Small Business Taxes & Management^TM--Copyright 2020, 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 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 2021--

    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   $  19,900     10%         $0.85        $0.10      $0.05      $0.93
  19,900      81,050     12%           .83          .12        .05        .91
  81,050     172,750     22%           .73          .22        .05        .87
 172,750     329,850     24%           .71          .24        .05        .86
 329,850     418,850     32%           .63          .32        .05        .82
 418,850     628,600     35%           .60          .35        .05        .80
 628,300     ......      37%           .58          .37        .05        .79

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 22% bracket, you'll be paying for 73% of the cost of the truck. Thus, your out-of-pocket cost for a $40,000 truck would be $29,200. On the other hand, if you're in the highest bracket, your cash outlay will be only $23,200. In the case of meal expenses that are subject to the 50% disallowance rule, you'll be picking up 87% of the expense if you're in the 22% federal bracket--more in lower brackets, less in higher brackets.

Corporations are now taxed at a flat 21% (we've assumed another 5% for state). That means the business's out-of-pocket expense would be about $0.74 for most expenses; $0.88 for meals.

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 $142,800 (for 2021 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 $142,800 (2021) 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.).

For 2021--

   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   $  19,900  10% + 15.3%   29.5%        $0.70       $0.25     $0.05      $0.85 
  19,900      81,050  12% + 15.3%   31.3%          .69         .26       .05        .84
  81,050     142,800  22% + 15.3%   41.4%          .59         .36       .05        .79
 142,800     172,750  22% +  2.9%   29.9%          .70         .25       .05        .85
 172,800     329,850  24% +  2.9%   31.9%          .68         .27       .05        .84
 329,850     418,850  32% +  2.9%   39.9%          .60         .35       .05        .80
 418,850     628,600  35% +  2.9%   42.9%          .57         .38       .05        .79
 628,600     .......  37% +  2.9%   44.9%          .55         .40       .05        .78

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 $142,800 (2021). 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. Find the rate for your bracket and use it the table above.

Finally, the exact value of a deduction depends on the time value of money. If you can expense that $40,000 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.

--Last Update 12/11/20