Is Starting a Small Business for the Tax Deductions Worth It?
I’m pretty notorious in my circle of friends for making sure that I get a receipt for anything I could conceivably write off as a business expense — I want every last tax deduction I qualify for. As big a fan as I am of business deductions, though, there’s a piece of financial advice that crosses my desk on a regular basis that may not make as much sense as it seems to on the surface — starting a small business for the tax deductions. It just isn’t as simple as it sounds. (See also: 16 Great Tax Deductions You May Have Overlooked)
A Question of Qualifying Deductions
The logic behind starting a business to get a few more tax deductions makes sense at first glance. You can write off some of the gas for your vehicle, maybe some of your rent or mortgage for a home office, and even the occasional meal. Maybe you’ll even make a little money along the way.
But the reason that the IRS will let you write off business expenses is because you’re spending money beyond what you normally would for your personal life, with the intention of building up a business. You don’t have the option to write off any of the expenses you already have before you start up this hypothetical business. And if the IRS even suspects that you’re writing off personal expenses as part of your business, you can be required to pay additional taxes, plus penalties.
You’ve Got to Make Money
On top of being able to prove that your expenses are directly related to your business, you have to be able to show a profit from your business. It’s true that the IRS doesn’t require you to make money off the bat. There are even provisions in place to make sure that a bad year doesn’t cause the IRS to reclassify your business as a hobby. But you do have to turn a profit for three out of five years when you’re operating your business. Otherwise the assumption is that you’re not motivated by profit and therefore not really running a business.
Actually, operating a business that turns a profit is hard. Even if you’re just working on the side and you’ve got a full-time job that can subsidize your business, it’s a big time commitment. If you aren’t interested in running a business — if you’re just after a tax shelter — it’s just not worth the effort.
Better Tax Options
There are much easier ways to save money on your taxes than starting a whole new business. Anyone who tells you otherwise probably didn’t start a business exclusively for the tax benefits, if they’ve followed all the rules when it comes to operating a business in the first place. You’d be better off from a tax point of view by looking for opportunities to donate to nonprofits.