The Philosophy Of Tax Deductions

The Dad-a-Base
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[00:00:00] Steve: I could read you a dad joke from my "dad-a-base."

[00:00:04] Tyler: From your "dad-a-base?" Oh my gosh.

[00:00:08] Steve: This cup they got me for my birthday.

[00:00:10] Tyler: You know what irritates me about dad jokes is that every time I hear one, I've never heard it before.

[00:00:20] Steve: And so

[00:00:21] Tyler: There's just so

[00:00:22] Steve: it gets you every time.

[00:00:23] Tyler: Yeah, it's, well, it just makes me roll my eyes every time, but Yeah,

[00:00:29] Steve: Are you a fan of dad jokes?

[00:00:31] Tyler: Um,

[00:00:32] Steve: well, and let me, let me phrase that two ways. Do you like telling dad jokes and do you like hearing dad jokes? Because I think the experience is different on either side,

[00:00:43] Tyler: I would... I would say publicly that I don't enjoy telling dad jokes, and I think that would be because that's the socially acceptable thing to say, and because I don't have good ones. I don't, I don't think of them very well, right? But when I do, oh yeah, it feels so good.

[00:00:58] Steve: right?

[00:00:59] Tyler: So, I'm a hypocrite. Yeah, I hate him, but, you know, I'm a participant, for sure. I

[00:01:04] Steve: I i, like telling them if, if they're, if they're good ones. And if you can, if, if I hear one that it's just got a really good pun or something. I love that. I, I have no shame about laughing.

[00:01:18] Tyler: mean, the desired reaction really is an eye roll, right? I think that's more of the aim than to get a laugh, right? It's just like, ugh, a groan from your teenager, probably. I mean, I don't know.

[00:01:26] Steve: Mm

[00:01:27] Tyler: So,

[00:01:28] Steve: hmm. I'm looking forward to that because my, my kids are not teenagers yet, but they'll, they'll still roll their eyes or, or groan. But from a teenager, that's, that's gonna be great.

[00:01:38] Tyler: it's going to be brutal. Yeah.

[00:01:48] Steve: Hello, dear listener. I am Steve.

[00:01:51] Tyler: And I'm Tyler, and this is another episode of It's Not About The Money, our podcast where we discuss a wide range of topics related to creating and running small businesses.

[00:02:02] Steve: Tyler and I both run small businesses and, uh, like, like you perhaps. And this podcast is our attempt to make sense of the world of business and personal life and taxes and everything else. One episode at a time.

Should you buy that truck for your business?
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[00:02:16] Tyler: That's right. And after doing a bunch of episodes about stuff I wanted to talk about, Steve has, uh, twisted my arm and convinced me that it's time to talk about taxes again. And in this case, particularly tax deductions, how, you know, what they are, how you can get them, the philosophy around them, et cetera.

Yes. Yes.

[00:02:36] Steve: Yep. I, I am, after all, a tax professional. So this is a thing that lights me up. got to talk about it sometimes. But before we start, uh, we, we don't always have a disclaimer on here, uh, because we're usually not giving like specific advice or, well, I don't think we're ever giving specific advice. I don't know.

Maybe we are. But anyway, the disclaimer for this time, none of this is tax or legal advice. Consult your own professional. I am a tax pro, but I'm probably not your tax pro. And so I can't give you specific advice about your taxes. Talk to your own, folks, but

[00:03:12] Tyler: So now we can say anything we want. Right. Since we're off the hook,

[00:03:16] Steve: You can use this for general information

[00:03:18] Tyler: educational purposes. Yeah.

[00:03:19] Steve: yeah, yeah, yeah. So I had a discussion with a client recently and I don't remember exactly the details of it, but I had a realization about tax deductions that you usually have to spend money to get them, like there's no free lunch. Which sounds kind of obvious now that I'm saying it, but it was sort of a realization for me. Um, and like. The classic example is probably like, I should go buy a truck for the business because then I can write off a bunch of money that I spent on the truck. And well, like if you need a truck for your business, then yes, by all means go buy the truck for the business, but don't. Don't, uh, go chasing a tax deduction for a truck if you don't need a truck.

Does that make sense?

[00:04:06] Tyler: it would be cheaper not to buy a truck either way. Right.

[00:04:09] Steve: Right. You, you will save some money on taxes. Yes. But you had to spend a bunch more than that to get the truck in the first place.

[00:04:17] Tyler: Right.

[00:04:19] Steve: So that's sort of the, uh, the, the general thread that runs through all of these, all, all of the ones that I could think of, at least,

[00:04:28] Tyler: So I'm curious, do you feel like the general populace has some misunderstandings around this as you work with your clients? Like, is this something that you encounter?

[00:04:38] Steve: uh, it does come up occasionally. Uh, especially if we're into like March or April and a client will come along and say, get, you know, let's get my taxes as low as possible, get all the deductions. Like, yes, we'll get you everything that you're entitled to according to what happened last year. But, uh, the, the time for making those decisions is past for most of these anyway. So it needed to, it needed to happen during the year as a. business decision or as a, uh, personal, the way you're running your personal financial affairs, that it made sense to do the thing that would result in the deduction at the time. And there's not always a lot I can do at when we're coming to filing your taxes.

If I haven't been working with you before that,

[00:05:28] Tyler: Yeah, so, I mean, as a relatively new small business owner, I think, you know, especially towards the beginning, if you go back to like our very early episodes on this podcast, we kind of talked about this a little bit and, uh, how business expenses can be written off, uh, taxes

[00:05:44] Steve: right,

[00:05:45] Tyler: depending on what they are and, you know, depending on how much, and, you know, I think I fell prey early on to this idea that like, oh, like Business expenses don't count because it's a tax write off or like, you know, I'm actually saving money by, but, but to your point, no, no, no.

Like tax write offs are not equal in amount to the amount that you spent on the thing that is earning the write off. Right. Obviously. Or else it'd be like an infinite money glitch. That'd be pretty cool.

[00:06:11] Steve: There's no perpetual motion machine here in the tax code.

[00:06:14] Tyler: Yeah. Yeah. So, so I'm curious, what can you teach us about, uh, tax deductions? Like why do they exist? What's the point of them? Is it just to make filing taxes harder?

[00:06:28] Steve: to make work for people

[00:06:29] Tyler: Yes.

[00:06:30] Steve: So that keep us in business. Uh, right.

Taxes as a tool for policy goals
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[00:06:33] Steve: The, the high level idea here is that tax deductions are a tool for achieving policy goals. And so cynically that's either, uh, they're a reward for getting, for doing the things that the government wants you to do, or, uh, in a more optimistic, uh, point of view, they're an incentive for pursuing the kinds of activities that we as a society have decided to encourage.

At this time, and they will change over time,

[00:07:03] Tyler: I like, I like the, you basically said the same thing, uh, twice. The cynical version and the, uh, uh, optimistic version of that. I like that. That's, that's funny.

[00:07:14] Steve: it's just, it's just, uh, the level of analysis of like, who's making the decisions about the policy goals. Is it us as the people, or is it the, some, you know, Washington?

[00:07:24] Tyler: Right.

[00:07:24] Steve: Yeah. So that's the high level idea and our tax code, at least currently in America. Uh, is set up to encourage a lot of things like child rearing and home ownership and real estate development and small business and big business too, frankly, uh, charitable donations, those kinds of things.

So if you're doing those things, like we've decided those are good for the society. And so if you're doing those things, we'll. Give you some credit for it.

[00:07:55] Tyler: Right. Because by doing those good things, I suppose the theory goes that's money that if no one was doing those things, we'd have to spend tax dollars on to achieve good outcomes anyway. So if you're going to do it of your own free will and choice, we'll cut you a break on taxes. Or am I reading too much into that?

[00:08:13] Steve: Yeah, no, I think that's accurate for some of them. Uh, and then others like child rearing, like we need, we need children for the society to continue functioning into the future. And so like no amount of money paid, uh, can like create humans. And so we need humans to create humans. And so let's encourage that activity, that sort of thing.

[00:08:35] Tyler: That's interesting. I remember in college, I took a political science class. I actually minored in political science.

[00:08:42] Steve: Oh, okay.

[00:08:43] Tyler: one section that we studied was, uh, we spent a whole section on demographic studies. So basically, you know, the different types of populations out there and how, what affects them and things.

And, and at the time I remember learning that no. No population has ever recovered after their fertility rate drops below like the replacement rate. And so for governments who are interested in continuing to have a country with people in it, child rearing actually is super existentially important. And so it's interesting that that's financially incentivized.

That's how they've chosen to approach it in our country.

[00:09:16] Steve: Yeah, the replacement rate is like 2. 1 or something,

[00:09:20] Tyler: just over two,

[00:09:23] Steve: Yeah, that makes sense. You need to replace both of the parents and,

[00:09:27] Tyler: a little bit

[00:09:28] Steve: and, and then factor for early death or whatever else. Yeah, okay.

The philosophy of tax deductions
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[00:09:34] Steve: Uh, good. So, let's see. We could probably talk about a few of these here and like how this What I'm calling the philosophy of tax deductions manifests.

So if we take kids, for example,

[00:09:49] Tyler: Yeah.

[00:09:50] Steve: um, you're not getting a free lunch with the 2, 000 a year child tax credit, because it costs, it costs way more than that to raise a child.

[00:10:01] Tyler: It costs way more than that to give birth. I mean, you know, at the hospital.

[00:10:05] Steve: I mean, yeah, just beyond that, that's a huge cost to start with physically and, uh, and financially.

[00:10:12] Tyler: Yeah,

[00:10:14] Steve: And then, while you're raising the kid, you have to pay lots of people for the goods and services needed to raise your child.

Food, childcare, activities, clothing, uh, medicine, doctor's visits, vaccinations, all of those things. And so, that adds up to way more than 2, 000 a year, but it is nice. And that one, that one I should say though, actually is a credit, not a deduction, which means that a deduction is reducing your taxable income

[00:10:49] Tyler: Uh huh.

[00:10:50] Steve: and a tax credit is after the amount of tax due has been calculated, reducing that amount of tax due.

So the tax credit is actually a lot more powerful than a, just a deduction.

[00:11:06] Tyler: I actually did not realize that even though it's called the child tax credit, it never occurred to me. I don't have any children. Maybe that's why, but that's cool. So it's more potent than the regular deduction in that sense.

[00:11:16] Steve: Yeah. Yeah. So, so actually, now that I'm thinking about it, this is probably, that one's less of a good example than these other ones that we'll talk about, but,

[00:11:25] Tyler: Because it's not a

[00:11:26] Steve: because of that distinction of a credit versus a deduction.

[00:11:29] Tyler: Yeah.

[00:11:30] Steve: Uh, but anyway, let's go through some more, um, charitable deductions. The, the cost there to you is you have to give someone else money. Uh, and the benefit is you get to reduce your taxable income by that amount, but. The caveat there is only if you give lots of it, lots of money or goods or whatever

[00:11:54] Tyler: What do you mean by that? Like why, why is it, uh, that way?

[00:11:57] Steve: This is because of the way the standard deduction works. You can deduct charitable donations if you itemize, but the standard deduction is so high now that most folks don't need to itemize to get Or like if they did itemize, it would be still be less than the, the standard deduction.

At, at one point in the last couple of years, there was, if you, uh, took the standard deduction, you could still deduct $600 of charitable deductions without having to itemize.

But that's not, uh, there anymore. So this one, uh, like we want to incentivize giving to charities because they do good work in the world, uh, and in ways that the government may or may not do, uh, because they're doing different things or serving different people, whatever it might be. Uh, anyway, but that one, that one's a little more complex about how it gets incentivized through deductions.

[00:13:01] Tyler: complex. Meaning you just have to overcome the standard deduction for it to be worth anything on its own.

[00:13:08] Steve: Right. Yes.

If you have other things like, is it the, the, the big things that cause people to itemize are mortgage interest and property taxes... And, and, uh, state and local taxes. So if you own real estate, uh, and especially if that real estate is in a state that has high property taxes, like Texas, for example, uh, then, uh, you're more likely to be able to itemize and then your charitable donations are itemize.

[00:13:46] Tyler: Um,

[00:13:50] Steve: So anyway, uh, but, uh, on like real estate, you're, you have to pay your lenders and the local government for the privilege of owning the home that you live in, that's the cost you pay for being able to get the deduction. Uh, an IRA contribution is, is kind of a fun one. You have to give someone money, but the, the someone is future you.

[00:14:15] Tyler: I like the sound of

[00:14:15] Steve: So like you get to deduct it now. Uh, because you're giving it to your future self,

[00:14:20] Tyler: And this is a,

[00:14:21] Steve: who, who, future you will then have to pay taxes

[00:14:24] Tyler: yes, this is a traditional IRA, correct?

[00:14:27] Steve: Yeah, traditional IRA, uh, Roth is the other way around. You pay taxes on it now, but you don't pay taxes in the future. Uh, yeah, I don't know. We could go through a couple more, but I think you kind of get

[00:14:45] Tyler: Yeah, no, I get the idea. So I'm, I'm actually curious since you are calling this the philosophy of tax deductions, what is your take on the philosophy behind raising the standard deduction so much? Like, is the, because wouldn't that like disincentivize some of these behaviors since people like, you know, it'd be harder for them to itemize.

[00:15:08] Steve: Uh, yeah, it does. So that is a good question. Um, I'm not sure what the. motivation there is other than making it easier for folks that are not already in these situations to get a break on their taxes,

[00:15:28] Tyler: that, so, so if they weren't itemizing before, now they could potentially have a lower tax bill because the standard deduction is higher.

[00:15:37] Steve: yes, that's right. Uh, and if you were itemizing before, then you may still be able to itemize. The folks that are already well, uh, well situated enough that they have these costs of they own real estate, uh, they are in a, in a place where they can give generously to charities, those kinds of things,

[00:16:04] Tyler: Yeah.

[00:16:06] Steve: we, we want to encourage those behaviors toward our policy goals, but, uh, we don't want to leave behind everyone else who's below that threshold. And so that's, that's probably why the standard deduction is higher.

[00:16:20] Tyler: I mean, uh, there's probably political reasons as well, which I'm not qualified. I mean, um, back to your cynical approach on things. There's all the, there's always the politics of it. Right. So,

[00:16:32] Steve: the, the current higher standard deduction was part of the tax cuts and jobs act in 2018 during the Trump administration. And it's set to expire in a couple of years anyway, unless Congress renews it. So this, you know, here's another point where it's, it's, it's always changing,

[00:16:50] Tyler: I was going to ask you, like, how often as a tax preparer, like how often does the tax code change enough that it impacts, like you have to relearn everything or like you have to be aware of things that are changing is every year.

[00:17:04] Steve: uh, relearn. Everything,

[00:17:05] Tyler: I shouldn't say relearn

[00:17:06] Steve: is rather infrequent, but, uh, but yes, there's, there's usually enough that has changed each year that you have to go, uh, study up on the differences.

[00:17:18] Tyler: Does the IRS produce any like help documents about this? Like here's what's changed or is it up to you to stay on top of all of these things?

[00:17:27] Steve: they do have a lot. I typically get, uh, my summaries of what has changed through continuing education. Companies, uh, because part of maintaining my credential as an enrolled agent is I have to do a certain amount of continuing education each year. And one of those courses that I almost always take is the federal tax update.

You know, if I haven't already read enough about it through other means, then a couple of my continuing education credits will be, uh, the class to, uh, refresh me on what has changed this year.

[00:18:06] Tyler: Okay. That's interesting.

Tax planning season
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[00:18:08] Tyler: Well, Steve, I want to go back to something you said earlier though, which is sometimes when you're in tax filing season, people come to you and say, I'd like to get as many deductions as possible. Well, the tax year is already over. Right? So you said a lot of the actions that, that someone can do to, to get deductions for, you know, that it should have happened before December, for example. Right? So when, when is the right time to start talking to your tax professional about this kind of stuff in the year?

[00:18:36] Steve: okay. That's a good point. I'm glad you asked that because when this episode goes out, it'll be, I don't know, middle of November. That's kind of like, there's still time to make these kinds of decisions for 2023. And that's probably the right, you know, that's probably the right time to think about those things if you haven't already done it earlier in the

[00:18:58] Tyler: Uh huh.

[00:18:59] Steve: But you, you've still got time to make those moves where it can count for 2023. So, uh, you know, it's, it's kind of tax planning season. And so if you have a tax pro. Now's a great time to talk to them, like run projections, like do, you know, another one is like, have I made enough, uh, estimated tax payments that I'm not going to have a surprise in April?

This is also the time to run that calculation, uh, in case you need to increase your withholding on your W 2 or make additional estimated tax payments. So that's always a great one to ask, but also.

your tax pro can understand your situation and what the, what would make sense for your business and your personal finances? Uh, what kind of decisions could you make now that would impact your lowering your tax bill in April? This is the right time to be asking those questions.

[00:20:01] Tyler: Okay, great. So just to summarize everybody, remember that, uh, spending money for the sole purpose of getting a tax deduction is really not going to save you money at the end of the day. So only spend on those things if you were going to anyway, right? Or if you need to for your business or something.

Um, and get in touch with your tax professional for any specific advice or questions.

[00:20:24] Steve: Right. Well, and I will caveat that with saying, because, because, because I have to, because it's always a, it depends.

[00:20:30] Tyler: Of course. Of

[00:20:31] Steve: So let me rain on your parade here for just a second. But it could be, it could be that, um, when you're looking far into the future of like, you know, that you're going to want to sell the business in the next five years, or you know, that you're going to have your revenue will go up next year or go down next year, those kinds of things where you can look into the future and do some tax planning.

And structure things where I need to make these moves now, even though if we were just looking at this year, it might not make sense to do that, but over the long term, it would. And so that's, obviously that's a very situation dependent kind of a question. So I don't really have anything specific to say on that, but there, there are some situations where that can come up.

[00:21:18] Tyler: Okay. And that's why you have a job. And I apologize for ever trying to summarize anything related to taxes in a succinct statement.

[00:21:29] Steve: Uh, well, we all try and it's, it's always, it's always much more complicated than, than maybe it needs to be. But I mean, again, these, these things and, uh, tax deduction specifically, and really the whole tax code is about. Trying to Achieve Policy Goals. And so it's a complicated way of getting there. I mean, and there's lots of special interests and things that creep into it as well.

So it's not, it's not all just, uh, the high and mighty ideals of let's, uh, incentivize the things that we want. I, I think on the whole, that's the general direction that the tax code takes.

[00:22:09] Tyler: Great. Well, thank you, Steve.

[00:22:12] Steve: You're welcome. Thanks for letting me twist your arm into this one.

[00:22:15] Tyler: Yeah, I'm sure it'll

[00:22:16] Steve: Because I know people love hearing about taxes.

[00:22:20] Tyler: Well, for better, for worse, it affects us all. So.

[00:22:23] Steve: It does.

[00:22:23] Tyler: Uh, thanks a bunch and, um, you can join us again on another episode of It's Not About The Money.