pocket cost may be only $0.56 of every dollar of expenditure. But keep in mind that you're still picking up more than half the cost.
If you do business as a sole proprietorship, partnership, or LLC, you'll be subject to the self-employment tax (the self-employment tax is basically social security taxes for self-employed) on the business income. The tax is generally 15.3% of 92.35% of your self-employment income up to the FICA cutoff of $118,500 (for 2016 amount). For a sole proprietorship, your self-employment income is your net income from the business. (Things can be somewhat more complicated for a partnership and LLC, but the same rules generally apply.) Above $118,500 (2016) only the 2.9% Medicare tax applies (we'll ignore the 0.9% for the additional Medicare tax). For salaries and self-employment income above $200,000 ($250,000 married, joint) that's an additional 0.9%. And the table assumes that all your income is earned income (i.e., partnership, wages, etc.). You could have a combination of self-employment income and S corporation income, or income from an LLC where you're not a managing member. In that case use the first table, above.
For 2016--Notes: * - Effective tax rate for the rates shown is the income tax rate plus the FICA rate (or Medicare tax) plus the state rate. For the first three rates we've adjusted for the deduction of one-half of the self-employment tax on an individual's return. The difference is nominal for the 2.9% tax.
Taxable Income Effective Your State Pays M&E Out-of- (Married, Joint) Tax Rate Rate* Out-of-Pocket Fed Pays (5% rate) Pocket Over But not over $ 0 $ 18,550 10% + 15.3% 29.5% $0.70 $0.25 $0.05 $0.84 18,550 75,300 15% + 15.3% 34.2% .66 .29 .05 .83 75,300 118,500 25% + 15.3% 43.4% .57 .38 .05 .78 118,500 151,900 25% + 2.9% 33.0% .67 .28 .05 .84 151,900 231,450 28% + 2.9% 35.9% .64 .31 .05 .82 231,450 413,350 33% + 2.9% 40.9% .59 .36 .05 .80 413,350 466,950 35% + 2.9% 42.9% .57 .38 .05 .79 466,950 .......39.6% + 2.9% 47.5% .52 .43 .05 .76
Please keep in mind that this is a rough calculation with a number of simplifying assumptions. If you want a closer answer, try entering the information in your tax software.
The only difference in the table from the one for married filing joint above is that we've included the self-employment tax. The taxable income ranges are slightly different because we've had to cut the 25% bracket at the FICA cutoff at $118,500 (2016). Clearly, if you're doing business as a sole proprietorship, partnership or LLC, the federal government is picking up a larger share of any expenditure. We haven't taken into account the 0.9% additional medicare tax and we've assumed that all your income is subject to the self-employment tax. While that would change the outcome, those assumptions are reasonable. Even so, at best, you'll be out-of-pocket for 53 cents on every dollar.
Not married filing joint? Just go to our current tax tables and look up your rate bracket based on your taxable income.
Finally, the exact value of a deduction depends on the time value of money. If you can expense that $30,000 truck (using the Sec. 179 expense option) in the year of purchase, you'll be much better off than if you have to depreciate it over 5 years. Or, in the case of many other assets, over a longer period of time. And, if you sell the asset after deducting the cost, you'll have repay some of the deduction.
Copyright 2006-2015 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536
--Last Update 11/17/15