Since the drastic changes made by Tax Reform, the best source of tax breaks is your own business. Business owner’s tax advantages:
Fully deductible business expenses. For the self-employed, business expenses are deductible in full directly from gross income. Employees may deduct their business expenses only if they are itemized, and the deduction is reduced by 2% of Adjusted Gross Income (AGI).
Full home-office-expense write-off. If you run a business from your home, you may deduct not only property taxes and mortgage interest but also a percentage of depreciation, utilities, insurance, repairs, and any other costs. You get these deductions even if they result in a tax loss. Essential: To take these deductions, you must reserve a part of your home exclusively for business.
Greater tax-deferred retirement savings. Tax Reform severely limited IRAs and capped 401(k) contributions at $9,240 in 1995 (indexed each year for inflation). But Keogh plans for the self-employment were practically left untouched. Business owners may make annual deductible contributions of up to 20% of business income of $30,000-whichever is less-to a defined-contribution plan and may stash away even more in a defined-benefit plan.
Potential drawback: If you have employees, you must include them in your plan on a nondiscriminatory basis. Expectations: You may exclude employees under 21, those who have worked for you for less than a year, and part-timers with fewer than 1,000 work hours in a 12-month period.
Hiring your kids. Their wages are deductible business expenses, and they can earn up to $3,900 a year (indexed for inflation) tax-free. If they open an IRA, up to $2,000 more is tax-free. If they do make enough to be taxed, it’s at minimum rates. And you may still claim them as dependents.
Hiring your spouse. Advantages:
Your spouse may participate in any retirement plans that you have for employees (pension, 401(k), etc.). In some cases, he/she may qualify for deductible IRA contributions.
If your spouse accompanies you on a business trip as an assistant or colleague, you may write-off travel expenses for both of you.
Timing income. If you use the cash accounting method, you can easily defer income from one year into the next. You just don’t send out bills late in the year-wait until January.
More deductible transportation expenses. Going to work and coming home are nondeductible commutation expenses. But if you work out of your home, you’re already at your place of business when you get up in the morning. So all travel costs are deductible-trips to visit customers, buy supplies, mail correspondence, etc.
Justifying transportation deductions is also easier for business owners. Employees may be asked by IRS auditors why they weren’t reimbursed by their company if their travel costs were truly “ordinary and necessary” business expenses.
Fully deductible casualty losses. Business casualty losses (from fire, theft, accident, natural disaster, etc.) may be written off in full against business income. But personal casualty losses are deductible only for itemizers, and the deduction is reduced by 10% of AGI, plus a $100 deductible.
Full write-offs for bad depts. A business’s bad depts. may be deducted in full in the year in which they become uncollectible. But personal bad depts. are treated like capital losses-you may deduct only up to $3,000 a year.
How To Offset Operating Losses
For the past year, I have been running an unincorporated start-up business. So far it’s still losing money, and I don’t have enough income to offset my losses. Can I carry them into next year? If so, is there any limit on the amount?
Since your business in unincorporated, its losses must first be deducted on your personal return against your income from other sources. If this leaves you with a net operating loss for the year, you can carry it back three years (to get a refund of past year’s taxes)…or forward 15 years (to offset future income). There’s no limit on the amount you can carry back or forward.
Figure your carryback or carryforward using IRS Form 3621. If you carry back your losses, you can get an expedited refund of previous years’ taxed by filing Form 1138.
Great Tax Breaks For Business Owners
The owners of closely-held company often have to personally guarantee the company’s debts. Such owners often overlook the fact that they can charge a fee for providing this service and that the company can deduct this fee as a business expense.
In one case, the Claims Court allowed a deduction for fees paid to owners equal to 3% of a major financing deal. Key facts: Each shareholder separately decided how much of the loan he was going to guarantee, so the guarantee fee wasn’t distributed in proportion to shareholdings. The company was able to show that the loan plus guarantee was cheaper than other methods of financing. And the 3% fee was reasonable when compared with other guarantee fees paid in similar arrangements.
Source: Tulia Feedlot, Cl. Ct., 52 AFTR2d 85-5702.