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3 Key Tax Strategies for Small Business Owners

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Jun 19th 2017
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Small business owners pay their taxes all year long, so they should be focusing on tax planning all year long. That doesn’t mean small business owners should make financial decisions based solely on tax considerations. But it does mean they should never make important financial decisions without at least considering the tax consequences.

1. Health insurance deductions for self-employed individuals. Many freelancers needlessly overpay their taxes because they’re unaware that the law entitles them to deduct 100 percent of their spending for medical insurance premiums (including qualifying long-term coverage) for themselves and their spouses and dependents.

They take the health insurance deduction “above the line” on Line 29 on the front of the 1040 form, thereby reducing their adjusted gross income (AGI), Line 37.

This is a big break for freelancers and other self-employed individuals, regardless of whether their unreimbursed medical expenses aren’t high enough to claim as itemized deductions on Schedule A of Form 1040, notes the New York Times of Feb. 19, 2017.

Long-standing rules forbid itemizers from writing off all of their medical outlays. Itemizers can claim their expenditures just to the extent they exceed 10 percent of AGI. No deduction for anything below the 10-percent-of-AGI threshold.

There’s an exception for people 65 and older. Their threshold is 7.5 percent. This break went off the books at the close of 2016, though there’s bipartisan support in Congress to extend it beyond 2016.

2. First-year expensing. Tax-savvy freelancers know they have two ways to write off their outlays for purchases of equipment – for instance, computers and file cabinets.

Freelancers who go the “standard” route recover the cost through depreciation deductions over a period of years. Their other option is the frequently overlooked tactic of “expensing,” meaning they deduct a specified amount of equipment in the year of purchase.

To illustrate, a self-employed person’s equipment purchases include $10,000 for cameras, computers, copiers, tape recorders, and the like. Instead of depreciating them over five years, they can be immediately expensed under Code Section 179. A $10,000 write-off lowers taxes by $3,000 for an individual in a top federal and state bracket of 30 percent.

3. Profit from paying your kids. Do your children help out with some of the chores connected with your business? Could they? Then a savvy way to take care of their allowances or spending money – at the expense of the IRS – is to pay them wages for work they do on behalf of the business. This holds true whether it’s a full-time, long-established operation or just a new, part-time sideline.

Putting your children on the payroll is a perfectly legal way to keep income in the family, while shifting some out of your higher bracket and into their lower bracket. IRS auditors require this kind of expense to pass a two-step test:

  1. Your children have to actually render services.
  2. You pay them wages that the IRS deems “reasonable” – agency lingo for not more than the going rate for unrelated employees performing comparable chores like clerical work or deliveries.

Section 3121(b)(3)(A) authorizes another break. It permits you to sidestep Social Security taxes on the wages you pay your children under the age of 18. To qualify for the exemption, you must operate as a sole proprietorship, meaning the lone owner of a full-time or part-time business that’s not formed as a corporation or partnership, or do business as a husband-wife partnership. Put another way: No exemption for a family business that’s incorporated or a partnership with a partner other than a spouse. 

Another break for business owners is that write-offs for equipment purchases and wages save more than just income taxes. They also reduce self-employment taxes owed.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 180 and counting).

Stay competitive with your fellow accountants who turn to the articles when, say, they correspond with clients or they want to show clients how to nimbly sidestep pitfalls while capitalizing on opportunities to diminish, delay, or deep-six payments of sizable amounts that would otherwise swell IRS coffers.

Also be mindful of the articles when you strive to build name recognition, a goal attainable only by choosing and implementing strategies that set you apart from ferocious competition. Use the articles to prepare talks to audiences, such as business owners, investors, and retirees.

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