Quick Definitions (Taxes, Depreciation, Deductions, Tax Credits)

What are Taxes?

Think of the government as a giant company. By living in the country, we are in essence agreeing to buy all of the goods and services that the company (the government) provides. The taxes are the payment. The same way as going to the store and spending 5 dollars to buy a sandwich, the taxes you spend are your payment for all actions of the government.

What is Depreciation?

All objects (property, equipment, etc.) have effectively a life span. Eventually an object will break and become unusable. Occasionally there is some value to the raw materials so that object can be sold for scrap. Usually at this point it isn’t worth anything, so its value is zero. However, in real life, it is not always completely known how long an object will last. If someone takes very good of their car, it might last many hundreds of thousands of miles. If someone treats their car badly it might last only 10,000 miles. So the government has to arbitrarily assign a useful life to various objects within your business. Over time that object (on paper) will decrease in value, which can be used to offset your income and thus reduce income taxes.

It is a paper loss because that object due to maintenance, quality craftsmanship etc. might not actually be any less valuable. For example: you bought a piece of equipment that will survive (according to the government) 10 years. Brand new the equipment is worth $10,000. So the equipment (according to the financial statements) gets less valuable by $1000 each year. So if you earned $100,000 in income, you can offset that $100,000 with your $1000 “loss”. So you would only pay taxes on $99,000.

What are Deductions?

With income tax you are taxed on the money you earn. The more money you earn, the more money you pay. Deductions are a way you can offset your income. It reduces the amount of income you earned for the year. Thus you pay less tax. You are allowed to deduct business expenses, which means any income you use on business is income you don’t have to pay tax on. For example: A person earns $100,000 and spends $30,000 on business expenses. They would only be taxed on $70,000.

Before anyone start scheming ways to reduce their taxes, they should know that these deductible business expenses to be eligible have to be ordinary and necessary to the operation of your business. For example: you can deduct the cost of your stationary, but you can’t deduct the parking fines you got for incorrectly parking the company car. The IRS will come down on you like a hammer if you try to abuse the system, and they are pretty good at finding things out. In addition to ordinary and necessary business expenses, you are allowed to deduct loan interest and a few other things. You can find out all things that are allowed to be deducted by talking to your accountant.

What are Tax Credits?

Tax credits are a direct offset to taxes paid. For example: if you owed $1000 in taxes, and you got a $100 tax credit, you would then only owe $900 dollars in taxes. Most tax credits that you are eligible for depend on your total amount of income. Some depend on disability, whether or not you’re conducting research, etc.

Fee Structure

Rate Assets Under Management
1.44% Below $125,000
1.00% Between $125,000 and $750,000
.85% Between $750,000 and $1,250,000
.80% Between $1,250,000 and $1,750,000
.75% Between $1,750,000 and $2,500,000
.70% Between $2,500,000 and $3,250,000
.65% Between $3,250,000 and $4,250,000
.60% Above $4,250,000

A single rate is applied to the entire account. So a person with a $750,000.01 account pays less than a person with a $750,000 account. I will waive personal tax return fees for accounts over $1 million. For accounts that are above $5,250,000, we’ll need to discuss a custom rate.

As I’m writing these to help my readers, I would be very appreciative of any input in regards to what I should write next. If you want me to write about a particular topic, please contact me. If you would like to submit a post to my blog, please contact me.

If anything that I mentioned above interests you, please consider downloading my free e-book. The book contains my thoughts on investment management and some information that I think everyone should know. You can also download it below.

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Questions for the comments

Did my explanation make sense? Do you agree or disagree with what I said?

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