by Jean Miller | Accounting News, News, Newsletter, Small Business, Tax, Tax Planning
Navigating the complex landscape of taxes as a self-employed professional can be overwhelming, but implementing effective tax strategies can help you shift from paying an excess of taxes to retaining more of your income. In this article, we’ll explore some key tax strategies that will help you keep more of your hard-earned money.
Choosing the Right Business Structure
Selecting the appropriate business structure is foundational to optimizing your tax situation. Sole proprietorship, partnership, limited liability company (LLC), S corporation, and C corporation each have distinct tax implications.
For many self-employed professionals, an LLC offers a balance of liability protection and tax flexibility. It combines a corporation’s limited liability aspects with a sole proprietorship’s simplicity, allowing for pass-through taxation while safeguarding personal assets.
On the other hand, an S-Corp can be advantageous for self-employed individuals aiming to minimize self-employment taxes. By structuring income into a reasonable salary and distributions, S-Corp owners can potentially save on taxes. Furthermore, the flexibility in offering fringe benefits, which can include health and life insurance, retirement plan contributions, and other perks makes an S-Corp structure a strategic choice for tax optimization and fostering business growth.
Itemized Deductions vs Standard Deductions
Understanding the differences between itemized deductions and standard deductions is crucial for self-employed professionals. While the standard deduction provides a fixed reduction in taxable income, itemized deductions can potentially yield greater tax savings if you have significant qualifying expenses. Common deductible items include business-related travel, home office expenses, and professional development costs. Carefully tracking and documenting these expenses can contribute to substantial savings during tax season.
Maximizing Retirement Accounts
Taking advantage of various retirement accounts can reduce taxable income and secure a financial future. Contributions to Individual Retirement Accounts (IRA) and Simplified Employee Pension (SEP) IRAs are tax-deductible, providing an immediate benefit. Solo 401(k) plans, designed for self-employed individuals, allow for higher contribution limits, enabling professionals to save more for retirement while minimizing their tax liability.
Understanding Constructive Receipt
The tax concept of constructive receipt states that income is taxable when it’s made available to you, even if you haven’t physically received it. Self-employed professionals can optimize tax planning by strategically timing invoices and income recognition. For instance, deferring income to a later tax year can help minimize current tax liability. Keep in mind that effectively leveraging this flexibility requires maintaining precise records and compliance with tax regulations.
Investing in Real Estate and Rentals
Incorporating real estate rental properties into an overall tax strategy offers diverse opportunities for tax benefits and savings. Property owners can capitalize on depreciation deductions, enabling them to deduct a portion of the property’s cost annually. This deduction can substantially lower taxable income, effectively reducing the overall tax liability.
Health Insurance Plans and Premiums
Health insurance premiums for self-employed professionals are generally deductible, reducing taxable income. Alternatively, S-Corp owners can generate significant tax savings by establishing a group health insurance plan, allowing the S-Corp to cover premiums through payroll. The utilization of Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs) provides additional avenues for entrepreneurs to reduce taxable income, offering tax-free contributions, growth, and withdrawals for qualified medical expenses.
by Stephen Reed | Accounting News, News, Retirement Savings, Uncategorized
If you are a freelancer, an independent contractor, or a self-employed individual, you know the perks of working for yourself, but you likely also notice one major drawback: the lack of an employer-sponsored retirement plan like a 401(k). Enter the Solo 401(k) plan. Below we’ll discuss how this plan provides the highest savings potential for solo business owners.
What is a Solo 401(k) Plan?
A solo 401(k) is a tax-advantaged retirement account for self-employed business owners as well as spouses who work for them at least part-time. Individuals who hold a full-time job with access to workplace retirement plans are also permitted to save for retirement in a solo 401(k) with funds earned from a side hustle. A solo 401(k) is also referred to as an individual 401(k), one-participant 401(k) plan, or a self-employed 401(k).
Eligibility Rules and Contribution Limits
There are no age or income restrictions with a 401(k), but you must be a business owner with no employees (apart from a spouse). You may be able to contribute up to $61,000 in 2022 (up from $58,000 in 2021). If you are 50 or older, you can make an additional $6,500 in catch-up contributions.
Solo 401(k) Tax Advantages
With a solo 401(k) you can pick your tax advantage: a traditional 401(k) or a Roth solo 401(K).
- Traditional solo 401(k): Contributions reduce your income in the year they are made, which reduces taxable income. However, distributions in retirement will be taxed as ordinary income. You may owe a 10% penalty in addition to ordinary income taxes on withdrawals you make from a traditional solo 401(k) before age 59 ½.
- Roth solo 401(k): Offers no initial tax break but allows for tax-free distributions in retirement. You may be subject to penalties on withdrawals before age 59 ½.
Generally, if you expect your income to increase in retirement, a Roth solo 401(k) is the better option. If you expect your income to decrease in retirement, go for for the tax break now with a traditional 401(k).
How to Open a Solo 401(k)
If you decide to set up a solo 401(k), you can do so through a financial institution that administers 401(k) plans. Set-up typically follows these steps:
- If you don’t already have one, you need to get an Employer Identification Number (EIN) from the IRS.
- Choose a provider. When reviewing potential plan administrators, look into any applicable fees. You many also want to look for a plan that offers a mix of investment options, including mutual funds, stocks, bonds, ETFs, and CDs.
- Fill out an application and any required documents. The IRS requires an annual report on Form 5500-SF if your 401(k) plan has $250,000 or more in assets at the end of a given year.
- Once you are ready to fund the account, you can roll over money from another retirement account or set up a transfer from a checking or savings accounts.
- Finally, choose your investments and establish contribution levels. Keep in mind that there is no minimum contribution requirement, so you can increase contributions in good years and save less in years when you need more cash reserves for your business.
With high contribution levels, flexible investment options, and fairly easy administration, the solo 401(k) could be a good fit for a one-person business operation, freelancer, or independent contractor, especially if you want the option to save aggressively for the future.
by Stephen Reed | Accounting News, News, Tax, Tax Planning, Tax Planning - Individual
Understanding self-employment taxes can be intimidating, but it’s important to educate yourself so you don’t miss out on deductions that can lower your tax bill. Below is a list of 15 self-employment tax deductions you may be eligible for as a freelancer or a self-employed individual.
1. Self-employment tax deduction
Self-employment tax is the portion of Medicare and Social Security taxes that self-employed individuals are required to pay, but you can claim 50% of this as an income tax deduction. For example, a $1,000 self-employment tax payment reduces taxable income by $500.
2. Qualified Business Income (QBI) Deduction
As of January 1, 2018, self-employed taxpayers can deduct generally 20% of their qualified business income from qualified partnerships, S corporations, and sole proprietorships.
3. Home Office Deduction
If your home office is your primary place of business – and used solely for your business – you are permitted to deduct it from your taxes. You can also deduct a percentage of household expenses such as electricity, gas, water, trash, cleaning services, and certain repairs to the home.
4. Retirement Plans
If you use a qualified retirement plan, such as a 401(k), an IRA, or a simplified employee pension (SEP), you are able to deduct your contributions to that plan.
5. Office Supplies
Provided they are used solely for your business, materials such as tools, basic office supplies, and machinery (including service expenses) may be deducted.
6. Depreciation
Capital expenses that experience the gradual loss of value (particularly business equipment or buildings) through increasing age, natural wear and tear, or deterioration may be deducted if they are used to generate income for your business.
7. Educational Expenses
Business-related educational expenses, such as continuing education classes, seminars and conferences, conventions and trade shows, and subscriptions and dues for industry organizations can all be deducted.
8. Health Insurance
If you are self-employed or own more than 2% of your S Corporation, you can deduct health insurance premiums for yourself and any dependents under the age of 27.
9. Advertising and Promotion
Any materials or services used to promote your business, such as business cards, web hosting, full media advertisements, etc. are deductible.
10. Internet Fees and Communication Expenses
Internet costs can be deducted, but only the percentage of time that it’s used for business purposes. Cell phone services also may be deducted in the proportion that it relates to business usage. To keep the personal vs. business line clear, it’s recommended to have separate computers and phones for business when possible.
11. Mileage
If you use your car for your business, you can take a standard mileage deduction, or take a deduction based on actual costs of fuel, maintenance, licensing, and depreciation. Some public transportation expenses are also deductible. Good record and receipt keeping as proof of business is key here.
12. Bank Fees and Interest Charges
As long as your business bank account is separate from your personal account, some bank fees connected to your business account may be deductible. Likewise, you can deduct interest on credit card balances and loans that are directly linked to your business.
13. Travel
Some business travel expenses can be deducted by 100% if they occur away from your home office and are considered necessary. Under the new Tax Cuts and Jobs Act, certain entertainment write-offs have been removed, but the 50% deduction on food and beverage expenses is still applicable.
14. Security System
If you work from a home office, you can deduct a percent of the expenses of a total home security system, and the purchase and installation of the system can be included when calculating depreciation.
15. Moving Expenses
If you move more than 50 miles from your location for business purposes, you are able to deduct most incurring expenses, such as transportation, packing, and utility connection fees.
