Tax Tips for Small Business Owners

Table of Contents

• Business Income and Expenses
• Defer or accelerate income
• Take full deduction on biz expenses
• New Equipment purchase by year end
• Hire your family members or relatives
• Contribution to Retirement Plans
• Business Use of Your Home or Car

Many small business owners ignore tax planning. They don’t even think about their taxes until it’s time to meet with their accountants. There are much more tax planning opportunity to reduce the tax liability. some is at the business owner, and some are for business itself.

Business Income and Expenses

If you use the cash method, you normally report your business income in the year you constructively receive it and deduct your expenses in the year in which you pay them. If you use the accrual method, you report your income in the year in which you have completed the steps necessary for you to earn it, even if you don’t receive it until the following year. You deduct your expenses when the amount of the expense can be determined and all events that fix the fact that you owe the money have occurred. Special rules apply if you are required to use inventories and to prepaid expenses.

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that’s common and accepted in your trade or business. A necessary expense is one that’s helpful and appropriate for your trade or business.

It’s important to separate business operating expenses from expenses used to figure the cost of goods sold, capital expenses and personal expenses.

we would like to stress the importance of proper documentation. Many taxpayers forgot worthwhile tax deductions because they have neglected to keep receipts or records. Keeping adequate records is required by the IRS for business expenses. But don’t do it just because the IRS says so. Neglecting to track these deductions can lead to overlooking them. You also need to maintain records regarding your income.

Defer or accelerate income

In high-income tax bracket years, consider deferring some income to later years. For example, if your biz uses the cash method of accounting, you might defer income by delaying billing notices so that payment won’t be received until early next year. For example:

A plumber finishes a project in December. He can defer the income until the following year by not billing the customer until January. Because he doesn’t receive the income until January, it’s not taxable for the current year. He reports the income in January but can deduct his expenses on the current year return because he paid for them before January.

If you use accrual accounting method, you might defer income by delaying shipping products or providing services until the early of next tax year. You could use FOB destination shipment (rather than FOB shipping point) to delay the transfer of title until next year. Income won’t be realized until title transfers.

But you can’t defer income for which you had “constructive receipt” during the year. For example, you can’t defer income if you receive a check during 2008 and don’t cash the check until 2009. See IRS Publication 538 for more information about constructive receipt.

If you expect to be in a high income tax bracket next year, you may be better off accelerating income into the current year.

Take full deduction on biz expenses

Make sure that your biz is taking advantage of any deductible business expenses. You may be able to deduct a variety of business expense, including rent or home office expense, and cost of office equipment, furniture, supplies and utilities. To be deductible, biz expenses must be both ordinary (common and accepted in your trade or business) and necessary (appropriate and helpful for your trade or business). An expense does not have to indispensable to be considered necessary. Because of the broad scope of this definition, IRS generally only denies the most flagrant expenses—and more often attempts to differentiate and deny non-deductible personal expenses. Even the biz use a percentage of otherwise personal expenses are also deductible such as the portion of a vacation expense spending on conduction business.

New Equipment purchase by year end

Depreciation-Depreciation is an important approach to recover some of the cost of biz assets over time. When you purchase assets and how you choose to depreciate them can make a difference in your tax bill. A special rule allows biz a full half-year’s depreciation for equipment and other asset (not real estate) that are purchased and placed in service late in the tax year. Thus, last-minute purchase of biz assets may achieve significant tax savings. An exception applies where the aggregate cost of assets placed in service during the last three months of the year exceeds 40% of the year’s total purchase. Then, assets are treated as through they were acquired in the middle of the appropriate quarter.

Hire your family members or relatives

If you have your own business, an income-splitting opportunity is to put your children on your payroll. What you pay them is a business deduction for you and earned income for them. You can do this only if they actually work for you, and you can’t pay them more than their services are actually worth.

You can hire your children to work in your business during school breaks. As long as you pay them a reasonable amount for the work they do, you can deduct their compensation as biz expense. And if your biz is unincorporated, you don’t have to pay FICA tax on wages paid to your child if he or she is under 18. It also will not be subject to federal unemployment insurance tax if the child is under 21. The child’s compensation could also be subject to state and local income and payroll taxes. Be sure that your business complies with child labor laws. Your children also get benefit: they can earn as much as $5,350 (the amount of standard deduction for singles) and pay zero federal income tax. In addition, the wages can be used as a basis for funding your children’s IRA contributions, giving them a start on retirement. For example, they can earn an additional $5,000 tax-deferred if they contribute it to a traditional IRA. Keep in mind that the children must perform actual work for wages in line with what you would pay non-family employees.

Contribution to Retirement Plan

If you are the owner of a small biz or a self-employed person, consider setting up and contributing as much as possible to a retirement plan. Several types of plans are available which minimize the paperwork involved in establishing and administering such a plan. These plans generally are called Keogh or HR-10 plans.

For details on Keogh plans and other retirement plans for small business or self-employed owners, see your tax adviser.

Health insurance premium for small business or self-employed owners

If you are small biz owner, you are not allowed to deduct amount paid for health insurance and long-term care insurance premiums for yourself, your spouse, and your dependents as a biz expense. So it is not taken as a deduction on schedule C, nor is it taken into account in determining net earnings from self-employment on schedule SE. however, you can deduct the amount of the HSA contribution and health insurance payment on their personal income tax return (form 1040). The deduction is above-the-line deduction to arrive AGI if there is no employer-paid coverage for you or your spouse. You can pay insurance premium for your spouse as employee as business expense under some conditions. In this case, your spouse must your legitimate employer (pay reasonable compensation, compliance with federal/state/local tax and other law). The 105 plan must be formally set up.

Health insurance premium for partnerships
Contributions on behalf of partners by the partnership are treated as distributions to the partners under section 731. They are not deductible by the partnership and do not affect the distributive shares of partnership income and deductions. The contributions are reported as distribution of money on schedule K-1 but not included in net earning for SE purpose. The partner can then take a deduction for HSA contribution on their personal income tax return. Contributions made pursuant to the under 125 plan will be added back to the owners as a taxable fringe benefit. No tax-free or favored benefits might otherwise be allowed from the section 125 plan.

Health insurance premiums paid by S corporations on behalf of each over-2% shareholder are not deductible by the S corporation as fringe benefits and must be reported as wages for income tax withholding purposes on the shareholder’s form W-2. This amount is not subject to the FICA and federal unemployment (FUTA) taxes. It is included in box 1 on W-2, but not be included in boxes 3 or 5 on W-2. Payments of the health and accident insurance on behalf of the 2-% shareholder may be further identified in box 14 (others) on W-2. The shareholder must report it on his/her tax return. An over-2% shareholder will generally be allowed a 100% deduction from gross income for health insurance premium on their individual tax return.

Business Use of Your Home or Car

If you use part of your home exclusively and regularly for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, real estate tax, rent, insurance, utilities and repairs. You can also depreciate the cost of assets such as office furniture and equipment you acquire for use in your business. You also may be able to deduct year the cost of certain items you acquire for use in your business by claiming the Section 179 deduction.

If you use your car for business such as visiting clients or going to business meetings away from your regular workplace you may be able to take certain deductions for the cost of operating and maintaining your vehicle. You can deduct car expenses by taking either the standard mileage rate or using actual expenses.

Consider meeting with a tax professional to learn more about home office and automobile deductions.