I was recently interviewed by Dawn Reiss of U.S. News and World Report on year end tips for small business owners. It was a well written article.
3 Year-End Questions for the Self-Employed
Making the right end-of-year financial moves can make a major impact.
By Dawn Reiss | Contributor Dec. 7, 2016, at 9:00 a.m.
Taxes are complicated for everyone, especially if you’re self-employed. Many self-employed people see their incomes fluctuate from year to year. That can make it difficult for planning.
If your income significantly dropped off, consider converting all or a portion of your retirement accounts to a Roth IRA, while you’re income is lower, says Edward Collins, founding partner and wealth advisor at Artisan Wealth Management in Lebanon, New Jersey.
“While a conversion creates a taxable event in the year of conversion, the long-term benefits of tax-deferred growth and tax-free access to the funds in retirement might just outweigh those upfront costs,” Collins says.
Here are three important questions to ask before the end of the year:
What can I do to lower my tax bill before year end? Determine what is deductible from industry conferences and membership dues to business travel.
“The biggest mistakes I see is people not knowing what you can and can’t deduct on your taxes,” says Stephen Alred Jr., founder of Ignite Financial in Atlanta.
Consider buying business equipment by Dec. 31 to take advantage of IRS Section 179 of the tax code that allows businesses to deduct the full price of up to $500,000 on qualifying purchases such as software, a printer or farm equipment.
If you’re healthy, consider opening a health savings account to take advantage of saving for qualified medical and retiree health expenses on a tax-free basis, Alred says.
Look at optimizing home office deductions. Do this by determining whether it’s the simplified option – where a portion of the residence is exclusively used on a regular basis for business purposes and can be deducted at the standard $5 per square foot, but does not exceed 300 square feet, or the regular method that takes a percentage of the home used for business using IRS form 8829, whichever is more beneficial for your specific situation, says Dave Du Val, chief advocacy officer for TaxAudit.com in Sacramento, California.
Either way it’s essential to keep good records. That includes receipts for expenses you pay, such as rent, mortgage, internet and phone bills, along with equipment and capital improvements, such as a computer and printer, Du Val says.
For business travel, it’s important to keep a mileage log where the self-employed person has the date, destination, starting and ending odometer, whom you met with, the address of the location and the business purpose.
Du Val says the IRS wins a lot of audits because “they know the taxpayer doesn’t keep all the required information.”
Ideally, he says, mileage logs should also be kept for all personal uses for the vehicle, as well as business purposes.
Consider adding spouses and children to the business. “Hiring children can be a way to acclimate family to the business, transfer income to a lower tax bracket for use by the children for their expenses and possibly create earned income allowing contributions to IRA accounts for children to use for education or first time home purchase or retirement,” says Julia Brufke Wenger, partner of Bala Financial Group in Phoenixville, Pennsylvania.
Do I have the right retirement account for my situation? Consider whether or not you should start a solo 401(k) or simplified employee pension – SEP IRA – to save more cash than a Roth or traditional individual retirement account, Alred says.
Alred says he considered creating a solo 401(k) and SEP IRA to help lower his income bracket by choosing a tax deferred option. He ended up creating a SEP IRA because there was less paperwork and it was an overall easier process.
A SEP IRA allows you to contribute whatever is the lesser amount: 25 percent of your net earnings from self-employment – your revenues, minus expenses minus the deduction of half of your self-employment tax and deduction from your SEP IRA contributions – or $53,000 in 2016.
An individual 401(k) allows an employer to make a contribution in the role as an employee and in the role of employer, which translates into an employee contribution of $18,000 for 2016 and 2017, ($24,000 if you are 50 or older) and an employer contribution of 20 percent multiplied by your business’s profit, minus the deduction for one-half of your self-employment tax.
“A solo 401(k) may work best for a self-employed individual who wants to max out a contribution but have less than $72,000 of income and $96,000 if over 50,” says Colin Exelby, president and founder of Celestial Wealth Management in Towson, Maryland. “In that situation, the solo 401(k) will allow for higher dollar deferral than the 25 percent SEP IRA contributions.”
A Savings Incentive Match Plan for Employees – also called a SIMPLE IRA – is usually created by a small business owner on behalf of an employee, including the owner if that person is a sole proprietor.
For this plan, an employee’s contribution equals to 100 percent of your net earnings from self-employment, up to $12,500 for 2016 ($15,500 if you are 50 or over) and an employer contribution is equal to 3 percent of your net earnings from self-employment – which means your revenues, minus your expenses, times 92.35 percent, to account for your deduction for one-half of your self-employment tax.
There’s also a traditional IRA, a Roth IRA and a defined benefit plan.
“The defined benefit plan is ideal for a 55-plus-year-old self-employed with high income and no employees, but many don’t know about it,” says Debra Brennan Tagg, managing partner of Brennan Financial Services in Addison, Texas.
What can I do to be more prepared for 2017? Tax professionals are quick to point out that taxes shouldn’t just be reviewed at year end. Put together a 100-day plan in December, says Jason Hogg, CEO Partner for Tritium Partners in New York.
Be honest about what’s working and what’s not working in your business, Hogg says.
“Start shutting down and cutting ties with any activities, employees or customers that aren’t going to produce results in the new year so you can hit the ground running after the holidays,” he says.
The worst mistake is being complacent and sticking with the status quo without any goals or plan to reach those goals, he says.
“There’s a reason you started your own business,” Hogg says. “Are you living up to your vision and your dreams? If the answer is no, take note of what’s holding you back and do something about it.”