Wednesday, December 23, 2009

Year End Tax Planning

The best motivation for planning your taxes is to legally minimize how much of your money goes to the IRS. Many years ago, Judge Landis of the U.S. Supreme Court declared that everyone has the right to legally minimize his or her taxes. To do this, you need to have an idea of what your income and deductions are now, and what you expect them to be next year. You must then move income and deductions in a way that minimizes what you pay in taxes this year. Sometimes it is worth paying taxes now in order to save even more in taxes next year.

However, ” take the money and run” is a valid alternative. In this case you worry about tomorrow tomorrow. You delay as much income as possible to next year and accelerate as many of your deductions as you can to this year. This way, you pay the least taxes possible.

Step One: Analyze your situation. Will you be paying taxes this year? If so what is your tax bracket? Are you in the 15% bracket or the 35% bracket? If you are in the lower tax bracket you will only get back $15 for every $100 you lay out for a deductible expense. If you are in the 35% bracket then the deduction gets more attractive.

Step Two: Determine where you think you will stand next year. Will you be in a higher or lower tax bracket? With the way the economy went in 2009, many people will have a better year in 2010.

Step Three: Set your goal. Do you want money now or later?

Delaying income is tough when you have a job, a house, and no other tax complications. You get your salary each week and it is hard to push it off to next year. It might happen if you get a year-end bonus that might get paid in 2010. Your interest income or dividends is paid on a set schedule, so you cannot postpone them to next year.

Here are some ways to legally delay income to next year:

· Weigh your options if you are thinking of selling some common stocks. If you have gains, you may want to wait until January to realize them. That way you are not liable for the taxes for a year. If you have losses, then take them this year. However, always make a good investment decision first. If it’s time to sell then don’t worry about the tax consequences.

· If you are self-employed you can delay billing your customers so that you receive the income next year rather than this year. Please note, if you receive the money this year, you are legally required to report it this year. Keeping a drawer full of checks that you get in December and then deposit in January is illegal. You should report all your income in the year you receive it.

Here are some ways to accelerate your expenses

· Pay your mortgage before Christmas. That way the bank will include the interest you normally would pay in January on their annual statement for this year, making it easier to deduct it.

· If you are making donations to your favorite charity, make them by the end of December, rather than in January. If you mail the check on December 31st, you can deduct it on your 2009 tax return.

· If you have a lot of junk, (oops, I mean valuable furniture and other items), you can consider donating them to charity and getting a tax deduction for it. You must get a receipt if it is worth more than $250, and you must provide additional information on your return if it is over $500. Really valuable items might require an appraisal. Be careful, the appraisal might cost more than the tax benefit of making the donation. Generally charities will not value the items for you. They will just say that you gave them seven bags of clothing.

· If you were looking for a job in 2009, keep track of your job search expenses. They can be used as itemized deductions to reduce your taxes. Some examples of these expenses would be the cost of printing your résumé, fees for help in your job search, or hiring a career coach to help your efforts. However, the total must be above 2% of your income to reduce your taxes.

· Often the biggest job search expense is the use of your automobile for your search. Keep track of the mileage for getting to the printer, going to various employment agencies or job fairs, and traveling to interviews. Write it all down to make sure you get the benefit of all the mileage.

· If you pay your real estate taxes yourself rather than through a bank’s escrow account, you can pay them in December rather than January. That way you can deduct them this year.

· Medical expenses must be more than 7.5% of your total income to be deductible. Look at your income and medical expenses and pay any outstanding medical bills this year if you are over this limit. If you are paying for your own health insurance, you should not have a problem exceeding this limit.

Here are some suggestions for the Self-Employed: (These only should be used if you have a good business purpose in spending the money. New “toys” like the newest fanciest computer, don’t make good financial sense.)

· You can write and mail the checks for your business expenses on December 31st and deduct them on your 2009 return. This includes expenses like rent or office supplies.

· Items you charge on a bank credit card can be deducted when they are purchased rather than when you pay the charge card bill. So those office supplies you bought in late December on your Visa card are deductible in 2009. If you charged it on your Staples card, then they are not deductible until you pay Staples. The theory is that Staples has not gotten their money yet so you cannot deduct it.

· Upgrade your equipment. This is only a good idea if it will help you run your business better, lower your future costs, or increase your revenue. Again, fancy toys don’t make financial sense.

Careful tax planning can help you keep some of your money at a time when every dollar counts.

If you pay the dreaded Alternative Minimum Tax (AMT), then you have to be careful what you move deductions from year to year. Generally it does not help you to pay your real estate or other deductible taxes or things like job search expenses in December if you are subject to the AMT. The AMT would take a several blogs to explain. I might tackle it in a future blog.

These are general ideas that can help reduce your taxes. If you plan to implement any of these suggestions, it is well worth it to consult a tax professional.

Monday, December 14, 2009

Final Tips

Self Employment Blog #7

Quick Hitters

Tax Professionals

Owning your own business can be confusing and lonely. Legal and tax obligations appear at any time. If you hire a tax professional, they can help with your tax return and estimates. A good tax professional will also advise you on running your business and work with you to make it more profitable. They also can advise you on legal ways to reduce your taxes. Don’t depend on your friends and family when you are self-employed.

Checking Accounts

It is best to set up a separate business checking account for your business. Pay all your business bills from the business account and all your personal bills from your personal account. Transfer money from the business account to your personal account so your checks won’t bounce

Health Insurance
You can get health insurance from several sources. Chambers of Commerce offer health insurance options and there are various other organizations that offer this benefit. Your payments for health insurance are not deductible on Schedule C as a business expense, but could be deductible on the first page of your Form 1040.
Massachusetts requires that you offer health insurance to your employees if you have more than 10 employees. Most group health plans state that anyone working more than 20 hours a week must be covered under your plan unless they are covered under a spouse’s plan. The expense for covering your employees is deductible on your business tax return.

At some point you may need help in running your business. Often the first person hired is an administrative person to do all the things that keep you away from your clients and customers. You should talk with your tax preparer before you hire someone so that you understand your obligations. I’d recommend a payroll service to take care of all the myriad of details that go along with paying an employee.
Employees are expensive. You must have worker’s compensation insurance, match their taxes, and may even need to cover them with health insurance. Be careful who you hire and that you really need the person to help your business progress.
A quick bit of advice. If you view your employee as an expense rather than an asset, get rid of them and hire someone else.

Sales taxes
Be aware that if you sell a product you must collect and pay sales taxes in most states. Some states, such as Connecticut, have a sales tax on services.

Talk with your CPA before starting a partnership. They are harder to keep together than marriages. Generally partnerships break up because the various partners do not agree on the direction they are going in and how to get there.

In Massachusetts you are required to register with the town or city clerk where you live if you use a fictitious business name. That would be any name other than your own. If you are an LLC or corporation you are required to register. If you do register, you can expect that the city or town will eventually show up at your door and want to tax your business assets. Other states probably have similar requirements.


There are many different pension plans available to business. There is no perfect type for all business. A sole proprietor often wants to use a SEP plan because it is simple and inexpensive. Large companies use the 401(K) plan because it shifts the burden of funding the plan to the employee. There are many alternatives in between. You should discuss the options with your CPA as well as your financial advisor.

There is an old Vermont saying, “The eye of the farmer fattens the stock.” Of course, now there are very few farmers. What this means is that the business will run better when you are there. Too many things can go wrong when you are not there. To minimize this problem, you need to have procedures in place that help your employees understand what is expected of them.

Customer Service
The measure of customer service is not what happens when things go right. It what happens when things go wrong. It is critically important to deal with complaints and problems quickly and effectively. The proper handling of a complaint can turn a problem into an asset. If someone is happy with your service they will tell one person— if they are unhappy they will tell ten.

S Corporations
This is a special tax designation for corporations. A regular corporation pays taxes on its net income.

An S corporation does not pay taxes on its income. It transfers the income to the personal tax returns of the owners. This prevents the double taxation of the income and provides some tax-reducing benefits to corporate owners. You need to make a special election to be allowed this privilege. Check with your CPA as soon as you set up the corporation to see if this is an appropriate thing to do.

Wednesday, December 9, 2009

Paying your taxes

Self Employment Blog #6

Important details #3

Paying your taxes

Your goal should be to pay a lot of taxes, but the least amount legally required. The government would like to take all your money but have not yet found a way to accomplish this.

Be sure you are sitting down. The taxes on the income from your business can be as high as 40 to 50% of your net profit. It all depends on what other income shows up on your tax return. Your spouse’s salary can push you into this level of taxation, as can investment income, unemployment compensation, or rental income. Here is how it breaks down:

The Social Security Administration gets about 15% of your wages or net income from self-employment to cover your Social Security benefits and Medicare. When you are an employee, you pay half and your employer pays half. When you are self-employed you pay the whole 15%. Your itemized deductions, such as mortgage interest and real estate taxes, do not affect what you pay for Social Security taxes.

Your federal income taxes depend on your taxable income and marital status. This blog cannot provide all the alternatives. A large majority of taxpayers end up in either the 25% or 28% tax brackets. Your actual percentage will vary with your return.

Most states have an income tax. Even some states that do not have an income tax have a business tax that applies to self-employed people. New Hampshire is one of those states. Massachusetts has a tax rate of approximately 5%.

Using the numbers above you would be paying either 45% or 48% in total taxes. Now that you are totally depressed, let me back off from that statement a bit. The taxes you pay depend on how your tax return goes together. High mortgage interest and real estate taxes will reduce your federal taxes. A non-working spouse reduces your taxes. Many of my self-employed clients only pay Social Security taxes because their income is low.

My advice to my clients is to put 40% of their net income into a savings account to pay their taxes. Maybe there will be enough left over after paying the taxes for a cup of Starbuck’s coffee.

The IRS and state departments of revenue require you to pay your taxes during the year, not when you file your return. So you must pay estimates each quarter to avoid being penalized. The due dates are April 15th, June 15th, September 15th and January 15th of the following year. There are vouchers that must be sent in with your check.

The final blog is a glossary of terms you will need to complete the process

Friday, December 4, 2009

Tax Deductions

Self Employment Blog #5

Important details #2

Tax Deductions

The reason you need a bookkeeping system is so that you can deduct all the expenses possible to minimize the taxes you will be paying.

There are a couple of expenses that you will not collect in your bookkeeping system.

The first is your automobile expense. You have two choices in calculating your deduction for your automobile. With either choice you need to keep a log of your business miles and know the total miles you drive your car during the year.

You could record every expense, (gas, insurance, repairs etc.) you incur using your automobile. Once you get a total cost you multiply it by your business-use percentage. (Business-use percentage is your business miles divided by your total miles.) Alternately, you use the IRS automobile mileage rate of $0.55 per mile for 2009, times the business miles. The vast majority of my clients use the IRS standard mileage rate. It’s simpler to work with and the IRS adjusts it every year.

The second one is the deduction for a home office. To legally deduct the cost to maintain an office in your home, you must use the area exclusively for business. Thus you cannot deduct the expense if you work at your kitchen table. You are allowed to deduct the business-use percentage of all the expenses to run the house. This would include mortgage interest, real estate taxes, utilities, heat, insurance, and general repairs. You cannot deduct repairs to the non-business use portion of the house, like your kitchen. As this is a complex deduction, it would benefit you to hire a tax professional to help you figure it out.

Here is a partial list of the other categories you should use to collect your expenses together:
• Advertising
• Insurance
• Interest
• Professional Fees
• Office Expenses
• Rent
• Repairs
• Supplies
• Taxes
• Licenses
• Travel
• Meals
• Entertainment
• Utilities
• Telephone
• Bank Charges
• Dues
• Subscriptions
• Computers
• Cleaning