RTS #024 What can I actually deduct?
“That might be tax deductible; let’s explore it together.”
That’s the line I use when taxpayers determine whether something is tax deductible, which happens constantly. Taxpayers understandably want to make sure they pay as little tax as possible, and trying to dream up tax deductions based on TikTok videos and clickbaity online articles seems like a more and more common occurrence.
The reality is that nearly every potential tax deduction is situational. Like all tax planning, it needs to be personal and specific to a taxpayer’s individual circumstances before we can know for sure if they can actually deduct whatever expense we happen to be talking about.
Here are a few common areas for misconceptions from taxpayers:
- Having an LLC means I can deduct anything I want – an LLC is a legal structure, not a tax status. Regardless of the legal structure of a business, the IRS has very specific rules on what counts as a business deduction. “Ordinary and necessary” are the two words the IRS uses to describe what can be deducted. This means that having a business, even an LLC, does not mean a person can suddenly deduct every swipe of their credit card.
That doesn’t mean that taxpayers with businesses shouldn’t be proactive and creative, but there are limits. One opportunity that does get missed often is reporting charitable contributions as marketing for a business instead of on Schedule A. The donation has to be made in the name of the business, but this is a great way to get a tax benefit from charitable contributions regardless of where a taxpayer is relative to the standard deduction and helps reduce self-employment income.
- Mortgage interest is always deductible – even 6 years into the Tax Cuts and Jobs Act, people seem genuinely surprised at how high the standard deduction is. To be able to deduct mortgage interest, it has to be on a taxpayer’s primary home, and they have to have deductions that exceed the standard deduction ($27,700 for a couple filing jointly in 2023). On top of that, there are limits on how much interest can be deducted based on the value of the taxpayer’s home.
- Charitable giving is always deductible – again, we have to contend with the standard deduction, and in this case, there are also limitations on how much of a deduction a taxpayer can take in a single year relative to their adjusted gross income. Different types of gifts have different limitations, and COVID changed the rules for a couple of years, but for 2023, we are back to AGI-based limits on charitable giving. So, while bunching and donor-advised funds can be great tools, we have to make sure we aren’t getting carried away. As mentioned above, “advertising” through a business instead of making a traditional charitable contribution is one alternative.
- Medical expenses don’t seem to ever make a difference – this one is somewhat understandable that people believe because for medical expenses to be deductible, a client has to be over the 7.5% AGI floor specifically for medical expenses AND over the standard deduction. On top of that, the IRS hates double dipping, so be particularly careful with clients who are eligible for the Premium Tax Credit or who use an HSA or HRA. All that being said, it’s an important question to routinely ask, especially for clients who are over the standard deduction. This can also be a great area for planning for clients with elective medical procedures or medical procedures that are not time-sensitive (think charitable bunching).
We want clients to come to us with questions and to think proactively, so how you communicate on these topics is important. Make sure you respond positively no matter how confident you are they are wrong. “Let’s explore that together,” and then having a guided discovery is a more valuable experience for the client than simply saying, “you can’t deduct that”.
What can you do about it?
Two things that we consistently see the best Advisors do when it comes to tax planning:
- Regularly include taxes as an agenda item during client meetings. Even if you don’t have a specific strategy to address in that meeting, this helps get it top of mind and make sure that taxes get addressed every year (since the IRS expects you to pay taxes every year).
- Set the expectation with the client that you want to be involved in every money decision, including taxes. If the client sees you as separate from the tax discussion, they won’t come to you with questions, and unfortunately, they most likely aren’t getting help and education from their tax preparer.
Happy Tax Planning!