Individuals whose businesses are incorporated typically do not have to worry about self-employment tax if they are paying themselves a reasonable salary. Any salary taken by owner-employees is subject to FICA taxes (Social Security and Medicare). FICA taxes are deducted from the shareholder’s paycheck and are remitted regularly through payroll tax payments to the IRS. Owners of sole proprietorships, partnerships, and limited liability companies (LLCs)—are not considered “employees” but “self-employed individuals”. Instead of paying FICA tax through wages, self-employed people pay self-employment tax. Partners, sole proprietors and LLC members do not take a regular salary through payroll, so there is no tax withheld from the payments they take which are called “draws”.
Self-employed individuals pay self-employment tax equal to the employer and employee share of FICA tax. In other words, they pay 15.3% (comprised of 12.5% for Social Security tax and 2.9% for Medicare tax) on the net earnings of their business. In basic terms, net earnings from self-employment is calculated by subtracting total expenses from total income. Oftentimes, self-employed clients get confused because they think they only pay tax on the draws they pay themselves from the business. This is not the case, however, because if the business is profitable and no draws are taken, the owner will still pay 15.3% self-employment tax on those profits. The draws that the owner takes do not decrease the net profits of the business and generally have no effect on self-employment tax. There are some “draws” called ‘guaranteed payments” taken by some partners in a partnership that do decrease the profits of the other partners, but those guaranteed payments are still subject to the 15.3% self-employment tax for the partner who has received such payments. An LLC can elect to be taxed as a corporation thereby allowing the owners to take a regular salary and have some control over the self-employment tax that they pay. This is a good option for LLCs that are profitable.
Extender from PATH Act means you can take bonus depreciation on your 2015 returns – but should you?
Once again, bonus depreciation has been extended allowing taxpayers to recover the costs of depreciable property more quickly by claiming additional first-year depreciation for qualified assets. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) extended 50% bonus depreciation through 2017. Many taxpayers may benefit from claiming this break on their 2015 returns however some might save more tax in the long run if they elect out of bonus depreciation.
What type of assets qualify for bonus depreciation?
For 2015, new tangible property with an IRS stipulated depreciable life of 20 years or less (such as computers, office furniture or equipment) qualifies for bonus depreciation. Off-the-shelf computer software, water utility property and qualified leasehold-improvement property also qualifies. The new assets must also have been put in to use in 2015 in order to qualify for any depreciation deduction.
To bonus or not to bonus, that is the question…
Typically, taxpayers always want to maximize their tax deductions in the current year. But wise tax planning calls for considering the effects of this year’s choices on future year’s tax burdens. If a taxpayer has assets that are eligible for bonus depreciation and they expect to be in the same or a lower tax bracket in future years, taking Section 179 deduction first, then bonus depreciation is most likely a good tax strategy. Doing so will defer tax, which generally is beneficial and usually the goal of tax planning.
However, if a business is growing and expects to be in a higher tax bracket in the near future, it may be better off forgoing bonus depreciation altogether. Why? Because it makes sense to decrease deductions in years when a taxpayer is in a lower tax bracket, when they expect to have a higher taxable income in future years. They will need the depreciation deductions more in the years they have higher taxable income, so electing out of bonus depreciation and not taking Section 179 deductions can be a smart tax move. Deductions are worth more when your tax bracket is higher.
Have questions about depreciation? We can help
If you’re unsure whether you should take bonus depreciation on your 2015 return — or you have questions about other depreciation-related breaks, such as Sec. 179 expensing — contact us – we can help.
Are You Eligible to Deduct Home Office Expenses?
Just because you have a home office space doesn’t mean you can deduct expenses associated with it.
Home Office Requirements
The eligibility requirements for deducting home office expenses differ depending upon if you are an employee or if you are self-employed. For example, as an employee, having a home office must be for your employer’s convenience and not just your own. The IRS even has a “Convenience of Employer Test” in which an employee’s home office is deemed to be for an employer’s convenience only if it is:
- a condition of employment
- necessary for the employer’s business to properly function, or
- needed to allow the employee to properly perform his or her duties.
Most likely, you won’t pass the employer convenience test if you have another office provided by your employer but like to take work home with you. However, you would pass the test if your employer doesn’t provide you with an office, or if there is some valid business reason why you must work at home.
If you’re self-employed, generally your home office must be your principal place of business, but there are a few exceptions.
Whether you’re an employee or self-employed, the space must be used regularly (not just occasionally) and exclusively for business purposes. If, for example, your home office is also a family room, guest room or where your kids do their homework, the space is NOT a home office in the eyes of the IRS.
How Does the Home Office Deduction Affect Taxes?
The home office deduction can be a nice tax break – especially for self-employed people because you save not only on regular income tax but that pesky 15.3% self-employment tax as well! How the deduction works – the first step is figuring out the square footage of your home office, then you divide that number by the total square footage of your home. The result is a percentage. You may be able to deduct that percentage of your mortgage interest, property taxes, home owner’s insurance, utilities and certain other expenses, as well as the depreciation allocable to the office space.
In the last couple of years, the IRS has created a simpler “safe harbor” deduction in lieu of calculating, allocating and substantiating actual expenses. The safe harbor deduction is capped at $1,500 per year, based on $5 per square foot up to a maximum of 300 square feet.
For employees and S-corporation shareholders, home office expenses are a less beneficial miscellaneous 2% itemized deduction. This means you’ll get a tax break only if these expenses plus your other miscellaneous itemized expenses exceed 2% of your adjusted gross income (AGI).
Finally, be aware that we’ve covered only a few of the rules and limits here. If you think you may be eligible for the home office deduction, contact us for more information.
Using the “per diem” approach when reimbursing employees for lodging, meals and incidental expenses requires the use of either IRS tables or a simplified high-low method to reimburse workers up to specified limits. Organizations seem to really like the per diem approach because of its simplicity. It doesn’t require too much record keeping and keeping up with receipts. However, the per diem method may put your organization at risk if you exceed the per diem limits. Exceeding the per diem limits exposes your organization to IRS penalties and your employees to higher tax liabilities. This is typically why organizations will often switch to an “accountable plan” for handling employee expense reimbursements.
Tax Advantages of An Accountable Plan
An accountable plan is a formal arrangement to advance, reimburse or provide allowances for business expenses. The biggest advantage is that your organization can deduct expenses (subject to a 50% limit for meals and entertainment), and employees and subcontractors can usually exclude 100% of advances or reimbursements from their incomes. Workers whose jobs involve frequent travel may realize significant tax savings.
How to Qualify As An Accountable Plan
Under IRS rules, your accountable plan must meet the following three criteria:
- The plan must only reimburse “ordinary & necessary” business-related expenses that would otherwise be deductible by the employee or subcontractor.
- Employees must substantiate these expenses — including amounts, times and places — ideally at least monthly by turning in receipts.
- Employees must return any advances or allowances they can’t substantiate within a reasonable time, typically 120 days.
Failure to meet these conditions, will cause the IRS to treat your plan as “non-accountable”, which then transforms all reimbursements into wages taxable to the employee and subject to income and employment taxes.
Need Some Help?
Accountable plans take time to establish and require meticulous record keeping. Let us help. We’d be happy to assist you in setting up your accountable plan and regularly reviewing its compliance with IRS rules.
Maximize tax benefits of carryforwards and carrybacks
Although the tax code contains some exceptions, income is generally taxable in the tax year received and expenses are claimed as deductions in the year paid. But “carryforwards” and “carrybacks” have special rules. In this case, certain losses and deductions can be carried forward to offset income in future years or carried back to offset income in prior years, providing tax benefits.
* Capital losses. After you net annual capital gains and capital losses, you can use any excess loss to offset up to $3,000 of ordinary income. Remaining losses can be carried over to offset gains in future years. The carryforward continues until the excess loss is exhausted.
* Charitable deductions. Your annual charitable deductions are limited by a “ceiling” or maximum amount, as measured by a percentage. For example, the general rule is that your itemized deduction for most charitable donations for a year can’t exceed 50% of your adjusted gross income (AGI). Gifts of appreciated property are limited to 30% of your AGI (20% in some cases) in the tax year in which the donations are made. When you contribute more than these limits in a year, you can deduct the excess on future tax returns. The carryover period for charitable deductions is five years.
* Home office deduction. If you qualify for a home office deduction and you calculate your deduction using the regular method, your benefit for the current year can’t exceed the gross income from your business minus business expenses (other than home office expenses). Any excess is carried forward to the next year. Caution: No carryforward is available when you choose the “simplified” method to compute your home office deduction.
* Net operating losses (NOLs). Business NOLs can be carried back two years and forward 20 years. Tip: As an alternative, you may opt to forego the carryback and instead carry the entire NOL forward.
Give us a call (757) 926-4109 for help in maximizing the tax benefits of carryforwards or carrybacks, planning has to be done on these strategies before the end of the year.
Do you ever take the home office deduction?
Do you work at home or have a home-based business? If so, you should be aware that the IRS has created a simpler option for calculating the deduction for the business use of your home. The new option makes record keeping easier because, instead of maintaining records of specific home office expenses, you can use a standard rate per square foot. The rate is $5 per square foot (up to a maximum of 300 sq. feet or $1,500) for qualifying business use space in place of taking a pro rata percentage of items such as mortgage interest, taxes and repairs. Keep in mind there are good and bad aspects to this “simpler” method. The new method gives you back your full interest and tax deduction on schedule A, but you will lose your depreciation and loss carryover deductions. Of course, you must still use your home office regularly and exclusively for business. This may be a welcome relief for some taxpayers, but it might not be the best choice for others. Let our firm’s tax experts help you determine if the simplified deduction is the right choice for you. Please contact us at (757) 926-4109 for answers to all your financial questions and concerns – it’s what we do.
The decision of whether to trade in an old business car or try to sell it for cash generally should be based on factors such as the amount you can get on a sale versus a trade-in, and the time and bother a sale will entail. However, important tax factors also may affect your decision-making process. Here’s an overview of the complex rules that apply to what appears to be a simple transaction, and some pointers on how to achieve the best tax results.
In general, the sale of a business auto yields a gain or loss depending on the net amount you receive from the sale and your basis for it. Your “basis” is your cost for tax purposes and, if you bought the asset, usually equals your cost minus the depreciation deductions you claimed for the auto over the years. Under the tax-free swap rules, trading in an old business auto for a new one doesn’t result in a current gain or loss, and the new car’s basis will equal the old car’s remaining basis plus any cash you paid to trade up. As a general rule, you should trade in your old business car if you used it exclusively for business driving, and its basis has been depreciated down to zero, or is very low. The trade-in often avoids a current tax. For example, if you sell your business car for $9,000, and your basis in it is only $7,000, you will have a $2,000 taxable gain, but if you trade it in, a current tax is avoided because any gain is deferred. Your basis in the new car will be lower than it would be if you bought it without a trade-in, but that doesn’t necessarily mean lower depreciation deductions on the new car. Because of the so-called “luxury auto” annual depreciation dollar caps, your annual depreciation deductions on a new car may be the same whether you sold the old car or traded it in.
However, you should consider selling your old business car for cash rather than trading it in if you used it exclusively for business driving and depreciation on the old car was limited by the annual depreciation dollar caps. In this situation, your basis in the old car may exceed its value. If you sell the old car, you will recognize a loss for tax purposes. However, if you trade it in, you will not recognize the loss.
For example, let’s you bought a $30,000 car several years back and used it 100% for business driving. Because of the annual depreciation dollar caps, you still have a $16,000 basis in the car, which has a current value of $14,500. Now, you want to buy another $30,000 car. If the old car is sold, a $1,500 loss will be recognized ($16,000 basis less $14,500 sale price). If the old car is traded in for a new one, there will be no current loss. Of course, if the old car’s value exceeds its basis, the tax-smart move is to trade it in and thereby avoid the gain.
You also may be better off selling your old business car for cash rather than trading it in, if you used the standard mileage allowance to deduct car-related expenses. For 2016, the allowance is 54¢ per business mile driven. The standard mileage allowance has a built-in allowance for depreciation, which must be reflected in the basis of the car. When it’s time to dispose of a car, the depreciation allowance may leave you with a higher remaining basis than the car’s value. Under these circumstances, the car should be sold in order to recognize the loss. All of this sounds very complicated, and it is. Before you sell or trade in your business car or lease a new one, please give us a call and we’ll set up a meeting to discuss your options.
We often get asked about the requirements for deducting business meals and entertainment expenses. This type of expense requires you to jump through several extra hoops to qualify as deductible and is subject to limitations. Nevertheless, if you pay careful attention to the rules outlined below, the expenses should qualify as deductible.
- Ordinary and necessary business expenses. All business expenses must meet the general deductibility requirement of being “ordinary and necessary” in carrying on the business. These terms have been fairly broadly defined to mean customary or usual, and appropriate or helpful. Thus, if it is reasonable in your business to entertain clients or other business people you should be able to pass this general test.
- “Directly related” or “associated with.” A second level of tests especially applicable to meals and entertainment expenses must also be satisfied. Under them, the business meal or entertainment must be either “directly related to” or “associated with” the business. “Directly related” means involving an “active” discussion aimed at getting “immediate” revenue. Thus, a specific, concrete business benefit is expected to be derived, not just general goodwill from making a client or associate view you favorably. And the principal purpose for the event must be business. Also, you must have engaged actively during the event, via a meeting, discussion, etc. The directly related test can also be met if the meal or entertainment takes place in a clear business setting directly furthering your business, i.e., where there is no meaningful personal or social relationship between you and the others involved. Meetings or discussions that take place at sporting events, night clubs, or cocktail parties—essentially social events—would not meet this test. If the “directly related” test cannot be met, the expense may qualify as “associated with” the active conduct of business if the meal or entertainment event precedes or follows (i.e., takes place on the same day as) a substantial and bona fide business discussion. This test is easier to satisfy. “Goodwill” type of entertainment at shows, sporting events, night clubs, etc. can qualify. The event will be considered associated with the active conduct of the business if its purpose is to get new business or encourage the continuation of a business relationship. For meals, you (or an employee of yours) must be present. That is, for example, if you simply cover the cost of a client’s meal after a business meeting but don’t join him at it, the expense does not qualify.
- Substantiation. Almost as important as qualifying for the deduction are the requirements for proving that it qualifies. The use of reasonable estimates is not sufficient to stand up to IRS challenge. You must be able to establish the amount spent, the time and place, the business purpose, and the business relationship of the individuals involved. Obviously, you must set up careful and detailed record-keeping procedures to keep track of each business meal and entertainment event and to justify its business connection. For expenses of $75 or more, documentary proof (receipt, etc.) is required.
- Deduction limitations. Several additional limitations apply. First expenses that are “lavish or extravagant” are not deductible. This is generally a “reasonableness” test and does not impose any fixed limits on the cost of meals or entertainment events. Expenses incurred at first class restaurants or clubs can qualify as deductible. More importantly, however, once the expenditure qualifies, it is only 50% deductible. Obviously, this rule severely reduces the tax benefit of business meals and entertainment. If you spend about $50 a week on qualifying business meals, or $2,500 for the year, your deduction will only be $1,250, for tax savings of around $300 to $400.
Please call if you have any questions or would like my help in setting up record-keeping procedures.
The IRS issued “final” rules known as the “repair regulations” this year. They will effect your 2014 tax return if you have any depreciable assets or if you regularly purchase materials & supplies in your line of business. The rules clarify which costs should be capitalized and which can be expensed when your business buys, makes, maintains, or improves certain fixed assets such as buildings, equipment, vehicles and machinery.
Here are three ways your business can be affected:
1. Accounting policies. You’ll need to update your accounting policies to reflect how you treat expenses for repairs, materials, and supplies, and the acquisition of assets. Having a written policy in place will help keep you in compliance with the rules. Your accounting policy must be in effect as of January 1 of each year. Contact us for a template to help you with tax compliant wording.
2. Elections. The final regulations include six elections. You’ll want to review them to learn if they are beneficial to you. For example, by choosing the “de minimis safe harbor election,” you can opt to expense the cost of property below a specific dollar amount, typically $500 but your industry standard could dictate more.
3. Form 3115. You may want to file Form 3115, Application for Change in Accounting Method, with your 2014 federal income tax return to revise certain decisions you made regarding the treatment of tangible property in prior years. Alternatively, under simplified rules recently issued by the IRS, certain small businesses have the option of applying the repair regulations to 2014 and future years without filing Form 3115.
The final repair regulations will affect every business with fixed assets on the books as well as individuals with rental properties. This law is very complex and requires a lot of paperwork to be in compliance. Our tax preparers understand the ins and outs of the new repair regulations. Please contact us to schedule an appointment so we can help you determine how to apply the rules.