Living on Pretax Dollars in a Post Tax World, Part Three - How to Take Tax Deductions Correctly

Are you paying too much in taxes? In the first two parts of this series, we addressed the need to have your own business and how that helps reduce your taxes, often dramatically. Read on for more details on how to make sure this system works the way it's supposed to.

First of all, it's crucial that you know how to take your deductions properly -- and keep good records. This would include retaining all receipts, maintaining good journals or diaries (scheduling programs like Outlook are very good for this). That's what this idea of living pretax in the after tax world is all about. You need to know where all the loopholes are that you can legally use.

After all, this is not about grey areas, where you're not sure whether or not a tax deduction is legitimate. These deductions are all very acceptable. It's not an issue of whether you can take them but whether you have taken them correctly.

For example, I haven't taken my wife out for a date in years. But we take weekly due diligence trips. I have put her on one of my companies as a director, so when we go out, we always talk business, even though we're in business together. I also don't take her on vacations anymore. We go on legitimate annual retreats for the businesses. So we can honestly mix our business and vacations together thus obtain verifiable write-offs.

Her car is run through her company. Her insurance is run through her company. She works out of the house, so our computers have all been paid with pretax dollars. In fact, if I cannot figure out a way to deduct something, I try not to even spend money in that area anymore.

Of course, it's hard to do this with everything, but you can do this with an awful lot, so that your real net after-tax expenditures, those expenses that you cannot deduct, end up being a surprisingly small portion of your lifestyle.

But it won't work unless you do it correctly. If you want to bring your tax bills down, you'll need to not only have a business, but one that's set up as a real business. That way, you'll avoid the problem that many people have in this country, which is that they get audited and have their deductions disallowed, which can leave them with huge bills for interest and penalties.

So how do you set up your business correctly? First of all, avoid operating as a sole proprietor. Because if you do, you'll end up being a big fish in the small sea. You're very easily audited, and they will go rifling through your books.

Whereas when you become a "real" company, i.e., a corporation, or an LLC, you become a small fish in a big sea. With that, you'll lower your risk of being audited in two ways: you'll be less likely to get audited because the IRS knows you probably have your books in order, and if you should get audited, there's less that can go wrong.

With a proper business, you'll get accountants on board, which means, someone is keeping your books, and you'll also have justifications for all of your expenses. So when you do get audited, you'll have all that information together, and your paperwork will have been done correctly.