“You don’t have any more deductions?” the accountant asked me.
I’d always done my own taxes, working through my self-employment income with help from TurboTax, but I agreed to see him when my wife wanted an independent check on our finances. We weren’t paying a ton in taxes, but we also suspected we were paying more than we needed to.
The accountant’s advice? “You need to spend more on your business if you want to lower what you owe.”
Encouraged by the accountant, I spent more on my freelance writing career. Each week, I tracked my business expenses on a spreadsheet. I wrote down household expenses like utilities or internet, which I’d claim proportionally for my home office deduction. I listed software, magazine subscriptions, conferences and webinars, books, supplies and more.
I congratulated myself for making all of these investments in my business. And it was money well spent, creating new opportunities for my career.
Recently, a simple budgeting exercise showed me how these seemingly smart decisions may not have been the right ones for me. Sure, I’d been acting on good faith to nurture my freelance business – but I’d never stopped to think about the actual cost of those allowable expenses, or to notice the bottleneck it created for my cash flow.
What I Discovered After Doing a Profit and Loss Exercise
As part of a profit and loss exercise, I calculated the money I spent on my business across the categories like auto, business costs, professional development, business meals and travel, home office, retirement, savings and more.
The profit and loss exercise was the first time I’d really reviewed my business expenses outside of tax season. It was also the first time I’d looked at my business expenses alongside my wealth building goals.
Once I crunched the numbers in each category, I totaled my business expenses and compared the number to my total business income and the amount I paid myself. The new numbers made me gasp. I was spending more than I was paying myself, even though I’d increased my earnings over the last few years.
The culprit? An automated retirement savings strategy that didn’t take into account my business expenses or personal income.
My wife and I shared most of our money. We kept 25% of our income in individual accounts to use as we choose. For her, that was student loans; for me, it was retirement and business expenses.
While some deductible business expenses — utilities, mortgage, and auto — were paid jointly, I covered most business expenses myself, as well as a retirement allocation of 10% off every check. We were left with 15% to cover business expenses and anything personal.
Inspired by the FIRE movement, I had aspirations of saving more for retirement. But I couldn’t afford what I had been setting aside.
Each dollar I invested in allowable business expenses, even things that didn’t seem like a big deal — a $15 planner here, a $3 submission fee there — added up over time.
I found months when I spent the entirety of my personal income on business expenses and retirement, then tapped my personal account balance for a conference ticket, lodging and transportation. I would also turn to my personal account to max out my IRA so I could meet my retirement goals.
I’d gotten used to seeing low numbers in my personal account after spending years aggressively paying off my student loans, but I always felt slightly confused logging into my online account and seeing the balance so low. Now I understood why.
Confronting the Big Picture
The profit and loss exercise forced me to confront the big picture of my business spending habits.
While some business expenses were inflexible — given another choice of internet provider, I’d take it — I had discretion over my spending in other areas.
First, I immediately downsized my retirement spending to an amount I could realistically afford. Then I evaluated what spending habits I could shift to lower expenses. I started using the library for professional development reading and switched to a lower-cost cloud backup. Since professional development spending was down this year, thanks to tons of free Zoom events, I set aside one-third of the cost of a new laptop, helping to take care of future needs.
In the crunch of tax season, it was easy to think of all business deductions as good: The more I spent on my business, the more I could deduct and the less we would owe. I’d been encouraged by a tax professional to think of business spending as virtue.
And while I’d implemented his advice, I’d done it because I was trying to avoid a high tax bill. I hadn’t paused to evaluate that advice against my own personal goals and needs. Instead, when I decided to apply what I knew about personal finance to my freelance business and evaluate the professional advice I received through the context of my individual situation, I was finally able to gain the clarity and control needed to make decisions that would set me up for future success.
Lindsey Danis is a contributor to Codetic.