Every November and December you hear about year-end tax moves--the same year-end strategies you've heard for the last fifteen years or so.
While the standard tips are certainly valid, you're probably already using them. So what about potential tax moves you don't know about that can save your business money?
It's hard to know what you don't know... and that's where as my friend Bill Zumwalt, a Tulsa-based CPA, comes in.
Bill knows what we don't know. Check out the following tax moves--and of course run them by your own accountant to make sure they're applicable to your situation--and see if you can apply them to your business.
1. Rent your home to your S Corporation and get tax-free income.
Your S Corp is a separate entity from you and can have meetings wherever it likes--including at your home. You can rent your home for up to 14 days each year without having to report the income.
Have the meeting at your house and charge your company for the rental of your home and you get tax-free income and your company gets to deduct the expense.
Does that sound too good to be true? Of course there are conditions.
One, you can't provide "entertainment" at your meeting. That would color your home as an entertainment facility and kill this strategy. But there are two exceptions. You can have an employee summer picnic and/or a holiday party that involves entertaining; those are allowed exceptions. Add to that great deduction the waiving of the 50% entertainment rule and for these two events you can deduct 100%!
Here's an example of how this can work. Betty owns Betty's Real Estate, Inc. and operates as an S Corp. She has a team of 20 agents. Each year Betty holds ten monthly all-day training sessions for her agents. She has researched competitive bids for these meetings and determined $1,500 is a fair and reasonable expense in her area. Betty can invoice her company a total of $15,000 for the year and that income is tax-free to her since she is renting her home for 14 days or less.
And her corporation can deduct the $15,000 as well. In effect Betty spends company money she would have spent anyway... except now she and not a third-party venue receives the income.
And you can too--as long as you meet IRS guidelines.
First you need to be able to document that the rent you charge is fair and reasonable for your area. Next is the "entertainment problem," which you can be address by making sure your event is strictly a training exercise. Document the business activities that took place, maintain a sign-in sheet, and keep copies of your training materials. Finally, have your corporation issue a 1099 for rents paid to you; you will then report the 1099 amount on your personal income taxes on Schedule E, showing a deduction under other expenses for non-taxable income.
2. Deduct your health insurance if you are the owner of an S Corp.
Let's say John is the owner of ABC Inc. and pays for his insurance out of his personal bank account. When he files his personal tax return he reports the expense under Medical Deductions on Schedule A: Itemized Deductions.
His premiums are $9,000 a year. Since John reported it under medical deductions he must meet the 10% deductible. In this case that deductible amount is $10,000, so that means John loses out on a potential $9,000 expense.
So how do we recover his lost $9,000 deduction? First, John needs to either have his S Corp pay the premiums directly to the insurance company or reimburse him if he continues to pay them personally. Then at year-end John must add the premiums to his W-2 as income that is not subject to Social Security taxes. Lastly, John deducts the $9,000 as an adjustment to income on the self-employed insurance deduction line 29.
So what just happened? First, John's S Corp deducted the insurance premiums, resulting in a $9,000 savings. Next income was added to John's W-2 and then deducted that amount as self-employment insurance. In the process he avoided itemized deductions entirely and the $9,000 got washed away on the first page of his individual tax return.
3. Maximize vehicle expense deductions.
Vehicle expenses for sole proprietors are often a major expense often accompanied by missed deductions. Most people think that the standard rate for 2014 of 56 cents a mile is their mileage deduction. But wait--there's more! The actual amount is 56 cents plus-plus; the plus-plus is the business portion of your tolls along with any interest expense related to the note on your car.
Before we go further, I cannot emphasize enough the need to keep a mileage log. You absolutely must record your beginning and ending odometer readings daily and describe where you drove your car.
But the IRS does allow exceptions to keeping these records 24/7. One is to keep your records for three straight months to determine the business usage of your travels. Or you can keep the same week of the month for twelve months as a method to determine the business usage.
But wait--that just shows the business percentage of the miles you drove; it does nothing to prove how many total miles you drove the car for the year. That's why I suggest getting an oil change the first of every year. Then you have third-party verification of your starting odometer readings.
(Be aware that there are situations where you will have to claim actual expenses and keep your mileage logs 24/7, so consult with your tax advisor.)
4. Don't sell a business vehicle.
Here's a big one that is often overlooked. If you use your car in your business, call your tax advisor beforeyou sell or trade in that business vehicle--even if you're buying a new vehicle for business use. (This is a majormistake that can cost you thousands.)
Most people think if they take the standard mileage deduction, they can just buy another car and keep on taking the standard rate. Not so fast.
Imagine that John is a sole proprietor who drives his car for business purposes and, for the sake of simplicity, let's says he uses the vehicle 100% for business. In 2009 he bought a new Chevy Impala for $40,000. Over the next 5 years he drove the car 100,000 miles and took the standard mileage rate.
Now he needs a new car for his business so he decides to trade the old one in. (An associate offered to buy the car for $5,000 but decided to trade it in instead.)
What John didn't know is that a component of the standard mileage rate is depreciation. That portion, over the last few years, is approximately 23 cents. So here's the calculation. Original cost is $40,000 less deprecation of $23,000 (100,000 X 23 cents) results in a basis of $17,000. John was offered $5,000. If he had sold the car he would have realized a $12,000 loss ($17,000 minus $5,000). By trading the car in to the dealer he deferred the loss to a future date by adjusting the tax basis of the new car.
But what if he gives the car to his daughter to use while she is in college? Say she keeps the car for 5 years and then it gets sold for little or nothing. That tax loss stays with the car until it is finally disposed of. Adjustments would have to be made for the non-business use, but a majority of the loss is still "embedded" in the vehicle.
Before you trade in a business vehicle always talk to your accountant.
5. Write off a vehicle twice.
This tax strategy is called a Gift-Leaseback. Say you own a fully depreciated SUV you use 100% for business. The fair market value is $20,000. You and your spouse give it to your college age daughter and lease it back from her for $400 per month. The arrangement creates $4,800 in new deductions and eliminates any self-employment tax you would otherwise have paid on that income.
Of course, there are the terms and conditions that must be met so be sure to check with your tax advisor to see if this works for you.
6. Take advantage of Medical Expense Reimbursement Plans.
Here is a really great tax strategy for sole proprietors, one that's been around for many years but is rarely utilized.
Medical Expense Reimbursement Plans (MERPS) let you reimburse your employees, their spouses, and their dependents for uninsured medical costs. Plan benefits are deductible by the business and nontaxable to the employee.
Ah, but I don't have any employees," you say. "I'm just a small business owner." No problem: if you hire your spouse to qualify for a MERP you can pay him or her in benefits only rather than in cash, avoiding managing payroll and filing a W-2.
The key to making this work is to document your spouse's bona fide employment. Consider creating a written employment contract. Track work hours to substantiate your deduction. You'll also need to pay medical expenses out of your business account or show actual reimbursement to the employee.
And last, the amount of benefit must be "reasonable" for the work performed.
For example, say you operate a childcare business and your spouse helps with the business in a variety of ways. You set up a Medical Expenses Reimbursement Plan and hire your spouse. Your spouse signs up for the MERP family plan and all expenses out of pocket for the spouse and dependents can be deducted up to the reasonable compensation paid to the spouse. Some of the available expenses for employees are:
- Employee health insurance.
- Out of pocket medical costs, including routine expenses such as co-pays, deductibles, and prescriptions; occasional expenses such as eyeglasses and dentistry; big ticket items like orthodontics, and fertility treatments.
- Over-the-counter medicines and health-care supplies, if prescribed by your physician.
7. Hire family members.
Tired of being the Bank of Mom and Dad? Hire your children to help in your business.
Your child can earn up to $6,200 for 2014 before they owe any taxes. The next $9,075 is taxed at only 10%.
The savings to you are substantial. If you are in the 25% tax bracket and say a 5% state rate you save over 40% when you include the self-employment tax of 15.3%.
Because your business is taxed as a sole proprietorship you don't owe Social Security or Medicare taxes on your child's wages until they reach the age of 18. (This same rule applies if your business is taxed as a partnership and you and your spouse own all partnership interests).
To verify your deduction and audit-proof your return, keep a timesheet showing dates, hours, and services performed. Pay your child by check and deposit the check in an account in the child's name. This can be a Roth IRA (my favorite), Section 529 college savings plan, or a custodial account. Money can be spent for private school tuition, summer camps, and similar expenses.
If you pay your child the $6,200 for a year your tax savings will be over $2,500 in the example above.
That's a lot of potential tax savings to discuss with your tax advisor. The goal is to reduce your tax burden as much as (legally) possible. Always remember that we all have to pay taxes... but nobody says you have to leave a tip.