Fall is a perfect time to begin tax planning for 2014, because waiting too long can be disastrous. This year tax planning is especially challenging because Congress has failed to act on many tax breaks that expired at the end of 2013. Given the gridlock in Washington it is impossible to determine what, if anything, Congress will do regarding the expired tax breaks. Nonetheless, it is very important to engage in tax planning in a timely manner, especially if you are a small-business owner.
Tax planning for small business owners is complex and due to the nature of most small business, filled with a lot of uncertainty. As such it is very important to know how your business is structured and make sure it is the right entity.
The structure of your business determines how your business income is taxed. Most small businesses are structured as pass through entities – either as S Corporations or LLCs. Profits and losses from these businesses are taxed directly to the owners on their personal tax return and both provide limited liability to its owners. Even though S Corporations and LLCs are very similar for tax purposes, there are subtle and sometimes significant differences between the two.
A business structured as a sole proprietorship is not afforded limited liability protection and therefore is not generally recommended. A sole proprietor however does report all of its income and deductions on the owner’s personal return.
Income generated from the business that is taxed on the owner’s personal return can also add to the owner’s tax liabilities. For example, investment income for individuals with adjusted gross income in excess of $200,000 ($250,000 for married couples filing jointly) is subject to an additional 3.8% tax on the investment income. Because most small business owners report profits from the business on their personal return, these owners are often surprised to find out that about the additional tax on investment income. To avoid or minimize the effect of the 3.8% additional tax on investment income, business owners should consider ways to reduce their investment income and/or defer income.
If your business income is from a LLC or sole proprietorship, you have to pay self-employment taxes. Self- employment taxes are Social Security and Medicare (FICA) taxes paid by employee and employer, so you are paying double. The Social Security component of the self-employment taxes is 12.4% and the Medicare component is 2.9%. In 2014 $117,000 of business earnings are subject to the Social Security part and all of your earnings are subject to the Medicare part. In addition, you will owe 0.9% of additional Medicare tax on earnings over $200,000 ($250,000 if filing a joint return). Since S Corporation profits are not subject to self-employment taxes, it may be beneficial to structure the business as an S Corporation (wages paid from a S Corporation are subject FICA taxes but S Corporation dividends are not).
If you are a business owner, here are some simple tax planning strategies you should consider to reduce your income and minimize your tax liability:
• Purchase and begin to use equipment for your business before the end of the year. Under IRS Section 179 you are able to fully deduct (rather than depreciate) the cost of qualifying new or used assets purchased for the business. For 2014 the Section 179limit has been reduced to $25,000 (the old amount $500,000 expired on 12/31/13).
• Realize losses on investments – capital losses can be used to offset capital gains. To take advantage of the losses you cannot repurchase the same investment within 30 days of the sale.
• Postpone income until 2015 and accelerate deductions into 2014.
• Consider using a credit card to pay deductible expenses before the end of the year. You are entitled to a 2014 deduction even if you don’t pay your credit card bill until after the end of the year.
• If you expect to owe state and local income taxes pay estimated tax payments of state and local taxes before year-end; this will enable you to claim a deduction for these taxes into 2014.
• If you are self-employed 100% of the cost of health insurance paid for yourself, spouse and children younger than 27 are deductible. You cannot claim more than your earned income. The health insurance deduction for self – employed individuals is a reduction to your adjusted gross income and is not an itemized deduction which makes it much more valuable.
• If you are eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2014. This is so even if you first became eligible on Dec. 1, 2014.
• If you have suspended passive activity losses selling the investment allow you to deduct suspended passive activity losses.
For many people, procrastination and taxes go hand-in-hand. That can also be the case for small-business owners, who are often so busy running their business that taxes take a back seat. But the advantages of early tax planning can be considerable, and now is the time to get a head start on ii by making sure your books and records up to date. And since every business is unique, you should also meet with your tax professional to determine which tax strategies are best.