As a self-employed person, do you ever envy your employed friends at tax time?
Having your own business definitely increases the amount of record-keeping you have to do for tax purposes. When you’re digging through boxes of business receipts, it’s easy to envy people who only have to enter income from a W-2 form.
However, as a self-employed person, you get some tax breaks that your employed friends don’t.
For example, employees can deduct certain expenses, but only after they exceed 2 percent of adjusted gross income.
You can deduct business expenses right off the top – and the expenses even reduce your social security and Medicare tax, which you pay in the form of self-employment tax.
These tips can make tax time less painful and help you take advantage of some of the tax benefits of working for yourself:
1. Estimate your business income
It’s absolutely essential that you find out where you stand tax-wise – before you start taking other tax planning steps.
You don’t want to make expenditures, for example, in a year when you don’t need the deduction.
If you expect to be in a higher tax bracket this year or next, you’ll want to take as many deductions as possible in the year you are subject to the highest tax rate.
Unless you estimate your business income, tax planning is guesswork at best.
2. Time your income
You can’t postpone income simply by not cashing checks that come to you, or by telling customers not to pay you until after the end of the year.
Income is generally taxable when it is available to you.
However, you can time billing near the end of the year to your advantage. You certainly can sell assets at a gain before or after the end of the year, depending on your tax situation.
3. Time your expenditures
There’s always a surge in business equipment sales at the end of the year – and it’s not entirely because computers and printers are a popular holiday gift.
If you buy business assets by December 31, you can start depreciating them this tax year. You may even be able to take a Section 179 deduction and expense the entire cost of the asset in one year.
Business expenditures are counted as made in the year you purchase them, even if you use a credit card or other deferred payment plan and don’t pay for the expenditures until the following year.
On the other hand, if you’re on the cash basis, paying some bills can help lower your bill this year.
Don’t bother buying inventory or supplies that will be part of inventory before the end of the year, unless you need them. You generally don’t deduct the cost of inventory until you sell the product.
4. Make the most of medical insurance deductions
You can deduct health insurance premiums for yourself, your spouse, and your dependents as an adjustment to income.
This includes premiums for long-term care insurance. The policy does not need to be in the business name – it’s deductible even if it’s in your name.
5. Keep the form of your company simple
Unless you need to form a partnership or a corporation for some reason, stick with a Schedule C, Sole Proprietorship. It’s the simplest way to file, and there’s nothing you have to disband if you move on to something else.
If you’re looking for legal protection, get liability insurance (and consult your lawyer).
6. Automate your record-keeping
Small business record-keeping doesn’t have to be as hard as it used to be. In fact, shoeboxes (or grocery bags) full of crumpled receipts should be a thing of the past.
Use personal finance software that’s synchronized to your bank accounts.
Automatic record-keeping not only saves you time, but it’s less prone to mistakes, too.
7. Understand itemized deductions vs. business deductions
By taking a business deduction instead of an itemized deduction, you reduce your adjusted gross income and your self-employment tax.
Whenever possible, deduct an expense or a portion of an expense as a business expense.
8. Pay your kids
You can deduct the amounts you pay your kids to work in your business, and the kids generally pay less tax than you would.
The first $5,950 the child earns is sheltered by the standard deduction, and any amount above that is taxed at the child’s rate, which is generally much lower than yours.
9. Take a home office deduction
If you have a qualified home office, you can deduct some of your otherwise nondeductible expenses, such as a portion of your home insurance, utilities, and rent.
To make this process easier, the IRS has devised the Simplified Home Office Deduction. This allows taxpayers to take advantage of small business tax perks without the stress of lengthy calculations and record-keeping.
10. Avoid the hobby trap
If the IRS deems your business to be a hobby, you’ll have to report any income, but you’ll only be able to deduct expenses up to the amount of your income.
That’s no deal if you’re seriously trying to earn a profit – especially if you may clear a handsome taxable profit in future years!
It helps to clear a profit in three out of five consecutive years, but you may still convince the IRS you are a for-profit business if you operate in a businesslike manner and keep good records.
On the other hand, if you make a little income every year from something that really is a hobby, such as breeding dogs or carving lawn ornaments, you may want to keep it that way.
Hobby income is not subject to self-employment tax, which otherwise would be 15.3% of your net income from the operation.
11. Turn charitable contributions into business expenses
Under normal circumstances, you can’t deduct charitable contributions on your Schedule C. However, if you give money to charities in exchange for advertising, it’s a business expense.
That will give you a greater tax benefit than an itemized deduction.
12. Increase your self-employed retirement contributions
Contributions to IRAs are still limited, but you can contribute significantly more by opening a SEP, SIMPLE, or profit-sharing plan, instead.
13. Track all business mileage
Whether you take the standard mileage deduction or your expenses for gas, oil, and other actual expenses, you must have good records to deduct vehicle expenses.
Your records must include mileage driven, the purpose, and the date. Count every trip to the post office and client meeting – those miles add up!
14. Check out your liability for the Alternative Minimum Tax (AMT)
Tax planning usually means finding more deductions and postponing income – but not always.
You might want to do just the opposite if you may lose certain deductions because of the Alternative Minimum Tax.
The Alternative Minimum Tax is a parallel tax system that calculates your tax liability without the benefit of certain tax breaks, such as substantial itemized deductions.
If your income tax calculated by AMT rules is greater than your tax under normal income tax rules, you pay the excess as AMT tax.