Should You Reduce Your Taxes By Reducing Your Income?

The answer is clear: No!

Family child care providers who have asked me a version of this question over the years are focusing on the taxes they pay, rather than the profit they earn.

Would you be better or worse off in these situations?

• You raised your rates, or started enforcing your late pick up fees, or started charging a registration fee and earned $100 more per month

• The Food Program increased its reimbursement rates

• You won $1,000 in your state lottery

In all of these situations your taxes would be higher. But you would be better off after paying the taxes!

Let's look at the first example.

You earn $100 more per month, or $1,200 more for the year. You will pay 15.3% Social Security taxes on this amount, plus federal and possible state income taxes. Your income taxes will be based on your family's adjusted gross income and might range from a total of 15% to 30%. So, your total tax on the $1,200 will be somewhere between $360 (15.3% + 15% x $1,200 = $360) and $540 (15.3% + 30% x $1,200 = $540).

Therefore, after you pay these taxes you will have somewhere between $840 ($1,200 - $360 = $840) and $660 $1,200 - $540 = $660).

Are you better off with an extra $660-$840 in your pocket after taxes? Yes! Is this still true even though your taxes went up by $360 to $540? Yes, again!

So, do not focus on how much tax you are paying. Instead, look at your profit. You always want a higher profit, regardless of how much extra in taxes you will pay on this profit. Your tax rate will never be above about 45%, so you will always be keeping at least 55% of extra income/profit after taxes.

Buy more?

Sometimes providers ask me a slightly different question:

"My expenses are less this year than last year, so I'm think about buying more toys so I don't pay more taxes this year. Should I do this?"

Whether you are trying to reduce your income or increase your expenses, my response is the same. Don't do it!

You never want to spend money just to get a deduction. If you spent $1,200 more in a year and were able to deduct it all, your taxes would go down by about $360 to $540. Your taxes would never go down by $1,200. Why spend $1,200 to get back $540 from the IRS? Instead, keep your money. Only spend it on things that are necessary to improve the quality of your program.

In conclusion: you always want more income and you never want to spend money just to get a tax deduction.

Tom Copeland - www.tomcopelandblog.com

Image credit: https://commons.wikimedia.org/wiki/File:Putting_money_into_a_piggybank.jpg