If you ask your tax preparer to explain the difference between your True Income and your Taxable Income they should be able to easily answer this question. However, what if you asked your tax preparer to explain the difference between True Cost and Taxable Cost? If this question made you (or them) say “huh?”, then read on!
It’s tax season, therefore the term Adjusted Gross Income (AGI) should have crept back into your brain. AGI is the amount of money that you use to calculate the income tax which you owe. In plain English, AGI is also called Taxable Income. How is it calculated?
Take your True Income, which is the amount of money that you earned before deductions and taxes. You will find this in box 1 on your W-2 form. You may also have interest and dividend income. The loose change found in your sofa doesn’t count.
Subtract as many deductions as possible – this should be easy for everyone. If you have a good tax preparer, they will find as many legal deductions (aka, loopholes) as legally allowable (some unscrupulous preparers will find a few more). You know the concept…the more deductions the better.
Next, let’s talk about your Taxable Income – the amount used to base the income tax that you will owe. The lower the number the better.
Your Taxable Income will vary depending on the tax rules in place each year. For instance, let’s say you made the same True Income, before and after any of the “tax reform” bills of the last 30 years. In most circumstances, your Taxable Income will be different. Sometimes “tax reform” changes the tax table. However, most of the time Congress fiddles with the deductions. If you were on Congress’s good side, your Taxable Income went down. If Congress thought you were not important (or not paying attention), your Taxable Income went up.
Your True Income is always bigger than your Taxable Income. And your True Income doesn’t change depending on which party is running Congress, or whether a “tax reform” bill was recently passed. You base your most important decisions, such as “Can I afford to buy this house?”, on your True Income. In fact, lenders look at your True Income, not your Taxable Income to decide if you are able to pay the mortgage on that new house.
The cost of your wine also has a True Cost and a Taxable Cost. There are other similarities:
- True Cost is higher than Taxable Cost (except for very large wineries who are not using QuickBooks and are not reading this article)
- The lower the Taxable Cost the better
- True Cost does not change when Congress passes new tax legislation
- You need to make your most important decisions based on True Cost
I work with a winery that initially made less than $1 million dollars in revenue. Within a few years, thanks to their awesome wine (and an excellent CFO…Yours Truly!), their sales grew to over $1 million dollars. At that point, their taxable cost more than doubled because they passed the $1M threshold, which was where the tax rules changed. Then, in 2018, Congress changed the threshold to $25M. This means that this winery (and all the others making between $1M and $25M) saw their taxable cost go down significantly.
Thus, in the course of five years, this winery’s Taxable Cost changed three times, and each change was significant. I cannot share their actual numbers. However, let’s revisit the ‘Three Muskateers’ from our How to Calculate The True Cost of Your Wine course or Discover QuickBooks for Wineries. Remember the True Cost for each of the wineries is the same. The first phase is similar to ‘Athos’ where the taxable cost was $36/case. The second phase was similar to ‘Aramis’ at $114/case because they had passed the $1M threshold. And in the third phase, it was back to ‘Athos’ at $36/case. (For purchased grapes the change is $90 to $197 and back to $90). If we had been managing the business using taxable cost, it would have been chaotic; possibly disastrous. Of course, we were using True Cost to manage the business, so the business continued to grow, and they could enjoy the tax windfall that first year.
The point is this: just as you have a True Income and a Taxable Income, your wine has a True Cost and a Taxable Cost. At your next appointment with your tax preparer, your accountant or CPA, ask them to explain the difference.
If your tax preparer’s response is “huh?”, then you have a big problem!