Six Overlooked Tax Breaks for Individuals

taxbreaksConfused about which credits and deductions you can claim on your 2013 tax return? You’re not alone. Here are six tax breaks that you won’t want to overlook.

1. State Sales and Income Taxes

Thanks to the fiscal cliff deal last January, the sales tax deduction, which originally expired at the end of 2011, was reinstated in 2013 (retroactive to 2012). As such, taxpayers filing their 2013 returns can still deduct either state income tax paid or state sales tax paid, whichever is greater.

If you bought a big ticket item like a car or boat in 2013, it might be more advantageous to deduct the sales tax, but don’t forget to figure any state income taxes withheld from your paycheck just in case. If you’re self-employed you can include the state income paid from your estimated payments. In addition, if you owed taxes when filing your 2012 tax return in 2013, you can include the amount when you itemize your state taxes this year on your 2013 return.

2. Child and Dependent Care Tax Credit

Most parents realize that there is a tax credit for daycare when their child is young, but they might not realize that once a child starts school, the same credit can be used for before and after school care, as well as day camps during school vacations. This child and dependent care tax credit can also be taken by anyone who pays a home health aide to care for a spouse or other dependent–such as an elderly parent–who is physically or mentally unable to care for him or herself. The credit is worth a maximum of $1,050 or 35percent of $3,000 of eligible expenses per dependent.

3. Job Search Expenses

Job search expenses are 100percent deductible, whether you are gainfully employed or not currently working–as long as you are looking for a position in your current profession. Expenses include fees paid to join professional organizations, as well as employment placement agencies that you used during your job search. Travel to interviews is also deductible (as long as it was not paid by your prospective employer) as is paper, envelopes, and costs associated with resumes or portfolios. The catch is that you can only deduct expenses greater than 2percent of your adjusted gross income (AGI).

4. Student Loan Interest Paid by Parents

Typically, a taxpayer is only able to deduct interest on mortgages and student loans if he or she is liable for the debt; however, if a parent pays back their child’s student loans the money is treated by the IRS as if the child paid it. As long as the child is not claimed as a dependent, he or she can deduct up to $2,500 in student loan interest paid by the parent. The deduction can be claimed even if the child does not itemize.

5. Medical Expenses

Most people know that medical expenses are deductible as long as they are more than 10 percent of AGI for tax year 2013. What they often don’t realize is what medical expenses can be deducted, such as medical miles (24 cents per mile) driven to and from appointments and travel (airline fares or hotel rooms) for out of town medical treatment.

Other deductible medical expenses that taxpayers might not be aware of include: health insurance premiums, prescription drugs, co-pays, and dental premiums and treatment. Long-term care insurance (deductible dollar amounts vary depending on age) is also deductible, as are prescription glasses and contacts, counseling, therapy, hearing aids and batteries, dentures, oxygen, walkers, and wheelchairs.

If you’re self-employed, you may be able to deduct medical, dental, or long term care insurance. Even better, you can deduct 100 percent of the premium. In addition, if you pay health insurance premiums for an adult child under age 27, you may be able to deduct them as well.

6. Bad Debt

If you’ve ever loaned money to a friend, but were never repaid, you may qualify for a non-business bad debt tax deduction of up to $3,000 per year. To qualify however, the debt must be totally worthless, in that there is no reasonable expectation of payment.

Non-business bad debt is deducted as a short-term capital loss, subject to the capital loss limitations. You may take the deduction only in the year the debt becomes worthless. You do not have to wait until a debt is due to determine whether it is worthless. Any amount you are not able to deduct can be carried forward to reduce future tax liability.

Are you getting all of the tax credits and deductions that you are entitled to? Maybe you are…but maybe you’re not. Why take a chance? Make an appointment with us today and we’ll make sure you get all of the tax breaks you deserve.

7 Common Small Business Tax Misperceptions

Tax MisperceptionsOne of the biggest hurdles you’ll face in running your own business is staying on top of your numerous obligations to federal, state, and local tax agencies. Tax codes seem to be in a constant state of flux making the Internal Revenue Code barely understandable to most people.

The old legal saying that “ignorance of the law is no excuse” is perhaps most often applied in tax settings and it is safe to assume that a tax auditor presenting an assessment of additional taxes, penalties, and interest will not look kindly on an “I didn’t know I was required to do that” claim. On the flip side, it is surprising how many small businesses actually overpay their taxes, neglecting to take deductions they’re legally entitled to that can help them lower their tax bill.

Preparing your taxes and strategizing as to how to keep more of your hard-earned dollars in your pocket becomes increasingly difficult with each passing year. Your best course of action to save time, frustration, money, and an auditor knocking on your door, is to have a professional accountant handle your taxes.

Tax professionals have years of experience with tax preparation, religiously attend tax seminars, read scores of journals, magazines, and monthly tax tips, among other things, to correctly interpret the changing tax code.

When it comes to tax planning for small businesses, the complexity of tax law generates a lot of folklore and misinformation that also leads to costly mistakes. With that in mind, here is a look at some of the more common small business tax misperceptions.

1. All Start-Up Costs Are Immediately Deductible

Business start-up costs refer to expenses incurred before you actually begin operating your business. Business start-up costs include both start up and organizational costs and vary depending on the type of business. Examples of these types of costs include advertising, travel, surveys, and training. These start up and organizational costs are generally called capital expenditures.

Costs for a particular asset (such as machinery or office equipment) are recovered through depreciation or Section 179 expensing. When you start a business, you can elect to deduct or amortize certain business start-up costs.

Business start-up and organizational costs are generally capital expenditures. However, you can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs paid or incurred after October 22, 2004. The $5,000 deduction is reduced (but not below zero) by the amount your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized.

2. Overpaying The IRS Makes You “Audit Proof”

The IRS doesn’t care if you pay the right amount of taxes or overpay your taxes. They do care if you pay less than you owe and you can’t substantiate your deductions. Even if you overpay in one area, the IRS will still hit you with interest and penalties if you underpay in another. It is never a good idea to knowingly or unknowingly overpay the IRS. The best way to “Audit Proof” yourself is to properly document your expenses and make sure you are getting good advice from your tax accountant.

3. Being incorporated enables you to take more deductions.

Self-employed individuals (sole proprietors and S Corps) qualify for many of the same deductions that incorporated businesses do, and for many small businesses, being incorporated is an unnecessary expense and burden. Start-ups can spend thousands of dollars in legal and accounting fees to set up a corporation, only to discover soon thereafter that they need to change their name or move the company in a different direction. In addition, plenty of small business owners who incorporate don’t make money for the first few years and find themselves saddled with minimum corporate tax payments and no income.

4. The home office deduction is a red flag for an audit.

While it used to be a red flag, this is no longer true–as long as you keep excellent records that satisfy IRS requirements. In fact, so many people now have home-based businesses that in 2013, the IRS rolled out the new simplified home office deduction, which makes it even easier to claim the home office deduction (as long as it can be substantiated).

Because of the proliferation of home offices, tax officials cannot possibly audit all tax returns containing the home office deduction. In other words, there is no need to fear an audit just because you take the home office deduction. A high deduction-to-income ratio however, may raise a red flag and lead to an audit.

5. If you don’t take the home office deduction, business expenses are not deductible.

You are still eligible to take deductions for business supplies, business-related phone bills, travel expenses, printing, wages paid to employees or contract workers, depreciation of equipment used for your business, and other expenses related to running a home-based business, whether or not you take the home office deduction.

6. Requesting an extension on your taxes is an extension to pay taxes.

Extensions enable you to extend your filing date only. Penalties and interest begin accruing from the date your taxes are due.

7. Part-time business owners cannot set up self-employed pensions.

If you start up a company while you have a salaried position complete with a 401K plan, you can still set up a SEP-IRA for your business and take the deduction.

A tax headache is only one mistake away, be it a missed payment or filing deadline, an improperly claimed deduction, or incomplete records and understanding how the tax system works is beneficial to any business owner, whether you run a small to medium sized business or are a sole proprietor.

And, even if you delegate the tax preparation to someone else, you are still liable for the accuracy of your tax returns. If you have any questions, don’t hesitate to give us a call today. We’re here to assist you.

 

Financial Troubles? Five Ways to Improve Your Situation

TaxesIf you are having trouble paying your debts, it is important to take action sooner rather than later. Doing nothing leads to much larger problems in the future, whether it’s a bad credit record or bankruptcy resulting in the loss of assets and even your home. If you’re in financial trouble, then here are some steps to take to avoid financial ruin in the future.

If you’ve accumulated a large amount of debt and are having difficulty paying your bills each month, now is the time to take action–before the bill collectors start calling.

1. Review each debt. Make sure that the debt creditors claim you owe is really what you owe and that the amount is correct. If you dispute a debt, first contact the creditor directly to resolve your questions. If you still have questions about the debt, contact your state or local consumer protection office or, in cases of serious creditor abuse, your state Attorney General.

2. Contact your creditors. Let your creditors know you are having difficulty making your payments. Tell them why you are having trouble-perhaps it is because you recently lost your job or have unexpected medical bills. Try to work out an acceptable payment schedule with your creditors. Most are willing to work with you and will appreciate your honesty and forthrightness.

Tip: Most automobile financing agreements permit your creditor to repossess your car any time you are in default, with no advance notice. If your car is repossessed you may have to pay the full balance due on the loan, as well as towing and storage costs, to get it back. Do not wait until you are in default. Try to solve the problem with your creditor when you realize you will not be able to meet your payments. It may be better to sell the car yourself and pay off your debt than to incur the added costs of repossession.

3. Budget your expenses. Create a spending plan that allows you to reduce your debts. Itemize your necessary expenses (such as housing and health care) and optional expenses (such as entertainment and vacation travel). Stick to the plan.

4. Try to reduce your expenses. Cut out any unnecessary spending such as eating out and purchasing expensive entertainment. Consider taking public transportation or using a car sharing service rather than owning a car. Clip coupons, purchase generic products at the supermarket and avoid impulse purchases. Above all, stop incurring new debt. Leave your credit cards at home. Pay for all purchases in cash or use a debit card instead of a credit card.

5. Pay down and consolidate your debts. Withdrawing savings from low-interest accounts to settle high-rate loans or credit card debt usually makes sense. In addition, there are a number of ways to pay off high-interest loans, such as credit cards, by getting a refinancing or consolidation loan, such as a second mortgage.

Tip: Selling off a second car not only provides cash but also reduces insurance and other maintenance expenses.

Caution: Be wary of any loan consolidations or other refinancing that actually increase interest owed, or require payments of points or large fees.

Caution: Second mortgages greatly increase the risk that you may lose your home.

You can regain financial health if you act responsibly. But don’t wait until bankruptcy court is your only option. If you’re having financial troubles, don’t hesitate to call us. We can help you get back on your feet.

Five Tax Changes Benefiting You in 2013

TaxThanks to the passage of the American Taxpayer Relief Act of 2012 (ATRA) in January 2013, several tax provisions were extended through 2013 that are of benefit to taxpayers filing 2013 returns this year. Here are five of them:

1.  Mortgage Insurance Deductible as Qualified Interest

ATRA extended, through 2013 (and retroactive to 2012), a tax provision that expired in 2011 that allows taxpayers to deduct mortgage insurance premiums as qualified residence interest. As such, taxpayers can deduct, as qualified residence interest, mortgage insurance premiums paid or accrued before Jan. 1, 2014, subject to a phase-out based on the taxpayer’s AGI.

2.  Limited Non-Business Energy Property Credits

Non-business energy credits expired in 2011, but were extended (retroactive to 2012) through 2013 by ATRA. For 2013 (as in 2011 and 2012), this credit generally equals 10 percent of what a homeowner spends on eligible energy-saving improvements, up to a maximum tax credit of $500 (down significantly from the $1,500 combined limit that applied for 2009 and 2010).

Because of the way the credit is figured however, in many cases, it may only be helpful to people who made energy-saving home improvements for the first time in 2013. That’s because homeowners must first subtract any non-business energy property credits claimed on their 2006, 2007, 2009, 2010, 2011, and 2012 returns before claiming this credit for 2013. In other words, if a taxpayer claimed a credit of $450 in 2012, the maximum credit that can be claimed in 2013 is $50 (for an aggregate of $500).

The cost of certain high-efficiency heating and air conditioning systems, water heaters and stoves that burn biomass all qualify, along with labor costs for installing these items. In addition, the cost of energy-efficient windows and skylights, energy-efficient doors, qualifying insulation and certain roofs also qualify for the credit, though the cost of installing these items do not.

3.  State and Local Sales Taxes

ATRA also extended, through 2013, (and retroactive to 2012) the tax provision that allows taxpayers who itemize deductions the option to deduct state and local general sales and use taxes instead of state and local income taxes.

4.  Simplified Home Office Deduction

Starting with their 2013 tax return, taxpayers who claim deductions for business use of a home (“the home office deduction”) now have another option. Taxpayers claiming the home office deduction are generally required to fill out a 43-line form (Form 8829) often with complex calculations of allocated expenses, depreciation and carryovers of unused deductions.

Taxpayers claiming the optional deduction will complete a significantly simplified form. The new optional deduction is capped at $1,500 per year based on $5 per square foot for up to 300 square feet. Give us a call if you’d like more information on the simplified home office deduction for 2013.

5. Transportation “Fringe Benefits”

ATRA reinstated parity for transportation fringe benefits provided by employers for the benefit of their employees in 2013 (retroactive to 2012). As such, the monthly limit for qualified parking is $250 and the benefit for transportation in a commuter highway vehicle or a transit pass is $245 for tax year 2013.

Looking to Grow Your Business Presence Online? It is Time to Call for “Yelp”

url-1Summary:  Having prominence on local review websites is important for businesses.  We look at Yelp and want it offers businesses and consumers.

Yelp.com was created to allow businesses to advertise locally, targeting a huge population in the region where the company is in operation.  Retailers, service businesses, and organizations can benefit from sharing their business facts on Yelp’s website for free.  Customer reviews are noticed by Google and other search engines, increasing traffic flow to the company’s online web pages.

Creating a Yelp Business Account

Business owners can simply sign up for an account with Yelp and then start placing information about their company on the local pages.  Yelp charges for business advertisement, but the benefits of a business account are numerous. The account holder can check the monthly stats for visitors, link visitors to the actual company website, and incorporate Yelp mobile apps to aid local customers who are searching for a certain type of business or product.

Yelp also has a messaging service that allows account holders to contact site visitors and answer questions they may have about the company, its products, or anything else.   There is also the search engine optimization benefit of a strong presence on Yelp.  Being on Yelp can be an effective means of gaining local customer traffic.

Customer Reviews and Comments

Yelp pages allow visitors to add comments and reviews to the company listings.  This is extremely important information for retailers, restaurants, hotels and motel managers, and merchandisers.  One of the best ways for a business owner to find out if anything concerning the company is in need of shoring up is to see what the buying public has to say.

Advertising on Google has become a much different game than it was just a few years ago.  Companies that desire a front-page ranking cannot rely on direct search traffic and advertisement relevancy.  Instead, focusing on things like customer reviews and comments is now a priority.  This is because the search engines take more factors into their algorithm, even if the company is mentioned only in passing on a social or business networking site.

A Growing Audience

Yelp is one of the most effective online means of getting the word out to the local public because it is one of the most popular websites when it comes to reviews for products and services.  Approximately 90 million unique viewers check out at least one business on Yelp each and every month and the numbers are increasing.

When business consultants advise clients to expand their exposure via the Internet, Yelp is often a component of that strategy.  The companies that are active on Google, have Google+ Local Pages, link their business on Facebook, and create a page on Yelp, and other social sharing sites, are in a better position to increase their sales.

Jason Nelson of Ascent Internet, a Utah online marketing company, contributed this article.  You can reach Jason through his website at www.ascentinternet.com.

Avoiding the Family Feud

Portrait of the angry young coupleOne of the things many entrepreneurs hope to do one day is to go into business with their family.  Although this is a very noble goal, to go into business with the people you love the most on this earth, it can often turn into a disaster.  Therefore, if you are contemplating going into business with family, or if you have already gone into business with family, there are a few key tips that can help make your experience a rewarding one.

Borrowed Money Must Come with Terms

No matter which side of the coin you are on when it comes to borrowing money from family for a business there are a number of key principles you need to make sure you follow.

First, if the family member does not qualify for a bank loan, or a loan from a regular financial institution, be very careful lending them money.  Banks are in the business of borrowing money and getting it all paid back with interest.  If a bank is unwilling to give a loan to your family member there might be a reason for it that your family member isn’t telling you about.  For example maybe their credit score is to low because they have had a history of not paying back loans, or maybe it is just because the banker can see there is no true business model in the investment your family is pitching you on.

Second, you need to make sure you are charging interest in accordance with the risk you are taking.  For most of you, you are not in the business of lending money; therefore, if you decide to lend money to a family member it is going to be a much riskier proposition for you than for a bank.  You need to get paid for this through a higher interest rate.

Third, make sure you get security and you get the loan in writing.  All too many family members believe their family would never stiff them, yet it happens all of the time.  The best way to increase your chances of getting paid back are to make the borrowing party not only sign the loan, but also personally guarantee it.  If they are unwilling to do this to protect you, then there is no reason you should be going out on a limb to risk your assets for them.

 

Separate Family from Work

All too many family businesses struggle with this one concept.  They cannot separate their families from their office and it creates a few problems.

First, it can cause major problems with other employees.  It is very hard for your good employees to stay motivated if you are always making special allowances for family members.  For example if you have a policy that your employees must be on time or they will be subject to consequences, yet your family member comes in late every day and you do nothing about it.  This sends a horrible message to your other employees of how little you really think of them.

Second, if you are in business with a spouse or someone who lives in your home, you have to have down time.  As a result, you have got to be able to leave work at work some days or you will find your personal relationships will suffer.  We all deal with the stresses of owning a business differently, but if your safe haven has always been your home and now you are in business with your spouse and they are bringing home work problems every night, you are going to find this very frustrating and damaging to your relationship.

 

Hold Each other Accountable

You can’t let things slide just because someone is family.  If you have family members in your business you need to make sure they are pulling their weight.  If they are not, it is your job to set them down and let them know what is expected and the consequences that will occur if they don’t start pulling their weight.  As hard as it might be to fire a family member, I can tell you from the clients I have talked to it ultimately is much easier than losing your business because the family member pulled everyone else down in the organization.

So whether you are already in business with family, or just looking forward to the day you can, remember the above and always remember that the best way to resolve any problem is to communicate with all parties involved.

5 Things You Can do to Help Your Tax Preparer

tax preparerAs much as tax professionals want to make sure they do a good job in preparing your income tax returns not one of them can do it without your help.  There are some key things that you can do to help your tax professionals do the best job for you they possibly can.

  1. If you have moved make sure they have your new address.  This may seem like a small thing, but if you move and your tax professional does not get the right address on your return, you might miss critical correspondence from the IRS or state taxing authorities.  If this happens, many times what starts as a very small issue can grow into a crisis very fast.
  2. Take time to fill out an organizer.  Most all tax professionals have the ability of sending you a tax organizer to help you not only organize your documents, but to make sure their isn’t something you have missed.  Most organizers also include a number of questions that will help you make sure your tax professional is aware of everything they need to be in order to prepare a complete and accurate return.
  3. Send all of your information in at one time.  When you send tax professionals your tax information in bits and pieces you open yourself up for the chance of one of your documents getting lost or not being included in your tax return.  Often times, tax professionals are so busy during tax season that if they are getting a number of emails from you with various documents attached they will end up missing something.
  4. Don’t be afraid to ask questions.  Many times tax payers don’t want to question their tax professional, because they think the professional knows more about taxes than they do.  Although this is probably true in general, you often times will know as much, or more, about your individual tax situation as your tax preparer does.  Therefore, don’t be afraid to question what has been done on your return.  Ultimately, you are the main one responsible for the return so it is important you understand it.
  5. Let your tax preparer know of life changes.  Often times your tax preparer only sees you once a year.  As a result they are very unaware of what goes on in your life on a daily basis.  Therefore, if you have had a baby, a child go off to school, or maybe you just started contributing more to your retirement, please make sure you let your tax professional know so they can make the necessary changes to your return.

By following these five tips you will find that your experience with your tax professional will be a much more rewarding one, because you will have a better chance of having a complete and accurate return filed.  Remember that your tax professional is human and is definitely capable of making mistakes if they are not correctly informed.

The Tale of Two Families

father and sonAh…the image of the family owned business.  Your head is overflowing with sweet Americana images from the 1950s where three generations of family members ran the country store together.  Then someone shakes you violently to awake you from this nostalgic fantasy world!

Often a business owner wants to turn over his or her business to a relative for a variety of reasons, but ninety nine percent of the time this turns out to be a horrible mistake.  The reality of small business ownership nowadays is that most family members don’t voluntarily want to share in the responsibilities of running a family business.  Unlike previous generations, today’s young adults have no desire to work as hard as they watched their parent’s work nor do they want the family arguments.

That is why you need to understand the risks of insisting your business be turned over to an unwilling family member.  Usually when this happens, the proverbial brother or sister-in-laws will very likely run the business into the ground and occasionally steal from the cash flow.

Let me share a tale of two families!  The first father & son team didn’t fare so well in the business world.  The father purchased a deli/café for his son.  The son and girlfriend proceeded to run the business into the ground, losing the father’s $100,000 investment in the process.  This store is now closed.  The second father & son team are doing much better.  They own several Dairy Queen franchises located in major malls and casinos.  They work together as a team running the businesses in a very professional manner, much like a president and vice-president.  They have built an empire together that will one day be passed onto the son.

From my 45+ years of experience in business brokerage, the story of the first family is a far more common reality than that of the second team.  Families usually start out with the best of intentions, but tend to ignore some of the harsh realities that are visible to a stranger.  I strongly suggest that if you are considering selling, or worse, giving your business to one or more family members that you at least sit down with an experienced business broker to get a second opinion and assessment of the situation from an unbiased independent third party.  This may save you many thousands of dollars and plenty of headaches!

Don’t ask your friends, neighbors, or other business experts like your dentist, Realtor, or hair stylist. Generally these people don’t know anything about businesses and would be afraid to give you any positive opinions.  The same goes for your other relatives.  You are intelligent, you will figure it out, but it pays to consult with an expert.  Don’t put more research into your next cell phone purchase than you do for selling your business to your family member or anyone else.  Remember, business mistakes can be extremely expensive!

If you want to help a family member, then let that person purchase all or part of the business, even if seller carry financing is a part of the deal.  This is when the seller becomes the bank and agrees to hold a certain portion of the purchase price as a loan usually payable from 1 to 5 years, sometimes a little longer and at a variety of interest rates regardless of the cost of money or prime rate.  The repayment is usually principle and interest every month like a car loan.  Sometimes the seller will want extra collateral such as a lien on your home. This is especially true if there are no or few hard assets with the business as found in many service businesses. The seller is not wrong to ask for it.

It is important for the Buyer, even if they are related to you, to have some “skin in the game.”  If they have money or assets at stake, they will work harder to make the business a success.  Working a business is not a labor of love, its hard work!  If they are not willing to purchase the business, even for a nominal sum, then it’s time to look for other buyers who are not related to you.  This will keep Thanksgiving gatherings a lot more friendly!  Look at all the heart ache I just saved you!

Article contributed by Ed Smith aka Edward J. Smith, Ltd. is a professional licensed business broker in the states of Nevada and Utah with First Choice Business Brokers LV 101 office.  He has over 45 years of experience in helping business Buyers and Sellers.  Call Ed at:  702.274.7320 or email him at:  edsmith@fcbb.com

As a Business Owner What Income is Subject to FICA/Self-Employment Tax?

Self employmentWhen looking at what entity you should use to set up your new business there are a number of things you need to consider and one of these is how will your income be taxed for FICA/self-employment (FICA) tax purposes.  Because you are now the employer and employee this tax rate is a whopping 15.3%, which means the more of your income you can keep from being subject to the FICA tax, the more money you are going to be able to keep in your pocket to run your business.

The following will give you some guidance on what income is subject to the FICA tax and what income is not.

C Corporation – Wages paid to the shareholder-employee are subject to FICA tax.  Distributions paid from a C Corporation are not.

S Corporation – Wages paid to a shareholder-employee are subject to FICA tax.  (which you must pay yourself a wage in order to stay compliant), but pass-through income reported on your K-1 is excluded from the shareholder’s self-employment income.  S Corporations are many times a great entity to use to help limit your FICA tax.

General Partner (General Partnership or LLC) – Pass-through income is included in the partner’s self-employment income and is subject to the FICA tax if the partnership engages in a trade or business.  Guaranteed payments to a general partner are also included in self-employment income and are subject to FICA tax.

Limited Partner (Limited Partnership or LLC) – Pass-through income is excluded from the limited partner’s self-employment income and is not subject to the FICA tax.  Guaranteed payments for services are included in self-employment income and are subject to the FICA tax.

Sole Proprietorship – All proprietor earnings are self-employment income and are subject to the FICA tax.  This is true whether the proprietor works in the business or hires others to do the work.

 

Are You Thinking of Quitting Your Job to Start a Business?

Are you one of the many Americans who are tired of the daily grind of working for an unappreciative boss who leaves you feeling overworked and underpaid and is quit your joblooking to start your own business?  If so, there are a number of things you should consider before you make the plunge of becoming self-employed.

 

Know the Rules for Rolling over Retirement Plan Funds

Upon leaving your job, you will generally be entitled to immediately receive vested amounts in your qualified retirement plan accounts.  You are probably aware that most distributions from qualified retirement programs can be rolled over tax-free into an IRA account.  However, you must arrange for a “direct rollover’ or the plan administrator is required to withhold 20% of your distribution for federal income tax.  Direct rollovers involve having the funds transferred directly from your former employer’s retirement plan into your designated IRA account.  (the distribution check cannot be made out to you)  Talk to your former employer’s benefits representative and to the financial institution or brokerage house where you will establish your IRA.  Tell them you want to make a direct rollover to avoid the withholding, and ask for the required forms and paperwork.  Failure to arrange a direct rollover means you will have to replace the 20% withheld to accomplish a totally tax-free rollover.

 

Expend Your Flexible Spending Accounts before You Quit

If you have a flexible spending account (or cafeteria plan reimbursement account) for uninsured medical expenses and/or childcare expenses, make sure you incur sufficient qualifying expenses to use up the funds in your account before you leave your job.  For example, go get new glasses or contacts if that’s what it takes to use up your account balance – otherwise, you will lose it when you quit.

 

Open a Separate Business Bank Account

Segregate your business and personal financial matters by keeping separate bank accounts.  Deposit all business income into the business account and pay all business expenses (including your own draws) out of that account.  If you pay business expenses in cash or out of your personal account, reimburse yourself with checks drawn on your business account and document this with receipts.  This will make your year-end recordkeeping easier.  Keeping separate accounts shows you are serious about running things in a businesslike manner, and IRS examiners like to see that.  You do not want to have to explain that the $10,000 deposited into your one and only checking account was actually a gift rather than business income.

 

Start Keeping Tax Records – But Do Not Overdo It

In addition to maintaining a separate business bank account, you need to start keeping documentation of your business income and expenses.  At the beginning this generally does not need to be anything fancy (however, if your business involves inventory, employees, or a corporation you are going to need to be much more detailed).  For example, in most cases, you can simply use file folders or envelopes to keep your business expense receipts until tax return time.  You may not really need a bookkeeping software program, a tax preparation program, or more sophisticated recordkeeping techniques until later.  Also keep a list of billings or sales and the dates you get paid.

 

Keep Good Auto Records

Expenses of using your personal auto for business uses are deductible, but only if you keep good records documenting the date, the number of miles, the business purpose of each business use of the car.  Mileage not properly substantiated is considered personal use and related expenses are not deductible.  You should also record the car’s mileage at the beginning of the year or when you first start your business.  Unless the standard mileage rate is used, receipts or invoices and cancelled checks should be retained documenting the car’s purchase price, fuel costs, repairs, taxes, insurance and other out-of-pocket costs.  Auto logbooks for recording mileage and expenses are available at local discount and office product stores.

 

Consider Setting up Your Own Retirement Plan

If you work for yourself, you are on your own when it comes to planning for your retirement.  A retirement plan set up for your benefit accomplishes two goals – it is a way to save money for your later years, and in most cases it saves taxes now.  Using a defined contribution Keogh plan, you can contribute and deduct up to 25% of your net self-employment income (maybe more if you set up a defined benefit Keogh plan), but remember Keogh plans must be in existence before the end of the year for you to take a deduction.  If this Keogh plan is also a 401(k) plan, you may also make elective deferrals.  A simplified employee pension (SEP) plan can be set up in the following year – as late as the extended due date of your return – and still get the current year tax return deduction.  SEP’s are simpler and cheaper to administer and you can contribute and deduct up to approximately 20% of your net self-employment income.  SIMPLE retirement plans are another option available to self-employed persons.  The biggest disadvantage of qualified retirement plans is that you may have to make contributions for any employees that you have.

 

Do Not Underestimate the Benefits of Tax Planning

Even after the above, tax planning can yield bigger benefits now that you are in business for yourself.  You may be able to employ your children part-time and save income taxes and SE tax.  If your spouse is an employee of your business, you may be able to set up a fully deductible accident and health plan that covers you and the family without the use of a corporation.  Certain expenses that your former employer did not reimburse (such as professional association fees and supplies for a home office) may now be deductible.  Year-end tax planning is critical – particularly if you can use the cash method for income and expenses.  As stated earlier, retirement plans other than SEP’s must be set up before year-end to get a current year tax deduction.

 

Do Not Automatically Incorporate

An often-repeated comment is that corporations are wonderful because they limit the shareholders’ business liability, which is true, but depending on the industry you are in this may not be an immediate concern for you.  You should know that using a corporation requires addition recordkeeping, tax preparation fees, legal expenses and state and local filing fees.  Significant effort must be expended to keep the affairs of the corporation and the owner separate.  Based on the above, depending on the size of your small business, incorporating may not be one of the first things on your list.