10 Most Expensive Tax Mistakes That Cost Business Owners
Thousands
Q: Are you satisfied with the taxes
you pay?
Q: Are you confident you’re taking
advantage of every available break?
Q: Is your tax advisor giving you
proactive advice to save on taxes?
I’ve got bad news and I’ve got good news.
A: The bad news is, you’re right. You do pay too
much tax. You’re probably not taking advantage of
every tax break you can. And most advisors do a poor
job of actually saving their clients money.
A: The good news is, you don’t have to feel that
way. You just need a better plan. Today, we’re
going to talk about some of the biggest mistakes that
business owners make. Then we’ll talk about how to
solve them.
#1: Failing to Plan
“There is nothing wrong with a
strategy to avoid the payment of
taxes. The Internal Revenue Code
doesn’t prevent that.”
William H. Rehnquist
#1: Failing to Plan
The first mistake is the biggest mistake of all.
It’s failing to plan.
I don’t care how good you and your tax
preparer are with a stack of receipts on April
15. If you didn’t know you could write off
your kid’s braces as a business expense,
there’s nothing we can do.
Why Tax Planning?
1. Key to financial defense
2. Guarantee results
Why Tax Planning?
Tax coaching is about giving you a plan for minimizing your taxes.
What should you do? When should you do it? How should you do it?
And tax planning gives you two more powerful advantages.
First, it’s the key to your financial defenses. As a business owner, you
have two ways to put cash in your pocket. Financial offense is making
more.
Financial defense is spending less. For most of us in this room, taxes are
our biggest expense. So it makes sense to focus our financial defense
where we spend the most. Sure, you can save 15% on car insurance by
switching to GEICO. (Everybody knows that!) But how much will that
really save in the long run?
And second, tax planning guarantees results. You can spend all sorts of
time, effort, and money promoting your business. But that can’t
guarantee results. Or you can set up a medical expense reimbursement
plan, deduct your daughter’s braces, and guarantee savings.
Taxable Income
Taxable Income
Let’s start by taking a quick look at how the tax system
works. This will “lay a foundation” for understanding
the specific strategies we’ll be talking about soon.
The process starts with income. And this includes most
of what you’d think the IRS is interested in:
• Earned income from wages, salaries, bonuses, and
commissions.
• Profits and losses from your own business.
• Interest and dividends from bank accounts, stocks,
bonds, and mutual funds.
Taxable Income
• Capital gains from property sales.
• Pensions, IRAs, and annuity income.
• Alimony and gambling winning.
• Even illegal income is taxable. The IRS doesn’t care
how you make it; they just want their share! (The good
news is, if you’re operating an illegal business, you
can deduct the same expenses as if you were running a
legitimate business. If you’re a bookie, you can deduct
the cost of a cell phone you use to take bets.
Adjustments to Income
Adjustments to Income
Once you’ve added up total income, it’s time to start subtracting
“adjustments to income.” These are a group of special deductions,
listed on the first page of Form 1040, that you can take whether you
itemize deductions or not. Total income minus adjustments to income
equals “adjusted gross income” or “AGI.” Adjustments to income are
also called “above the line” deductions, because you take them
“above” AGI.
Adjustments include IRA contributions, moving expenses, half of your
self-employment tax, self-employed health insurance, self-employed
retirement plan contributions, alimony you pay, and student loan
interest.
Deductions/Exemptions
Add Taxable Income
minus Adjustments to Income
minus Deductions/Exemptions
times Tax Bracket
minus Tax Credits
Medical/dental
State/local taxes
Foreign taxes
Interest
Casualty/theft losses
Charitable gifts
Miscellaneous itemized
deductions
Standard or Itemized Deductions?
Once you’ve determined adjusted gross income, you can take a
standard deduction or itemized deductions, whichever is greater. The
standard deduction for 2015 is $6,300 for single taxpayers, $9,250 for
heads of households, $12,600 for joint filers, and $6,300 each for
married couples filing separately.
Tax deductions reduce your taxable income. If you’re in the 15%
bracket, an extra dollar of deductions cuts your tax by 15 cents. If
you’re in the 35% bracket, that same extra dollar of deductions cuts
your tax by 35 cents.
You can also deduct a personal exemption of $3,950 for yourself, your
spouse, and any dependents.
Tax Brackets
Add Taxable Income
minus Adjustments to Income
minus Deductions
times Tax Bracket
minus Tax Credits
Rate Single Joint
10% 0 0
15% 9,076 18,151
25% 36,901 73,8011
28% 89,351 148,851
33% 186,351 226,851
35% 405,101 405,101
39.6% 406,751 457,601
Tax Brackets (2015)
Rate Single Joint
10% 0 0
15% 9,226 18,451
25% 37,451 74,901
28% 90,751 151,201
33% 189,301 230,451
35% 411,501 411,501
39.6% 413,201 464,851
Tax Brackets (2015)
Once you’ve subtracted deductions and personal exemptions, you’ll have
taxable income. At that point, the table of tax brackets tells you how much to
pay.
You may also owe self-employment tax, which replaces Social Security and
Medicare for sole proprietors, partnerships, and LLCs. You’ll also owe state and
local income and earnings taxes.
Some types of income aren’t taxed at the regular rate. For example, tax on
“qualified corporate dividends” and long-term capital gains is capped at 20%.
There’s also a 3.8% “unearned income Medicare contribution” on investment
income for single taxpayers earning more than $200,000 and joint filers earning
more than $250,000. For purposes of this new rule, “investment income”
includes interest, dividends, capital gains, rental income, royalties, and annuity
distributions.
Tax Brackets (2015)
Oh, and don’t forget that your itemized deductions and personal
exemptions start phasing out once your income hits certain levels.
For 2014, those are $254,200 for singles and $305,050 for joint
filers.
The bottom line here is that “tax brackets” aren’t as simple as they
might appear. Your actual tax rate can be quite a bit higher than
your supposed “tax bracket.”
Tax Credits
Tax Credits
Finally, you’ll subtract any tax credits. These are dollar-
for-dollar tax reductions, regardless of your tax bracket.
So if you’re in the 15% bracket, a dollar’s worth of tax
credit cuts your tax by a full dollar. If you’re in the 35%
bracket, an extra dollar’s worth of tax credit cuts your
tax by the same dollar.
There’s no secret to tax credits, other than knowing
what’s out there.
Two Kinds of Dollars
Pre-Tax Dollars
After-Tax Dollars
Two Kinds of Dollars
Ultimately, there are two kinds of dollars
in this world: pre-tax dollars, and after-tax
dollars. Pre-tax dollars are great. And
after-tax dollars aren’t bad. But they’re
not as good as pre-tax dollars.
Keys to Cutting Tax
1. Earn nontaxable income
2. Maximize deductions and credits
3. Shift income: later years, lower brackets
“You lose every time you spend after-tax
dollars that could have been pre-tax dollars.”
Keys to Cutting Tax
So here’s the bottom line:
You lose . . . every time you spend after-tax dollars .
. . That could have been pre-tax dollars.
Let me repeat that.
You lose . . . every time you spend after-tax dollars .
. . That could have been pre-tax dollars.
Keys to Cutting Tax
We’re going to spend the rest of this presentation
talking about how to turn after-tax dollars into pre-
tax dollars. We’re going to use three primary
strategies.
First, earn as much nontaxable income as possible.
Second, make the most of adjustments to income,
deductions, and credits. There’s really no magic to
it, other than knowing what’s available.
Keys to Cutting Tax
Finally, shift income to later tax years and
lower-bracket taxpayers. This includes
making the most of tax-deferred retirement
plans and shifting income to lower-bracket
children, grandchildren and other family
members.
#2: “Audit Paranoia”
#2: “Audit Paranoia”
The second big mistake is nearly as important as the
first, and that’s fearing, rather than respecting the
IRS.
What does the kind of tax planning we’re talking
about do to your odds of being audited? The truth is,
most experts say it pays to be aggressive. That’s
because overall audit odds are so low, that most
legitimate deductions aren’t likely to wave “red
flags.”
#2: “Audit Paranoia”
Audit rates are actually at historic lows. For 2014,
the overall audit rate was just one in every 100
returns. The IRS primarily targets small businesses,
especially sole proprietorships, and cash industries
like pizza parlors and coin-operated laundromats
with opportunities to hide income and skim profits.
In fact, they publish a series of audit guides that you
can download from their web site that tell you
exactly what they’re looking for when they audit
you!
#2: “Audit Paranoia”
Take a look at the bottom of the chart. You’ll see
that the IRS audits just one-half of one percent of S
corporations and partnerships. If you’re really
worried about being audited, you might consider
reorganizing your business to help fly “under the
radar.”
#3: Wrong Business Entity
C-Corp?
S-Corp?
Partnership?
Sole Prop?
#3: Wrong Business Entity
The next mistake is choosing the wrong business entity.
Most business owners start as sole proprietors, then, as
they grow, establish a limited liability company or
corporation to help protect them from business liability.
But choosing the right business entity involves all sorts
of tax considerations as well. And many business
owners are operating with entities that may have been
appropriate when they were established – but just don’t
work as effectively now.
Sole Proprietorship Sole Proprietorship
Report net
income on
Schedule C
Pay SE tax up
to 15.3% on
income
Pay income
tax on net
income
Sole Proprietorship Sole Proprietorship
I can’t make you an expert in business entities. But I
do want walk through one popular choice to illustrate
how important this question can be.
If you operate your business as a sole proprietorship,
or a single-member LLC taxed as a sole
proprietorship, you may pay as much in self-
employment tax as you do in income tax. If that’s the
case, you might consider setting up an “S” corporation
to reduce that tax.
Sole Proprietorship Sole Proprietorship
If you’re taxed as a sole proprietor, you’ll report your
net income on Schedule C. You’ll pay tax at whatever
your personal rate is. But you’ll also pay self-
employment tax, of 15.3% on your first $118,500 of
“net self-employment income” and 2.9% of anything
above that. You’ll also pay a new 0.9% surtax on any
earned income over $200,000 if you’re single,
$250,000 if you’re married filing jointly, or $125,000
if you’re married filing separately.
Sole Proprietorship Sole Proprietorship
Let’s say your profit at the end of the year is $80,000.
You’ll pay regular tax at your regular rate, whatever
that is. You’ll also pay about $11,000 in self-
employment tax.
The self-employment tax replaces the Social Security
and Medicare tax that your employer would pay and
withhold if you weren’t self-employed. How many of
you plan to retire on Social Security?
S-Corporation
Split proceeds
into “salary”
and “income”
Pay FICA up to
15.3% on salary
Avoid FICA/SE
tax on income
Salary Income
Pay income
tax on salary
and income
S-Corporation
An “S” corporation is a special corporation that’s taxed like
a partnership. The corporation pays you a reasonable wage
for the work you do. If there’s any profit left over, it passes
through to you, and you pay the tax on that income on your
own return. So the S corporation splits the owners income
into two parts, wages and pass-through distributions.
Here’s why the S corporation is so attractive.
You’ll pay the same 15.3% tax on your wages as you
would on your self-employment income.
BUT – there’s no Social Security or self-employment tax
due on the dividend pass-through.
Employment Tax Comparison
S-Corp FICA
Salary $40,000
FICA $6,120
Net $73,880
Proprietorship SE
Income $80,000
SE Tax $11,304
Net $68,696
S-Corp Saves
$5,184
Employment Tax Comparison
Let’s say your S corporation earns the same $80,000 as
your proprietorship. If you pay yourself $40,000 in
wages, you’ll pay about $6,120 in Social Security.
But you’ll avoid employment tax on the income
distribution. And that saves you $5,184 in employment
tax you would have paid without the S-corporation.
#4: Wrong Retirement Plan
#4: Wrong Retirement Plan
Now let’s talk about the fourth mistake: choosing the
wrong retirement plan.
If you’re looking to save more than the $5,500 limit for
IRAs, you have three main choices: Simplified Employee
Pensions, or “SEPs,” SIMPLE IRAs, or 401ks.
I’m not here to make you an expert on retirement plans.
But I can help you decide pretty quickly if the plan you
have is right for you – or if you should be looking for
something more suited for your specific needs. So bear
with me, even if the next few slides look intimidating.
These are some very powerful strategies.
Simplified Employee Pension
“Turbocharged” IRA
Contribute up to 25% of
income
Max. contribution: $53,000
Must contribute for all
eligible employees
Contributions directed to
employee IRAs
No annual administration
Simplified Employee Pension
The SEP is the easiest plan to set up because it’s just a
turbocharged IRA:
• If you’re self-employed, you can contribute up to 25%
of your “net self-employment income.”
• If your business is incorporated and you’re salaried,
you can contribute 25% of your “covered
compensation,” which is roughly the same as your
salary.
• The maximum contribution for 2015 is $53,000.
Simplified Employee Pension
• If you’ve got employees, you’ll have to contribute for them, too.
You generally have to contribute the same percentage for your
employees as you do for yourself. However, you can use what’s
called an “integrated” formula to make extra contributions for
higher incomes.
• The money goes straight into employee IRA accounts. There’s no
annual administration or paperwork required. The SEP is easy to
adopt, easy to maintain, and flexible. If there’s no money to
contribute, you just don’t contribute. But the contribution is
limited to a percentage of your income. If you set up an S
corporation to limit self-employment tax, you’ll also limit your
SEP contribution.
SIMPLE IRA
Defer 100% of income up to
$11,500
Age 50+ add $2,500 “catch
up”
Business “match” or “PS”
Contribute to IRAs
No annual administration
SIMPLE IRA
The next step up the retirement plan ladder is the SIMPLE
IRA. This is another “turbocharged IRA that lets you
contribute more than the usual $5,500 limit:
You and your employees can contribute up to $12,500. If
you’re 50 or older you can make an extra $3,000 “catch
up” contribution. If your income is under $50,000, that
may be more than you could sock away with a SEP.
(That’s because $12,500 is more than 25% of whatever you
could contribute to a SEP.)
SIMPLE IRA
But - you have to match everyone’s deferral or make
profit-sharing contributions. You can match
everyone’s contribution dollar-for-dollar up to 3% of
their pay, or contribute 2% of everyone’s pay
whether they defer or not. If you choose the match,
you can reduce it as low as 1% for two years out of
five.
The money goes straight into employee IRAs. You
can designate a single financial institution to hold the
money, or let your employees choose.
SIMPLE IRA
Like the SEP, there’s no set-up charge or annual
administration fee.
The SIMPLE IRA may be best for part-time or
sideline businesses earning less than $50,000. You
can also hire your spouse or children, and they can
make SIMPLE contributions. We’ll be talking more
about those strategies in a few minutes.
401(k)
Defer 100% of income up to $17,500
Age 50+ add $5,500 “catch up”
Employer contributes up to 25% of “covered comp”
Max. contribution: $52,000
Loans, hardship withdrawals, rollovers, etc.
Simplified administration for “individual” 401(k)
401(k)
The final step up the ladder is the 401k. Most people think of
401ks as retirement plans for bigger businesses. But you can set
up what’s called a “solo” or “individual” 401k just for yourself.
The 401k is a true “qualified” plan. This means you’ll set up a
trust, adopt a written plan agreement, and choose a trustee. But
the 401k lets you contribute far more money, far more flexibly,
than either the SEP or the SIMPLE.
You and your employees can “defer” 100% of your income up
to $18,000. If you’re 50 or older, you can make an extra $6,000
“catch up” contribution.
401(k)
You can choose to match your employees
contributions, or make profit-sharing contributions
up to 25% of their pay. That’s the same percentage
you can save in your SEP – on top of the $18,000
deferral.
The maximum contribution for 2015 is $53,000 per
person, plus any “catch up” contributions.
401(k)
You can offer yourself and your employees loans,
hardship withdrawals, and all the bells and whistles “the
big boys” offer their employees.
401ks are generally more difficult to administer. There
are antidiscrimination rules to keep you from stuffing
your own account while you stiff your employees. If
you operate your business by yourself, you can establish
an “individual” 401k with less red tape. And again, you
can hire your spouse and contribute to their account.
Defined Benefit Plan
Guarantee up to $185,000
Contribute according to
age and salary
Required contributions
“412(i)” insured plan
“Dual” plans
Age Regular 412(i)
45 $80,278 $164,970
50 $133,131 $258,019
55 $211,448 $395,634
60 $236,910 $450,112
Projections based on retirement at age 62
with $165,000 annual pretax income.
Defined Benefit Plan
If you’re older, and you want to contribute more than the
$53,000 limit for SEPs or 401ks, consider a traditional
defined benefit pension plan:
Defined benefit plans let you guarantee up to $210,000 in
annual income.
You can contribute – and deduct – as much as you need to
finance that benefit. You’ll calculate those contributions
according to your age, your desired retirement age, your
current income, and various actuarial factors.
Defined Benefit Plan
A 412(i) plan, which is funded entirely with life
insurance or annuities, lets you contribute even more.
Defined benefit plans have required annual
contributions. But you can combine a defined benefit
plan with a 401k or SEP to give yourself a little more
flexibility.
#5: Missing Family Employment
Children age 7+
First $6,300 tax-free
Next $9,225 taxed at 10%
“Reasonable” wages
Written job description, timesheet, check
Account in child’s name
FICA/FUTA savings
#5: Missing Family Employment
Now let’s talk about the fifth mistake: missing family
employment. Hiring your children and grandchildren can be a
great way to cut taxes on your income by shifting it to
someone who pays less.
Yes, there’s a minimum age. They have to be at least seven
years old.
Their first $6,300 of earned income is taxed at zero. That’s
because it’s the standard deduction for a single taxpayer –
even if you claim them as your dependent. Their next $9,225 is
taxed at just 10%. So you can shift a lot of income
downstream.
#5: Missing Family Employment
You have to pay them a “reasonable” wage for the service
they perform. The Tax Court says a “reasonable wage” is
what you’d pay a commercial vendor for the same service,
with an adjustment made for the child’s age and
experience. So, if your 12-year-old son cuts grass for your
rental properties, pay him what a landscaping service
might charge. If your 15-year-old helps keep your books,
pay him a bit less than a bookkeeping service might
charge. Does anyone have a teenager who helps with your
web site? What would you pay a commercial designer for
that service?
#5: Missing Family Employment
To audit-proof your return, write out a job description and keep a
timesheet.
Pay by check, so you can document the payment.
You have to deposit the check into an account in the child’s name.
But it doesn’t have to be his pizza-and-Nintendo fund. It can be a
Roth IRA for decades of tax-free growth. It can be a Section 529
college savings plan. Or it can be a custodial account that you
control until they turn 21. Now, you can’t use money in a
custodial account for your obligations of parental support. But
private and parochial school aren’t obligations of parental support.
Sleepaway summer camp isn’t an obligation of parental support.
#5: Missing Family Employment
Let’s say your teenage daughter wants to spend two weeks at horse
camp. You can earn the fee yourself, pay tax on it, and pay for
camp with after-tax dollars. Or you can pay her to work in your
business, deposit the check in her custodial account, and then, as
custodian stroke the check to the camp. Hiring your daughter
effectively lets you deduct her camp as a business expense.
If you hire your child to work in an unincorporated business, you
don’t have to withhold for Social Security until they turn 18. So
this really is tax-free money. You’ll have to issue them a W-2 at
the end of the year. But this is painless compared to the tax you’ll
waste if you don’t take advantage of this strategy.
#6: Missing Medical Benefits
#6: Missing Medical Benefits
Now let’s talk about health-care costs. Surveys used to show that
taxes used to be small business owners’ biggest concern. Now it’s
rising health care costs.
If you pay for your own health insurance, you can deduct it as an
adjustment to income on Page 1 of Form 1040. If you itemize
deductions, you can deduct unreimbursed medical and dental
expenses on Schedule A, if they total more than 10% of your
adjusted gross income. But most of us don’t spend that much.
What if there were a way to write off medical bills as business
expenses? There is, and it’s called a Medical Expense
Reimbursement Plan, or Section 105 Plan.
“Employee” Benefit Plan
Business Entity How to Qualify
Proprietorship Hire Spouse
Partnership Hire Spouse (if <5% owner)
S-Corporation >2% Shareholders ineligible
C-Corporation Hire Self
“Employee” Benefit Plan
The Section 105 plan is an “employee” benefit plan. That
means somebody needs to qualify as an employee. The
problem is, if you run your business as a sole
proprietorship (which includes a single-member LLC), a
partnership, or an S-corporation, you’re considered “self-
employed,’ and you can’t get benefits from the plan. So
you have to figure out another way to qualify:
If you’re a sole proprietor (or a single-member LLC
taxed as a proprietorship) and you’re married, you can
hire your spouse.
“Employee” Benefit Plan
If you’re a partner in a partnership (or LLC taxed as a
partnership), you can hire your spouse so long as they don’t own
more than 5% of the business.
If you’re a shareholder or member in an entity taxed as an S-
corporation, you don’t qualify and your spouse doesn’t qualify.
Your best bet in that situation is to segregate part of your income
into a separate entity, such as a proprietorship or a C-
corporation, and run the plan through that entity.
Finally, if you run your business – or even just a part of your
overall business – as an entity taxed as a C-corporation, you do
qualify as an employee all by yourself.
“Employee” Benefit Plan
By the way, you can also use the 105 plan for family
members other than your spouse. Let’s say you’re a
single mom working as a real estate agent. You can hire
your teenage child and use the plan to pay for their
eyeglasses, braces, or other medical costs. You can even
hire a retired parent to help cover their medical costs.
The “Fine Print”
Nondiscrimination:
Must cover all eligible employees
However, you can exclude:
– Under age 25
– less than 35 hours/week
– less than 9 months/year
– less than 3 years service
Controlled group rules
Affiliated service groups
The “Fine Print”
The plan has to cover all eligible employees. You can’t just cover
yourself or your family and exclude everyone else. However, there are
several “safe harbors” you can use to limit coverage. Specifically, you
can exclude:
Employees under age 25
Employees working less than 35 hours per week
Employees working less than nine months per year, and
Employees who have worked for you for less than three years.
There are a couple of other exclusions for larger employees – and the
IRS doesn’t pay a whole lot of attention in this area. But the fact remains
that you do have to cover all employees – so if you have nonfamily
employees and can’t exclude them under one of these rules, the 105 plan
may not be appropriate for you.
The Benefit
Reimburse medical expenses incurred for: – self
– spouse
– dependents
Not subject to 10% floor
Avoid self-employment tax
Supplement spouse’s coverage
The Benefit
Now for the benefit! Once you qualify, the plan lets
you reimburse your employee for all medical
expenses they incur for themselves, their spouse, and
their dependents.
Let’s say you’re a married sole proprietor and you
hire your spouse. You can reimburse them for all
medical expenses they incur for themselves, their
spouse (which means you), and your dependents.
The Benefit
Now you’ve taken what would probably have been a
nondeductible personal expense – and converted it into a
business expense.
You’ve avoided that 10% floor on itemized deductions.
And if you pay self-employment tax on your net income,
you’ll even avoid paying self-employment tax on the
money you deduct through the 105 plan. That’s another
15.3% or 2.9% or 3.8%, depending on your self-
employment income.
Eligible Expenses
Major medical, LTC, Medicare, “Medigap”
Co-pays, deductibles, prescriptions
Dental, vision, and chiropractic
Braces, LASIK, fertility, special schools
OTC medications (by prescription)
Eligible Expenses
What exactly can you deduct? Well, pretty much
everything you can think of!
This includes all the expenses you see listed here:
Major medical insurance, long-term care coverage,
Medicare Part B and D coverage, and Medigap
insurance.
Co-pays, deductibles, and prescriptions.
Eligible Expenses
Dental, vision, and chiropractic care.
Big-ticket expenses like braces for your kids’ teeth, LASIK
surgery for your eyes, fertility treatments, and special schools for
learning-disabled children.
You can even reimburse for over-the-counter medications,
vitamins and herbal supplements, and medical supplies, so long as
they’re actually prescribed by a physician.
The best part is, this is money you’d spend anyway, whether you get
to deduct it or not. You’re just moving it from a nondeductible
place on your return, to a deductible place.
The “Paperwork”
Written plan document
Benefits are “reasonable compensation”
Verify bona fide employment
Document payments
Certification
PCORI fee
The “Paperwork”
You’ll need a written plan document, which we can provide you.
You’ll need to make sure the benefits you pay are “reasonable
compensation” for the work your employee does. If your
teenager stuffs a few envelopes for you, the IRS will have a hard
time believing a full set of braces is “reasonable compensation”
for that little work.
You’ll need to verify the work your employee does in order to
establish that the benefits you pay are reasonable compensation.
This is a big hot button with the IRS and Tax Court.
The “Paperwork”
Finally, you’ll need to establish a “paper trail” to verify
payment. This means tracking expenses, of course. It also means
reimbursing your employee out of the business or paying their
expenses directly out of the business. It’s not enough just to pay
your family’s expenses out of personal funds, total them up, and
deduct them at the end of the year. A couple of recent Tax Court
cases have established that you really do need to establish a
business link to those expenses.
There’s no need for an outside third-party administrator.
However, IRS rules state that employees can’t “self-certify”
their own expenses.
The “Paperwork”
There’s no special reporting required. You’ll report
reimbursements as “employee benefits” on Schedule C,
Form 1065, or Form 1120. You’ll save income tax and self-
employment tax.
There’s no pre-funding required. You don’t have to open a
special account, like with Health Savings Accounts or flex-
spending plans. You don’t have to decide ahead of time
how much to contribute. And there’s no “use it or lose it”
rule. The plan is really just an accounting device that lets
you characterize your family medical bills as business
expenses.
The “Paperwork”
All Section 105 plan sponsors must file Form 720 to
report and pay a “patient-centered outcomes research
institute” fee of $2/per participant by 7/31 of the year
following the plan year. Ordinarily, this form is filed
quarterly; however, if an employer owes no other
excise taxes, they may file annually.
Health Savings Account
1. “High deductible health plan”
- $1,300+ deductible (individual coverage)
- $2,600+ deductible (family coverage)
Plus
2. Tax-deductible “Health Savings Account”
- Contribute & deduct up to $3,350/$6,650 per year
- Account grows tax-free
- Tax-free withdrawals for qualified expenses
Health Savings Account
If a medical expense reimbursement plan isn’t
appropriate, consider the new Health Savings Accounts.
These arrangements combine a high-deductible health
plan with a tax-free savings account to cover
unreimbursed costs.
To qualify, you’ll need a “high deductible health plan”
with a deductible of at least $1,300 for single coverage
or $2,600 for family coverage. Neither you nor your
spouse can be covered by a “non-high deductible health
plan” or Medicare.
Health Savings Account
The plan can’t provide any benefit, other than certain preventive care benefits, until the deductible for that year is satisfied. You’re not eligible if you’re covered by a separate plan or rider offering prescription drug benefits before the minimum annual deductible is satisfied.
Once you’ve established your eligibility, you can open a deductible savings account. You can contribute up to $3,350 for singles or $6,650 for families. You can use it for most kinds of health insurance, including COBRA continuation and long-term care premiums.
Health Savings Account
You can also use it for the same sort of expenses as a
Section 105 plan.
The Health Savings Account isn’t as powerful as the
Section 105 Plan. You’ve got specific dollar contribution
limits, and there’s no self-employment tax advantage.
But Health Savings Accounts can still cut your overall
health-care costs.
#7: Missing A Home Office
#7: Missing A Home Office
The home office deduction is probably the most misunderstood deduction in the entire tax code. For years, taxpayers feared it raised an automatic audit flag. But Congress has relaxed the rules, so now it’s far less likely to attract attention. Your home office qualifies as your principal place of business if: 1) you use it “exclusively and regularly for administrative or management activities of your trade or business”; and 2) “you have no other fixed location where you conduct substantial administrative or management activities of your trade or business.” This is true even if you have another office, so long as you don’t use it more than occasionally for administrative or management activities.
#7: Missing A Home Office
You have to use your office regularly and exclusively for business. “Regularly” generally means 10-12 hours per week. To prove your deduction, keep a log and take photos to record your business use. You can claim a workshop, studio, or “separately identifiable” space you use to store products or samples. The space doesn’t have to be an entire room. If you use it for more than one business, both have to qualify to take the deduction.
Qualifying Home Office
“Principal place of business”:
1. “exclusively and regularly for administrative or management activities of your trade or business”
2. “you have no other fixed location where you conduct substantial administrative or management activities of your trade or business.”
Source: IRS Publication 587
Qualifying Home Office
First let’s talk about how you qualify for the home office deduction in the first place.
Your home office qualifies as your principal place of business if:
1)you use it “exclusively and regularly for administrative or management activities of your trade or business”
2) “you have no other fixed location where you conduct substantial administrative or management activities of your trade or business.” This is true even if you have another office, so long as you don’t use it more than occasionally for administrative or management activities.
Qualifying Home Office
You have to use your office regularly and exclusively for business. “Regularly” generally means 10-12 hours per week.
To prove your deduction, keep a log and take photos to record your business use. You can claim a workshop, studio, or “separately identifiable” space you use to store products or samples.
The space doesn’t have to be an entire room. If you use it for more than one business, both have to qualify to take the deduction.
#7: Missing Home Office
Determine “BUP” of home
– Divide by rooms
– Square footage
– Eliminate “common areas”
144
1500
100
#7: Missing Home Office
Once you’ve qualified, you can start deducting expenses. If you’re taxed as a proprietor, you’ll use Form 8829. If you’re taxed as a partnership or corporation, there’s no separate form, which helps you “fly under the radar.”
1. First, you’ll need to determine business use percentage of your home. You can divide by the number of rooms if they’re roughly equal, or calculate the exact percentage of square footage. You can exclude common areas like halls and stairs to boost that business use percentage
#7: Missing Home Office
Deduct “BUP” of expenses:
– Mortgage/property taxes
(better than Schedule A)
– Utilities/security/cleaning
– Office furniture/decor
– Depreciation (39 years)
Increase business miles
#7: Missing Home Office
1. Next, you’ll deduct your business use percentage of rent, mortgage
interest, and property taxes.
1. You’ll depreciate the business use percentage of your home’s basis
(excluding land) over 39 years as nonresidential property.
2. Finally, you’ll deduct your business use percentage of utilities, repairs,
insurance, garbage pickup, and security. If business use percentage for
specific expenses differs from business use percentage for the overall
home – such as high electric bills for home office equipment – you can
claim the difference as “direct” expenses.”
Claiming a home office can also boost your car and truck deductions. That’s
because it eliminates nondeductible commuting miles for that business.
#7: Missing Home Office
When you sell:
– Recapture depreciation
– Keep tax-free exclusion
#7: Missing Home Office
You can use home office expenses to shelter profits, but
not below zero. If your home office expenses exceed
your net business income, you can carry forward those
excess losses to future years.
When you sell your home, you’ll have to recapture any
depreciation you claimed or could have claimed after
May 6, 1997. You can still claim the $500,000 tax-free
exclusion for home office space unless it’s a “separate
dwelling unit.”
#7: Missing Home Office
If this all seems like too much work, there’s a new
“safe harbor” method that lets you claim $5 per
square foot for up to 300 square feet of qualifying
home office. However, using the safe harbor method
might not let you claim nearly as much as the
traditional method. We can help walk you through the
calculations to see which method is best for you.
#8: Missing Car/Truck Expenses
AAA Driving Costs Survey (2014)
Vehicle Cents/Mile
Small Sedan 46.4
Medium Sedan 58.9
Large Sedan 72.2
4WD SUV 73.6
Minivan 65.0
Figures assume 15,000 miles/year; $3.28/gallon gas
#8: Missing Car/Truck Expenses
Now let’s talk about car and truck expenses. I don’t want to
take too much time here, but I do want to point out the most
common mistake clients make with these expenses.
(At this point, I ask audience members to raise their hands if
they take the standard deduction. I remind them that it’s 57.5
cents/mile, then ask them to tell me what they drive and how
much they deduct. The goal here is to show the wide variety
of vehicles clients drive . . . and emphasize that the
deduction is the same for them all.)
#8: Missing Car/Truck Expenses
Are you detecting a pattern here? That deduction is the same
for everyone, no matter what we drive. Do you think we all
spend the same to operate our cars?
It might surprise you to see how much it really costs to
operate your car. And it’s not exactly 57.5 cents per mile!
Every year, AAA publishes a vehicle operating cost survey.
Costs vary according to how much you drive – but if you’re
taking the standard deduction for a car that costs more than
57.5 cents/mile, you’re losing money every time you turn the
key.
#8: Missing Car/Truck Expenses
If you’re taking the standard deduction now, you can
switch to the “actual expense” method if you own your
car, but not if you lease.
You can’t switch from actual expenses to the mileage
allowance if you’ve taken accelerated depreciation.
#9: Missing Meals/Entertainment
Bona fide business discussion
– Clients
– Prospects
– Referral Sources
– Business colleagues
50% of most expenses
Home entertainment
Associated entertainment
#9: Missing Meals/Entertainment
Let’s finish up with some fun deductions for meals and
entertainment. The basic rule is that you can deduct cost for
meals with a bona fide business purpose. This means clients,
prospects, referral sources, and business colleagues.
And let me ask you – when do you ever eat with someone
who’s not a client, prospect, referral source, or business
colleague? If you’re in a business like real estate, insurance,
or investments, where you’re marketing yourself, the answer
might be “never.” Be as aggressive as you can with what
you define as bona fide business discussion!
#9: Missing Meals/Entertainment
The general rule is, you can deduct 50% of your
meals and entertainment, so long as it isn’t “lavish
or extraordinary.” The IRS knows you have to eat,
so you can’t deduct it all. But they’ll meet you
halfway.
How many of you entertain at home? Do you ever
discuss business? Are you deducting those meals,
too? There’s no requirement that you eat out. Don’t
forget to deduct home entertainment expenses too!
#9: Missing Meals/Entertainment
You can deduct entertainment expenses if they take
place directly before or after substantial, bona fide
discussion directly related to the active conduct of
your business.
You can deduct the face value of tickets to sporting
and theatrical events, food and beverages, parking,
taxes, and tips.
#9: Missing Meals/Entertainment
How much?
When?
Where?
Business purpose?
Business relationship?
#9: Missing Meals/Entertainment
You don’t need receipts for expenses under $75. But
you do need to record the five pieces of information
listed on the right side of the slide in your business diary
or records. And you should do it as close to daily as
possible.
The IRS wants to know how the cost of the meal, the
date of the meal, the place where it takes place, the
business purpose of your discussion, and your business
relationship with your guest.
#10: Missing Tax Coaching Service
True Tax Planning
Written Tax Plan
– Family, Home, and Job
– Business
– Investments
Review Returns
#10: Missing Tax Coaching Service
Now that you see how business owners miss out on tax
breaks, let’s talk about the biggest mistake of all.
What mistake is that?
The biggest mistake of all is failing to plan. Have you all
heard the saying “if you fail to plan, you plan to fail”? It’s a
cliché because it’s true. Fortunately, our tax coaching service
avoids the problem.
We offer true tax planning. We’ll tell you what to do, when
to do it, and how to do it.
We start with a three-page “check the box” questionnaire that
takes 5 minutes to fill out.
#10: Missing Tax Coaching Service
Then we prepare a written tax plan that addresses you
family, home, and job, your business, and your
investments.
We’ll even review your last three years’ tax returns to
see if we can find savings you overlooked.
If you’re serious about the strategies we’ve discussed
today, then why not give it a try?
#10: Missing Tax Coaching Service
Then we prepare a written tax plan that addresses you
family, home, and job, your business, and your
investments.
We’ll even review your last three years’ tax returns to
see if we can find savings you overlooked.
If you’re serious about the strategies we’ve discussed
today, then why not give it a try?
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