The following is a compilation of a number of tax breaks available to self-employed individuals and/or small business owners. Some can be implemented before year’s end, providing benefits for your 2011 return, while others will provide planning opportunities for 2012.
- Little or No Profit This Year — The farm and nonfarm optional methods for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.
- The Work Opportunity Tax Credit — The work opportunity tax credit allows employers tax credits (as much as $4,800) for hiring individuals from targeted groups (such as recipients of public assistance and qualified veterans).
- Elect to Deduct Start-Up Costs — Taxpayers can elect to deduct up to $5,000 of start-up and $5,000 of organizational expenses in the first year of a business. Each of the $5,000 amounts is reduced by the amount by which the total start-up expense or organizational expense exceeds $50,000. Expenses not deductible in the first year of the business must be amortized over 15 years.
- Deduct a Home Office — If you work from an office in your home, perform management or administrative tasks from a home office, or store product samples or inventory at home, you may be entitled to deduct an allocable portion of certain costs of maintaining your home. This would include allocated maintenance, utilities, etc.
- Business Travel Break — If you maintain your office in your home and it is your principal place of business, you may be entitled to a special tax break on your commuting costs.
- Establish an Employee Pension Plan — Establishing a pension plan for your employees can help you retain better employees. If you start a pension plan, you can take a credit of up to $500 a year for each of the first three years of the plan. The credit is for 50% of certain start-up costs incurred in each of those years.
- Deduct Vehicle Interest, Tax and License — Normally if you purchase a vehicle, the interest on the loan is treated as nondeductible consumer interest. However, if the vehicle is used partially for business (other than as an employee), then the business portion of the interest can be deducted on your business schedule. The business portions of the personal property tax and license fee can also be deducted on your business schedule. The business portion of the sales tax is added to your vehicle’s basis and depreciated if the actual expense method is used.
- Deduct Health Insurance Off-the-Top — A self-employed individual may deduct the amount paid during the tax year for medical insurance for himself, his spouse, his dependents, and even his children who are under age of 27 even if they are not dependents. There is no limit on the amount that may be deducted, except that the deduction cannot exceed net self-employment income. For this deduction, health insurance includes medical, dental, vision, and long-term care premiums. The medical care insurance isn’t limited by the normal 7.5%-of-AGI floor on itemized medical expenses, and it isn’t a business schedule deduction. Instead, it’s an above-the-line deduction on page 1 of Form 1040.
- Business Education Expense Options — Self-employed taxpayers can treat business education expenses for themselves either as a deduction on the business schedule or as an education tax credit. If the deduction option is chosen, it reduces both self-employment tax liability and income tax liability. How much is saved depends upon your tax bracket.
- Employ Your Child — You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some of your business earnings to a child as wages for services performed by him or her. For your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s salary must be reasonable.
- · Contribute to Your Retirement Plan — A variety of retirement plans are available to the small business owner or self-employed taxpayer. Some plans must be set up before year’s end.
- Trade-in versus Sale — If you are purchasing a new vehicle or other equipment, you should carefully consider whether to trade in the old asset or sell it in an unrelated transaction. The reason? If the disposition of the old vehicle or equipment would result in a tax loss, you might want to sell it separately. However, if the disposition would result in a tax gain, you would want to trade it in to avoid the gain and instead have it reduce the basis of the replacement asset.
- Avoid Underpayment Penalties — Taxpayers are expected to pay their taxes during the year through the payment of estimated taxes and/or withholding. If you have not paid enough and do not meet one of the exceptions, you could be subject to an underpayment penalty along with an unpleasant tax bill when the tax return is filed. Year-end increased estimates and withholding can mitigate those penalties.
- Borrow to Pay Deductible Expenses before Year’s End — If 2011 was a better than normal year for income, you might consider using a credit card to pay expenses that can generate deductions for this year.
Please give this office a call if you have additional questions about any of the tax breaks mentioned above. Most of these benefits require action before 2012 to gain any tax advantage for 2011. However, that does not preclude you from planning in advance for 2012.