When you have a profitable year, you might be looking at ways to decrease your taxable income, and thus your taxes. There are many ways to achieve this, and many business owners come across advice to “just buy some assets,” especially a car. While this can be a great way to decrease taxable income in one year, in order to make the best decision, you have to understand the full short-term and long-term economic implications.
Assets are typically used over a long period of time and are thus depreciated as used instead of expensed when incurred. The IRS gives business owners a few options for depreciating assets, which allows for tax planning to maximize savings. Follow these tips to maximize your tax savings when purchasing an asset.
1: Understand Your Options
Depending on the type of asset, there will be different options for deducting or depreciating it. You have to understand the time period that regular depreciation allows as well as options for bonus depreciation or Section 179 deduction. Once you know your options, you can begin your process to choose the best one.
2: Estimate Marginal Tax Bracket
The only way you will have genuine tax savings from choosing different depreciation schedules is if your marginal tax brackets change from year to year. If your tax bracket never changes, then it would not matter what depreciation schedule you choose since your tax savings would be the same each year. Bonus depreciation or Section 179 deduction are typically only beneficial in years when income is abnormally high and you are in a higher tax bracket.
3: Project Your Income
You need to project your income over the same time as your asset depreciation. For an asset with a five-year life, you need to project your income over five years. This will allow you to see the impact of your different depreciation options. If your income is increasing, then your tax savings will be more using regular depreciation rather than bonus or Section 179.
4: Calculate Tax Savings
The actual tax savings from choosing different depreciation options will become evident only once you sell the asset. Thus, any calculation for tax savings will depend on projections and assumptions, which can easily change. However, breaking down the numbers can make it easier to make a decision. Always be mindful of your assumptions and their impact on your decision.
5: Evaluate Economic Cost
As much as tax savings is a great reason to buy assets, it’s not always the most prudent economic choice. Evaluated tax savings from an asset purchase should be considered as a discount. Remember, you are still spending money; thus, if the purchase was unnecessary, economically, you will be worse off. Use the tax savings amount as an additional bonus, not as the basis for purchasing an asset.
Asset purchases can be a cornerstone of tax planning as they can make large swings in your taxable income. Always strive to understand your options so you can make the best decision. This type of tax planning isn’t something you should do without professional help, so be sure to reach out to your tax professional for guidance.
This article originally appeared on Forbes