Let’s suppose I have a consulting business. Clients pay me $100 an hour, I do some work. I have a certain amount of expenses to deliver the goods that I can definitely deduct from taxes.
Ok, well, suppose I have an idea for something that might potentially make me a lot of money in the future. Or it might not. So I spend the profits from this business on paying people and buying materials for whatever I am building in my garage or studio.
Maybe it’s an advanced tool that will, if it works, consult for others much more efficiently.
Conceptually, I’m reinvesting the profits into a high risk investment in the same field that I am part of.
Can I deduct the expenses for this project from my taxes?
I had the impression that if, say, Microsoft wants to develop a new piece of software, they can funnel the profits from their other businesses and deduct all the programmer salaries and expenses for the effort.
Of course, they are a multi-national with limitless money to pay legal fees (and bribes/fines if they get caught)
I’m certainly not an expert on this, or any other subject, but it seems pretty obvious you would have to have evidence, if you’re investigated, that whatever work you were doing in the garage is a legitimate extension of the business that earned the revenue. Revenue, not profit, because if you’re spending the money to further the business, it never becomes net profit (yes, I know that’s redundant) on which you would need to pay taxes. Legitimate companies have that evidence.
If it really is an entirely seperate enterprise, you could claim the expenses as losses on their own from operating a start up, and so reduce your taxes owed at tax time, but that gets very complicated, and if you’re just spending the money on something unlikely to ever produce revenue on its own, the IRS can decide it was illegal.
Consult a tax specialist, and don’t trick yourself into thinking you’re smarter than the IRS. You will lose.
Ok. So there is a possibility of it being deductible.
Here’s why I asked : if you just take your business profits and dump them into an index fund (the fund is owned by the business), you definitely have to pay taxes on those profits even though they haven’t been distributed to the business owners yet.
But, if you reinvest them in the business itself, this is like making an investment in the index fund, it’s just much higher risk (since you are betting it all on a single business, yours, doing well instead of an average like an index fund)
And if the business idea makes it big, you can apparently sell the business for a huge chunk of money and only pay capital gains on the funds received…
Paying for research is like paying rent, or for raw materials, or any other business expense. You’re buying all of them because you have to in order to make money later, you don’t have a business without them. But their performance as investments depends on your individual contributions to the business, they don’t operate independently from you like an index fund.
Beyond that, the profits are taxed differently as well. You pay income tax on the return on investment from creating a new product, on the profit it generates. Which if you’re wealthy can be considerably more than what you pay on a capital gains vehicle like the fund. It is possible to pay only the capital gains rate if you sell the business- but how valuable is a business that’s never shown a profit? And the investment at that point is done, you gain no more income from a sold business.
What you’re talking about is not a way to game the system, it IS the system. Plowing the money from sales into new expansion and R&D in order to gain more profit later to save on taxes is what the government is telling you to do; if it seems like it’s subsidized, that’s because it effectively is.
With at least one exception… if you are self-employed filing a Schedule C (or multiple Schedules C ) there are rules to force you to keep businesses separate as a means to make it more difficult to reduce your self-employment (social security) tax by offsetting income in one with losses in the other. Also to make losing “businesses” that might fall under the “hobby” rules stand out.
Agree with those saying that the R&D in the given example might be a separate business activity altogether, where nothing is deductible until you have a revenue stream to deduct it from.
For an ongoing business, there are some rules about capitalizing those expenses and then amortizing them over the life of the resulting intellectual property. Still, the assumption is that the expenses are deductible in some way, eventually. Many would always be deducted as incurred.
It might be worth reading up on the R&D tax credit, as one example of how US tax law looks at these things.