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We’re a San Diego, Calif.-based boutique tax consulting firm focused on personalized tax and financial guidance to individuals and businesses. Here on our blog, you’ll find you’ll find news, insights, and observations from trusted sources in the world of tax planning and and financial guidance.
Deducting the Costs of Business Meals, Entertainment, and Gifts, Part 10: Small Business Guide to Reducing Your Tax Burden Legally
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As a small-business owner, you know that you can easily rack up a considerable amount in expenses over the course of the year dining with and entertaining clients, colleagues, and partners. Then there’s hosting “free” seminars or presentations for prospective clients. And feeding your employees (for example, donuts and coffee for a morning meeting or pizza and soft drinks for a team that’s working overtime on a project). You may even have additional expenses related to gifts presented to customers and vendors to show your appreciation for their business and efforts on your behalf.
All this is money leaving the business and not going into your pocket, so it should be deductible, right? Yes, it is, but just how deductible it is depends on the context in which that money is spent and who received the benefit.
In this post — No. 10 of 12 in our Small Business Guide to Reducing Your Tax Burden Legally series — we break down business deductions for meals, entertainment, and gifts, to ensure that you’re taking full advantage of what the government allows, taking care to not do something that may prompt the government to question any of your deductions.
Deducting the Cost of Meals Out
If you’re in a business such as management consulting, marketing services, insurance, or personal finances, you likely spend considerable time meeting with clients over lunch, coffee, or drinks. In other businesses, you may meet with partners or colleagues to discuss plans for business ventures or projects you’re currently working on together. As long as meals you pay for under either of those scenarios are for a legitimate business purpose — with existing clients, new business prospects, and business colleagues such as vendors you work with — they’re deductible.
Costs for business meals (food and beverage) are generally deductible up to 50 percent, but expenses must meet the following conditions: Continue reading… Continue reading… Continue reading…
Deducting Qualifying Car and Truck Expenses, Part 9: Small Business Guide to Reducing Your Tax Burden Legally
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Did you know that if you have a motor vehicle and a business, you may have a tax deduction coming your way? It’s true. In many cases, you can deduct from your business profits the cost of buying, driving, and maintaining that vehicle. And if you use it exclusively or almost exclusively for work, you may be able to get the government to pay a good chunk of the expenses related to that vehicle (in the form of money you save on taxes).
That’s only fair. Every penny you put into driving to deliver product or perform a service for your customers is a penny out of your business profits!
In this blog post, Part 9 in our Small Business Guide to Reducing Your Tax Burden Legally series, we cover how it may be possible to claim a deduction on a qualifying car, truck and related expenses.
Two Ways to Claim Vehicle Expenses
In these United States, the Internal Revenue Code provides for two different ways to claim vehicle expenses:
- Actual expenses: You claim the business use percentage (BUP) of all expenses related to a vehicle, including fuel cost, auto insurance, lease payments (or loan interest and depreciation), personal property tax, repairs/maintenance (oil changes, tires, etc.), and car washes. For example, suppose you use a vehicle 75 percent for business and 25 percent for personal use, and your total vehicle expenses are $8,000 for the year. Your deduction would be $8,000 x 0.75 = $6,000.
- Standard mileage: You multiply the number of miles you drove the vehicle for business by the standard per-mile rate, which is 57.5 cents for the year 2020. For example, if you put 8,000 business miles on a vehicle 8,000 x 57.5 = $4,600. Using this method, you can also deduct the business use percentage of vehicle registration fees and taxes, vehicle loan interest, and tolls and parking fees. (Note: You cannot use the standard mileage method if you use five or more vehicles in your business, or you use your vehicle for hire; for example, taxi, Lyft, Uber, etc.)
Many small-business owners choose the standard mileage option because it’s so straightforward in terms of calculations and record-keeping. All you need is your odometer meter reading at the beginning and end of the year and a log of the number of miles you drove for business (which you should keep regardless of the method you use to calculate your deduction). You don’t need a receipt for every time you fuel up or take your vehicle in for an oil change.
However, using the easy method could cost you money. Every year, the American Automobile Association (AAA or more commonly “Triple A”) conducts in-depth research into vehicle operating costs. If you’re choosing to take the standard deduction for a vehicle that costs more than 57.5 cents/mile, could be losing money by not claiming your Continue reading… Continue reading… Continue reading…
Maximizing Your Home Office Deduction, Part 8: Small Business Guide to Reducing Your Tax Burden Legally
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If you’re self-employed or run a small business out of your home, you can reduce your income tax bill by claiming a home office deduction. This deduction enables you to subtract from your income a portion of expenses attributable to the area of your home that you use for business.
For example, if you run a pet grooming business out of 20 percent of your home and use that other 80 percent as living space, under the right circumstances, you may be able to deduct 20 percent of your mortgage interest, property taxes, homeowner’s insurance, homeowner association fees, and utilities (such as electricity, gas, water, sewer, and trash). You might even be able to deduct depreciation on that portion of your home.
Hey, it’s only fair. Other businesses get to deduct the cost of maintaining a building or renting office space, so you should get a tax break for the portion of your home you use for conducting business.
Unfortunately, many small-business owners don’t claim this deduction because they fear that doing so will raise red flags and increase their odds of becoming a target for a dreaded tax audit. Others avoid claiming it because they’re afraid that the calculations or record-keeping would be too complicated. However, the calculations and record-keeping are straightforward, and there’s no evidence that claiming the home office deduction increases your odds of being audited. Besides, as long as you’re honest about the business use of your home, and you have records to back up the expenses you claim, even if you do get audited, you have nothing to fear.
In addition to being able to claim the home office expense, if you are using your home office as the base for business auto mileage, it is a good idea to establish your home office as your “tax home.” This supports your claim for auto expenses any time you travel from your home office to another business location.
Pro Tip: You may be able to use expenses associated with a home office to reduce self-employment income and taxable income from your business — but not below zero. If your home office expenses for a particular year are more than your net income from your business, you may be able to carry forward the loss to future years.
Deciding Whether Your Office Space Qualifies
To qualify for a home office deduction, a portion of your home must be used in one of the following ways:
- Exclusively and regularly as your principle place of business
- Exclusively and regularly as a place where you meet and deal with your customers in the normal course of your business
- A separate structure that’s not attached to your home and is used exclusively and regularly in connection with your business
- On a regular basis, the space is used for storage of inventory or product samples used in your business for selling products at retail or wholesale (note: this usage does not have to be exclusive)
- For rental use
- As a daycare facility
Let’s translate this into plain English: Continue reading… Continue reading… Continue reading…
Improving Your Medical Benefits While Cutting Your Taxes, Part 7: Small Business Guide to Reducing Your Tax Burden Legally
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The Affordable Care Act (ACA), dubbed “Obamacare,” made health care much less affordable for many small-business owners. It led to higher health insurance premiums, while doing little to nothing to rein in the spiraling costs of doctor visits, diagnostic tests, pharmaceuticals, and hospital care.
As a result, many small-business owners have dropped their healthcare coverage, which is not something we recommend. That’s because a single unforeseen individual or family illness could stick you with a bill that could drive you into bankruptcy. What we do recommend is that you make healthcare more affordable for yourself and your family by taking full advantage of every tax break available for healthcare expenses.
You are probably already aware that if you pay for your own health insurance, you’re allowed to deduct it as an adjustment to income. You’re probably also aware that if you itemize your deductions, you’re allowed to deduct unreimbursed dental and medical that exceed 7.5 percent of your adjusted gross income. However, most of us don’t spend that much on healthcare, and since the standard deduction nearly doubled with the passing of the Tax Cut and Jobs Act of 2017, many of us don’t itemize. As a result, we end up losing a lot of money in otherwise legitimate deductions.
Here’s an idea. What if there was a way to write off medical bills as business expenses? Actually, there are three ways:
- Medical Expense Reimbursement Plan (MERP)
- Health Savings Account (HSA)
- Flexible Spending Account (FSA)
Pro Tip: Take a big-picture approach to healthcare costs. While a high-deductible healthcare plan costs less and makes you eligible to contribute to a health savings account (HSA) and pay out-of-pocket costs out of that account tax-free, a low-deductible plan that covers more expenses may be more cost-effective for your family depending on your situation. Here at Stees, Walker & Company, LLP, we can help you evaluate different plans and choose a plan that’s best for your overall finances.
In any event, in this post we cover each of the three ways to legally write off medical bills as business expenses, starting with the use of an MERP (medical expense reimbursement plan).
Medical Expense Reimbursement Plan (MERP)
The first thing to know about a MERP (also known as a 105 plan) is that it’s an employee benefit plan. That means it requires an employee: Continue reading… Continue reading… Continue reading…
Hiring Your Kids to Cut Taxes, Part 6: Small Business Guide to Reducing Your Tax Burden Legally
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Do you ever get the feeling that your kids are taking you to the cleaners? We’re not talking about the cost of necessities such as daycare, living space, food, school supplies, and clothing. It’s those discretionary expenses, like cell phone service, sports leagues, music lessons, games and entertainment, outings with friends, and car and driving expenses.
If you’re paying for all that, you’re doing so with after-tax dollars. And you should be putting the brakes on that habit immediately if not sooner.
As a small-business owner, you’re allowed to hire your family members (including children, grandchildren, parents, siblings, nieces, nephews) to work for your business, pay them a fair and reasonable wage, and then have them pay for their own bells and whistles. In addition, they can sock away some of that money to use later for college or to buy a car, pay for their own lavish wedding, start a business or support the start-up costs associated with starting a family, retire, pay for college or whatever else they decide to do when they’re ready to do it.
Even better, you won’t have to pay income tax or self-employment tax on the wages you pay them, and chances are good, in the case of your children, that neither will they. Also, when you hire your own children to work for you, the wages you pay them are exempt from FICA (Social Security and Medicaid) withholdings and federal unemployment (FUTA) tax unless your business is incorporated. Some restrictions apply, of course, but this tax loophole is perfectly legal and something that all small-business owners with children should consider.
So, How Does This Work?
Here’s how it works: You hire your child and the business pays them. Their first $12,400 of earned income is taxed at zero. That’s because $12,400 is the standard deduction for a single taxpayer, even if you claim them as your dependent. Their next $9,876 of taxable income is taxed at just 10 percent.
Here are the basic rules: Continue reading… Continue reading… Continue reading…
Leveraging the Tax Savings Power of Retirement Accounts, Part 5: Small Business Guide to Reducing Your Tax Burden Legally
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Some of the most powerful tools for cutting taxes are tax-deferred retirement accounts, which enable you to invest money tax-free now, then pay taxes on it when you withdraw it in your retirement years. As a small-business owner, you can take advantage of several different types of tax-deferred retirement accounts, including individual retirement accounts (IRA), a simplified employee pension (SEP), a Savings Incentive Match Plan for Employees (SIMPLE) IRA, 401(k), Defined Benefit Plans, and even the option of a hybrid plan. Roth IRAs and permanent life insurance plans are two more tools that can benefit you when planning for retirement.
Many people have one or more retirement accounts, which is great, but few have a retirement plan — a highly specific approach for using retirement accounts to maximize their tax savings and achieve their retirement goals. Without a properly crafted retirement plan in place, mistakes are more likely, such as choosing an account type with a contribution limit that’s too low, exposing yourself to high taxes when you retire, or paying too much in account/plan management fees.
For example, depending on your income and the type of retirement account, your contribution limit varies considerably. If you earn $90,000, for example, you can contribute $16,200 to a SIMPLE IRA, or $22,500 to a simplified employee pension (SEP), or $42,000 to a 401(k). (Note: That’s before any catch-up contributions you can start making at the age of Continue reading… Continue reading… Continue reading…
Deducting a Percentage of Your Qualified Business Income, Part 4: Small Business Guide to Reducing Your Tax Burden Legally
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The 2017 Tax Cuts and Jobs Act (TCJA) lowered the top tax rate on C corporation income from 35 percent to 21 percent. This is considerably lower than the top rate of 37 percent on pass-through income from sole proprietorships, partnerships, and S corporations.
Cutting taxes for C corporations without also cutting taxes for small businesses, would probably have caused a stir with small-business owners justifiably exclaiming, “No fair!” To balance the scales, the TCJA allows small-business owners to deduct up to 20 percent of their qualified business income (QBI) from their taxable income for the year, calculated on an activity-by-activity basis.
This is a major change for most small-business owners, but it may leave you wondering what QBI is, how this change is likely to impact your taxes, and what the heck “calculated on an activity by activity basis” means? In this post, the fourth in our Small Business Guide to Reducing Your Tax Burden Legally series, we bring you up to speed on the QBI deduction.
Understanding the Different Income Types
The tax code has always distinguished different types of income and taxed them differently. TCJA created an entirely new type of business income, called qualified business income (QBI), and taxes it in a unique way. In this section, we define and compare the different types of income, including QBI.
Ordinary income
Ordinary income is what you earn from your work or your business. If you draw pension or IRA income, that’s ordinary income too. Here are a few key points about ordinary income:
- Ordinary income is taxed at ordinary income tax rates.
- Any salary you earn from your small business is ordinary income.
- If your small business is a sole proprietorship, your entire net profit from the business is taxed as ordinary income. (You can change your business entity from sole proprietor to S corporation to reduce the amount taxed as ordinary income. See Part 3 in this series to find out more about business entities.)
- You pay taxes on net So, for instance, if you file as married, you earn a salary from a job, and should your spouse lose money in a business, your spouse’s business loss reduces your net income (subject to tax) as a married couple.
Investment income
Investment income is money you earn from your investment portfolio, and different types of investment income are taxed at different rates: Continue reading… Continue reading… Continue reading…
Selecting a Business Entity — Small Business Guide to Legally Reducing Your Tax Burden, Part 3
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Welcome to Part 3 of our 12-part series on how to legally reduce your income tax burden. Here, we describe the five ways you can choose to organize your small business, and then we provide guidance on how to choose the best business entity for your business in the current environment.
Here’s a common scenario to get us started. You set up a limited liability company (LLC) or S corporation for your small business, and now you are all set in terms of protecting your personal assets from lawsuits and minimizing your tax burden, right?
Not so fast.
One of the most expensive mistakes small-business owners make is choosing the wrong business entity — the legal/financial structure within which the business operates.
Most business owners start as sole proprietors. Then, as they grow, they establish an LLC to help protect their personal assets from any lawsuits filed against the business. Many of these same business owners make the common mistake of assuming that an LLC allows them to file their taxes as a corporation and use that filing status to save on taxes. The fact is that an LLC is a legal entity, not a tax entity. Operating a sole proprietorship as an LLC won’t save you any money in taxes.
You want a business entity (or more than one business entity) that not only provides legal protection, but also maximizes your Continue reading… Continue reading… Continue reading…
Audit-Proofing Your Tax Return – Part 2 of Small Business Guide to Legally Reducing Your Tax Burden
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Welcome to Part 2 of our 12-part series on how to legally reduce your income tax burden. Here in Part 2, we going to allay fears you may have of being audited by the Internal Revenue Service (IRS).
While failing to plan ahead for taxes (the subject of Part 1 of this series) is probably the No. 1 mistake small business owners make, letting the threat of an IRS audit discourage you from claiming certain deductions or credits is a close second. Here at Stees Walker & Company, we encourage clients to claim every legally allowable deduction and credit. Failure to do so leaves money on the table — our clients’ money — and that’s something we just can’t tolerate. The fact is, your chances of being audited are slim.
However, we encourage you to assume you will be audited. What?
On its surface, that advice may strike you as a contradiction, but it’s really not. Assuming you will be audited simply calls for documenting all income and expenses, so in the event your business is audited, you have the documentation needed to prove your case. In other words, respect the IRS, but don’t fear it. Today’s historically low audit rates make it pay to be aggressive in claiming deductions and credits, but they is no excuse for careless accounting and record-keeping.
Afraid to Raise Red Flags?
As a taxpayer, chances are good that, at some time, you chose not to claim a deduction or did not claim the maximum you’re allowed because you were afraid “it would raise a red flag.” The fact is, audit rates are so low, most legitimate deductions simply aren’t likely to raise any red flags. Audit rates hit an all-time high in 1972 at one for every 44 returns the IRS received. But lately they’ve dropped to historic lows. According to the IRS, for 2019, the overall audit rate was just one in every 220 returns, or 0.45 percent of all returns.
Roughly half of those hinged on one issue — the Earned Income Tax Credit for low-income working families. The rest of the audits focused mainly on returns filed by small businesses — especially sole proprietorships and businesses that have plenty of opportunities to hide income. Examples? Single location restaurants and laundromats. (The IRS publishes a whole series of Continue reading… Continue reading… Continue reading…
Small Business Guide to Reducing Your Tax Burden Legally — Part 1: Tax Planning
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Welcome to Part 1 of our 12-part series on how to reduce your tax burden legally. Here in Part 1, we address the first and most important step — tax planning. As the old saying goes, “Failing to plan is planning to fail,” and this is especially true when you are trying to reduce your tax burden legally.
Consider for a moment the first time you drove a car? If you were doing it right, you spent far more time looking where you were going than where you came from. You don’t drive forward staring in the rearview mirror. Unfortunately, that’s how most tax “specialists” are geared. They spend so much time looking back at last year’s finances that they rarely advise their clients to look forward.
They can tell you all about what you earned and spent last year and how much you owe in taxes as a result, but they rarely think to tell you what you should do today to save on taxes next year. Even the few who do tell their clients what to do rarely tell them when or how to do it.
Taking a proactive, forward-looking approach with tax planning can simplify next year’s taxes and save you a considerable amount of money, especially if you’re a small-business owner. Tax planning provides small-business owners with two valuable benefits:
Benefit No. 1: First, tax planning is a key component in your financial protection. As a small to medium size business owner, you have two ways to increase your net profits: financial offense (earning more) and financial defense (spending less). For most small-business owners, taxes are the biggest expense, so a big part of playing financial defense involves reducing the tax burden. And you do that through savvy tax planning.
Benefit No. 2: Second, participating in tax planning almost always ensures results. You can spend a huge amount of time, effort, and money promoting your business with no guarantee of achieving positive results. In contrast, every tax-savings initiative you implement guarantees a return on your investment. But those guaranteed results start with planning. For example, you can’t deduct medical expenses paid out of a medical expense reimbursement plan if you haven’t set up such a plan ahead of time.
To get this series started, indulge us for a moment as we cover how the tax system works here in the United States of America.
Understanding How the Tax System Works
A general knowledge about how the tax system works lays the foundation for understanding specific tax-savings approaches we present later on in this post. Here’s a graphic demonstrating how the tax system works: Continue reading… Continue reading… Continue reading…