Tax Deductions for the Self-Employed

If you’re self-employed, you work hard to build your business and satisfy your clients. Your biggest client to make happy might just be the IRS. Here is what you should know about making sure that Uncle Sam is getting their fair share while at the same time ensuring you’re not paying out more than necessary.

What is the Self-Employment Tax?

For purposes of our discussion, self-employment taxes are referencing taxpayers filing a Schedule C on their Form 1040. The self-employment tax represents the employer paid portion of Social Security and Medicare taxes. As an employee, you would pay one-half of the total taxes. This amounts to 6.2% on the first $118,000 in wages for 2016 and 1.45% in Medicare taxes regardless of the amount in wages that you earn.

When you are self-employed, your total percentage paid is 15.3% as you are responsible for both the employer and employee portions. Fortunately, you are allowed to deduct one-half of the amount paid in self-employment taxes as a business owner.
Self-employment taxes are paid on 92.35% of your net self-employment earnings.

Additional Medicare Tax

If you’ve done well this year, you may be required to pay an additional Medicare Tax of 0.9%. The tax is applied to taxpayers with combined wages and self-employment income that exceeds the following thresholds.
Single $200,000
Married Filing Jointly $250,000
Married Filing Separately $125,000

Retirement

We hear all the time about the importance of saving for retirement. For self-employed individuals, the incentive to save can be great. You can substantially reduce your tax liability by contributing to one of the numerous retirement plans available to the self-employed.
SEP IRA

SEP IRAs can be a substantial source for savings in addition to a tax benefit. For 2016, self-employed individuals can contribute up to $53,000, to a SEP IRA. Maximum contributions must be no greater than 25% of total compensation or $53,000, whichever is less. Contributions must be made by the extended due date for your tax return.

SIMPLE IRA

Self-employed individuals may contribute up to $12,500 ($15,500 for those over 50). The contribution is limited to total earnings from self-employment.

SOLO 401(K)

Solo 401(k) contributions have two parts: salary deferrals and profit sharing. Solo business owners may elect to defer up to $18,000 of their salary to a solo 401(k). An additional 20 – 25% of total compensation may be contributed via a profit sharing plan. Total contributions are a maximum of $53,000 ($59,000 for those over 50).

Home Office

If you use a space in your home for business, you may qualify for the home office deduction. In order to qualify for this deduction, you must meet the following requirements.
1. It must be the principal place of business.
2. It must be used regularly and exclusively for business.

If you meet these qualifications, you may use the actual method for determining your expenses, or you may use the simplified method. If you maintain good records and have tracked your receipts, the actual method of allocating home office expenses may be more beneficial.

Under the simplified method, taxpayers are allowed a deduction of $5 per square foot over a maximum of 300 square feet of home office space.

Educational Expenses

If you incur expenses necessary to maintain or improve skills needed for your business, you may deduct these for tax purposes. These would include continuing education expenses necessary to maintain a professional license or classes you take to improve skills needed in your industry.

Communications Expenses

Access to the internet and telephone services are a crucial part of any business. The cost of these services specifically related to your business use are considered a tax write-off.

Professional Subscriptions and Periodicals

If you purchase specialty journals or publications related to your business niche, you may deduct the cost of these purchases on your return.

Health Insurance Premiums

If you pay for health insurance premiums out of pocket, you may be able to deduct these on your tax return. If you are married and filing a joint return, you are eligible only if you do not qualify for coverage under your spouse’s plan. The coverage extends to health, dental, and long-term insurance premiums paid. Payments may be made to cover you, your spouse, and any dependents under the age of 27.

Interest

If you borrow money for business purchases, any interest paid on these funds is deductible for tax purposes. This includes payments made by credit card, so long as the purchases were made for business.

Meals and Entertainment

50% of eligible meals and entertainment expenses incurred when traveling for business or entertaining may be deductible. The meals must be considered not to be lavish or extravagant for the circumstance. For these expenses, you will want to ensure the keep meticulous records should you draw the attention of the IRS.

Vehicle Expenses

If you drive for business purposes, then you’re in luck. The IRS allows taxpayers to deduct a standard mileage rate for business trips taken. If you keep accurate records of your expenses, you may choose to deduct the actual expenses associated with your vehicle. If you also drive the vehicle for personal purposes, you must allocate the total amount of expenses between personal and business. The standard mileage rate for 2016 is 54 cents per mile.

Travel Expenses

For travel expenses to qualify for a tax deduction, the trip must last longer than an ordinary business day and take the taxpayer away from their tax home. The purpose of the trip must be for business and can include appointments for meeting with prospects, clients, or acquiring and maintaining skills in your industry (e.g., conferences, seminars, etc.)

Deductible travel expenses include the cost of transportation, hotel stays, and meals and entertainment. Remember meals and entertainment expenses are subject to a 50% haircut.

If you combine your business trip with a fun excursion not related to your business purpose, you may only allocate the portion of the trip related to the business at hand.
Being self-employed has its challenges, but there are also many rewards to having your own business. Knowing what expenses can be deducted can ensure that you pay only your fair share in taxes.

How To Legitimately Apply For Reduction of IRS Penalties

The IRS charges dozens of different types of penalties, but the three that we most commonly talk about are the late filing penalty, the late payment penalty, and the penalty for not making Federal Tax Deposits. These three penalties combined can add a whopping 65% to your total IRS bill. If your tax debt is more than two years old, you’ve maxed out all these penalties, and therefore over half your total debt is penalties.

The IRS does actually have a compassionate side, and it’s generally found in the penalty abatement process. Penalty abatement applications can also be appealed if initially denied, so you can always get a second set of eyeballs on the issue. The thing to keep in mind is that the IRS has very strict guidelines for granting penalty abatements, and these guidelines are referred to as “reasonable cause criteria”.

It should be noted up front that “we didn’t have the money” is NOT a reasonable cause criteria. A drop in revenue, by itself, is insufficient argument for obtaining penalty relief. Any request for penalty abatement simply citing the economic recession will be immediately denied.

Why is this? Here is the IRS’ logic: You made the money, and should have paid the taxes at the time on that money. If you are self-employed and receive a check, then you HAD the money, you simply didn’t give the IRS their chunk of it. Same goes with payroll taxes, particularly trust fund taxes (money you withhold from employee paychecks for income tax and Medicare/Social Security): If you had the expectation to pay some amount of wage, then you theoretically HAD the money sitting somewhere to pay that person, and should have withheld it and turned it over to the IRS. If you couldn’t cover the taxes, you shouldn’t have had the employee and should have laid people off or cut back their hours.

There are ways to argue around this, and we have done so very successfully, but there has to be some other circumstance. For example, you had the money to pay the tax, but paying the tax instead of something else would have created an “undue hardship”. Examples could include a large medical expense that unpaid would have left a condition untreated, or a court ordered payment that would have resulted in other legal consequences, or a bill such as a large automobile repair which would have left you unable to work and resulted in job loss. These arguments are difficult to make and require significantly more work than standard reasonable cause criteria applications, but they CAN be won.

The primary IRS penalty abatement reasonable cause criteria center around natural disasters, loss or destruction of vital business records, bad advice from the IRS or an accounting professional, criminal activity, medical issues, substance abuse problems, and other serious circumstances.

We developed a standard list of questions to ask clients to assist us in preparing their penalty abatement. This list of questions should be given some serious thought before requesting penalty abatement, as you are more likely to get what you want if it covers one of these areas:

  • Were any business records lost or destroyed?
  • Were there any circumstances that led to a substantial drop in collecting on accounts receivable?
  • Was there any transition in the business that lead to the failure to pay taxes?
  • Was there a death or serious illness that directly affected the business or personal wages?
  • Was there any embezzlement of funds, theft of valuable property, or identity theft?
  • Were there any alcohol or drug abuse issues that affected the business or wage earning capability?
  • Was there a natural disaster that impacted you or your business?
  • Did you rely on the advice of a CPA or IRS employee in making tax decisions?
  • Were there any circumstances that created substantial financial hardship, to the point where your business was close to going bankrupt?

These questions cover all of the IRS reasonable cause criteria to one extent or another, so finding an answer to your personal or business situation that covers one or more of these questions is the key to a successful penalty abatement application.

By explaining your situation in a letter to the IRS agent handling your case, and specifying the type of penalties and the tax periods you are requesting they be reduced on, and citing the specific situation addressed by the above listed questions, you can start the penalty reduction process.

IRS no longer rejecting ACA ‘silent’ returns

The instruction for individual taxpayers involving the Affordable Care Act has been to indicate on their Form 1040 filing whether they had health insurance, an exemption from coverage or made a shared responsibility payment. In recent years, tax returns silent in that regard were still processed.  This year, the IRS put in place system changes that would reject tax returns during processing in instances where the taxpayer didn’t provide that information.

The recent executive order directed federal agencies to exercise authority and discretion available to them to reduce potential burden.‎ Consistent with that, the IRS has decided to make changes that would continue to allow electronic and paper returns to be accepted for processing in instances where a taxpayer doesn’t indicate their coverage status.

However, legislative provisions of the ACA law are still in force until changed by the Congress, and taxpayers remain required to follow the law and pay what they may owe‎.

Processing silent returns means that taxpayer returns are not systemically rejected, allowing them to be processed and minimizing burden on taxpayers, including those expecting a refund. When the IRS has questions about a tax return, taxpayers may receive follow-up questions and correspondence at a future date, after the filing process is completed‎. This is similar to how we handled this in previous years, and this reflects the normal IRS post-filing compliance procedures that we follow.

-Daniel D