Because federal tax law reaches deep into all aspects of our lives, it’s no surprise that the rules that affect us change as our lives change. This can present opportunities to save or create costly pitfalls to avoid. Being alert to the rolling changes that come at various life stages is the key to holding down your tax bill to the legal minimum.
Have you recently gone into business for yourself? Check out these six ways to make tax law work for you.
Whether you are fully self-employed or do some freelancing in addition to your job as an employee, if you work at home the government might subsidize what are generally considered personal expenses.
The key to the home-office deduction is to use part of your home or apartment regularly and exclusively for your money-making endeavor. Pass that test and part of your utility bills and insurance costs can be deducted against your business income. You can also write off part of your rent or, if you own your home, depreciation (a non-cash expense that can save you real money on your tax bill).
Many work-at-home taxpayers skip this break, either because they don’t know about it, are afraid claiming it will trigger an audit, or are put off by the recordkeeping hassle necessary to back up the deduction if challenged. In recent years, though, the IRS has come up with a simplified method that allows taxpayers to deduct $5 for every square foot that qualifies for the deduction. If you have a 300-square-foot home office (the maximum size allowed for this method), your deduction is $1,500. You get this tax-saver every year you have a qualifying home office.
Health Insurance Premiums
Although medical expenses are deductible, relatively few taxpayers really get to deduct them. First, you have to itemize to get this break (and most taxpayers do not); second, you get a deduction only to the extent your expenses exceed 10% of your adjusted gross income (7.5% for those age 65 and older on 2016 returns).
But there’s a big exception for the self-employed. You can deduct what you pay for medical insurance for yourself and your family whether or not you itemize and without regard to the 10% threshold. You don’t qualify, though, if you are eligible for employer-sponsored health insurance through your job (if you have one in addition to your business) or a spouse’s job.
We break this out from the previous slide because it is so easily overlooked.
If you continue to run your businesses after qualifying for Medicare, the premiums you pay for Medicare Part B and Part D, plus the cost of supplemental Medicare (medigap) policies or the cost of a Medicare Advantage plan, can be deducted as health insurance premiums for the self-employed.That means you don’t have to itemize to claim this deduction and you don’t have to worry about the 10%-of-AGI test that applies to itemized medical expenses for folks age 65 and older in 2017 and later years (for those 65 and up, the threshold for 2016 returns is 7.5% of AGI).
Social Security Taxes You Pay
This doesn’t work for employees. They can’t deduct the 7.65% of pay that’s siphoned off for Social Security and Medicare. But if you’re self-employed and have to pay the full 15.3% tax yourself (instead of splitting it 50/50 with an employer), you get to write off half of what you pay. That deduction comes on the face of Form 1040, so you don’t have to itemize to take advantage of it.
Retirement Tax Shelters
Once you start working for yourself, the door opens wide to tax-sheltered retirement plans. Unlike employees, whose options are pretty much limited to whatever their employer offers and an IRA, self-employeds can contribute pretax money to a simplified employee pension (SEP) or a solo 401(k), both of which have higher annual limits than regular individual retirement accounts. (Oh, and you can still have an IRA, too.)
When you buy equipment for your business, you have two choices of how to share the cost with Uncle Sam.
The first is to depreciate the cost, deducting the expenses over the number of years the IRS figures is the “life” of the equipment. A computer has a life of five years, for example, so you can write off the cost over five years. But it’s not as simple as claiming 20% of the cost each year. For that computer, for example, you’d deduct 20% of the cost in the year you put it into service, 32% in year two, 19.2% in year three, 11.52% in year four, 11.52% in year five and the final 5.76% in year six. (Don’t ask why it takes six years to write off five-year property.)
Expensing (also known as the Section 179 deduction) lets you deduct 100% of the qualifying cost in year one. Is there any wonder why it’s the choice of many self-employed taxpayers? Up to $500,000 worth of equipment is eligible for the immediate write-off of expensing, although that amount is reduced if you place more than $2 million of new assets into service during any single year.
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Theresa Todman, Managing Partner/CEO of B&M Financial Management Services, LLC . Theresa specializes in bookkeeping, accounting, QuickBooks solutions, small business tax issues and consulting.