When you're filing a tax return for your business, you often can make choices about how you report different types of expenses. For example, in some cases, you can deduct the entire cost of a capital asset in the year of the purchase or you can opt to deduct it slowly over time.
Any potential savings for future years is called a deferred tax asset. Ultimately, tax advice varies based on your unique situation. But in most cases, you should opt for upfront savings over a deferred tax asset. Here's why.
1. Reducing your tax bill keeps money in your pocket.
When you use strategies that minimize your tax liability as much as possible, you get to keep the extra money in your pocket. You can reinvest the money in your business. Or if you want, you can give yourself a bonus owner's draw and use the money for fun.
2. Money has more buying power now than in the future.
Due to inflation, the same amount of money now has more buying power than the same amount of money in the future. Imagine how much you could buy with $20 in 1990, compared to 2020, for example.
If you could save $20 on your taxes in 1990, you could take that money out and buy all kinds of things. However, if you deferred the savings until a future year, that same amount would not be as worth as much.
When you keep the money, you can invest it into your business or into a stock or bond that's likely to earn money every year. Ideally, the investment's earnings should keep pace with or beat inflation. Investing the money prevents it from losing value over time.
You can invest money that you save by reducing your tax liability. You can't invest a deferred tax asset.
3. You can amend your return if needed.
You know the tax rate now, but you don't know what it's going to be in the future. If the tax rate goes down, you're better off claiming the deduction now when the income tax rate is relatively higher. However, if the tax rate goes up, you may be better off deferring the tax asset to the future.
Luckily, you can always amend. In general, the benefits of claiming a tax asset as soon as you can outweigh the benefits of waiting. But in the rare cases where you realize you should have deferred the asset, you can just have your accountant amend the tax return.
Trying to decide how to maximize your business deductions? Wondering if you should claim everything possible now or defer some of your tax assets? Then contact an accountant to help with your tax planning. They can guide you through these complexities.