If you are a US based Hair of the Dog fan you know what is looming on April 15th….tax day. Joy of joys. The U.S. tax code is 1.2 million pages long and would take the average reader 23,000 years to read it all. I’m not talking 1.2 million pages figuratively, but an actual 1.2 MILLION pages.
Below are just a few of the tax implications that may affect your or your business. Disclaimer: I am NOT a tax advisor, CPA or tax professional. Please consult your accountant or tax advisor for individual advice!
Home Office Deduction:
This is a big change for the 2013 tax year. You have always had to add up all of your home expenses, utilities, insurance, property taxes, repairs, etc and then determine your deduction based on the percentage of your home that is used for your business. For instance, if you have a 2,000 square foot home and 200 square feet of it is used for business then you may deduct 10% of your home costs. Now you can opt for a much easier flat deduction of $5 per square foot. It is capped at 300 square feet. You can add up the deduction both ways and take whichever is larger. Please note that in order to claim a home office deduction that space must be used for work ONLY. You can’t claim your living room because you work on the couch, that applies to your kitchen table too. It must be dedicated space.
As a self-employed person you are responsible for filing your tax returns as quarterly estimated payments if you will owe more then $1000 tax at the end of the year. If you do not file quarterly you will be fined with penalties and interest. If you are filing quarterly, don’t forget that your state and local municipality will want their share quarterly too.
One of the challenges of our business is that we make a big portion of our income in the 4th quarter and we may not know exactly what we will make for the year until the end of the year. You can avoid penalties for underpayment of taxes if you ensure that your quarterly payments add up to at least 90% of your previous year tax bill, or 110% of your previous years tax bill if your adjusted gross income is over 150,000.
Just the word “audit” strikes fear in the hearts of millions. I feel like we should insert the Jaws theme music here…. According to Money magazine, the IRS has stated that they are ramping up auditor training directed at sole proprietorships and partnerships. If you file a Schedule C you already face 2-3 times the audit risk of the average filer. It is imperative that you have some sort of accounting process for your business and you report all income. If you are in this business long enough it’s just a matter of time before you face an audit. This is also one reason that I am happy to pay my CPA to prepare my taxes, as that means I have someone on my side if the tax man ever comes knocking.
Sales and Use Tax reporting can also trigger an audit from your state department of revenue. For more information on those taxes see the Keeping the Greedy Tax Monsters at Bay series.
Retirement Savings – Fund your Retirement and Save Money on Taxes
Working as a self-employed individual or even working within a small business, you are the only person that is responsible for your retirement savings. If you are relying solely on your Social Security earnings you will be eating Ramen noodles well into your golden years. All Americans, but especially the self-employed, are responsible for planning and funding their retirement savings.
Retirement may seem a long ways off, but if you are young it’s the best time to start saving so that your money can do more work for you. Likewise, if you are older there is no time like the present to build that retirement nest egg. What is that old adage? The best time to plant a tree was 20 years ago, the second best time is now. It’s time to plant your money tree.
One of the perks of being self-employed is the access to retirement savings accounts with MUCH higher contribution limits. There are two main types of retirement contributions, taxable and tax-deferred. Generally any Roth plan will be funded with post-tax money now, but all of the income that it generates will be tax free upon withdrawal! That is huge! Tax-deferred accounts allow you to deduct your present year’s contribution from your income therefore not paying tax on that money…for now. All tax-deferred accounts will pay taxes on the money as you start to take it out in retirement.
Your tax accountant will be able to direct you to your best strategy, but generally a Roth IRA with a brokerage firm like Vanguard, T. Rowe Price, or Fidelity is a no-brainer place to start. Once you max that out you may want to open a SEP-IRA which will allow you to save up to 25% of your salary, up to $51,000 a year! That will immediately cut down on the income taxes that will be due by your business and save on some of that dreaded self-employment tax.
I do want to repeat my disclaimer, I am not a trained tax professional. Please ask your accountant about the details of how these laws affect you and your business. In the meantime, I’m going to start gathering up my tax paperwork since I’m meeting my accountant in the morning!