The short answer: probably not!
This is a sentence I hear at my tax desk every year, “I bought this for my business or I did that for my business but I’m not going to claim it because I have too many deductions!” Seriously? No you don’t.
I guess I should back track a little on this—if you’re claiming stuff you shouldn’t be claiming—that’s another story. But if you own a business and you have a legitimate business expense—then claim it.
Often times, small businesses, especially in the beginning, have losses. On your tax return it’s called a net operating loss or NOL. If you have an NOL, you carry that back two years and use it to offset income that you had two years ago. If you still have a loss, you can carry it forward for another 20 years!
Now sometimes you have an expense that gets limited if your business doesn’t have enough income—like a section 179 deduction or a home office expense. That doesn’t mean that you can’t claim these things, they just get carried forward to be used to offset your future income.
Don’t skip your deductions! I can’t stress this enough. Often, at the “big box” stores, they’ll skip your home office deduction because they’re “saving you money by not claiming it” since they charge you for each form. But it’s like that old expression, “pennywise and pound foolish.” Sure, you save a few bucks by not filing the 8829 form, but you just lost the carry-forward of a few hundred dollar deduction. This is especially important this year with taxes most likely going up next year. Even if your deductions won’t help your tax return right now—do not just leave them off. Otherwise, you would have to amend your prior returns to carryforward the deductions which will cost even more money in the end!
It’s still November, you have plenty of time to round up your receipts, review your mileage log, and make sure that you’re doing everything you need to be doing to maximize all of your deductions. Obviously you can’t claim stuff that’s not a real business expense. But you can claim everything that is a legitimate expense for your business. Not only can you claim it—it’s the right thing to do.
For those of you who do not have a home office, these posts will help get you started:
I generally don’t recommend using credit cards because it’s too easy to get into trouble with over spending. But I also know that most people do use them and how you use your credit card can have a profound effect on your business bottom line. If you are a sole proprietor of a small business, here’s what you need to know about credit card spending.
- 1. Your credit card purchase counts as a business expense the day it is charged, not the day the credit card is paid. If you charge a business expense on December 31, the expense is counted in that year, not the next year when you pay the bill.
- 2. You can pre-pay business expenses up to a year in advance. This can have a big impact on your company bottom line. For example: I lease extra office space for tax season. I know that the extra space will cost me $7,000 next year. Generally, I’d pay that over a course of 4 months from January through April and it will count as a deduction on my 2013 taxes. But—I could elect to charge it all in December of this year to reduce my tax bill for 2012. The plus side is that I have an extra $7,000 expense to write off this year. The down side is that I don’t have that expense to write off next year in 2013. But at least I have a choice.
- 3. Payments to your credit card do not count as business expenses because the charge itself was counted as an expense. This is what messes people up in QuickBooks all the time. I often hear folks complain that they couldn’t possibly have that much profit, because they don’t have that much money in their bank account. It’s because they charged things the year before and took the deduction then. You can’t count the same expense for your business twice.
- 4. If you do use a charge card for business, the interest expense on the charge card is deductible. (Remember, the interest charged on business expenses is deductible. If you’re charging your groceries and personal items, then it’s not.)
- 5. As a sole proprietor, you can charge something on your personal credit card for a business expense. If you own a corporation (C or S Corp) you must use a company credit card to count the charge as a business expense. If you charge something for your corporation on your personal business card, then you must reimburse yourself for the expense before the end of the year in order to write of the expense for the company.
It’s up to you to make wise choices about how and if you use your credit card for business. Knowing the rules can help you make better decisions.
Recently someone asked me if he could write off his iPad as a business expense. Now for that guy—the answer was a resounding, “Yes!” But I knew all of the circumstances and I knew he had an audit proof reason for the iPad. For most people though—deducting the iPad purchase is a resounding, “Maybe.”
First, you need to consider if the purchase of your iPad would be an “ordinary and necessary” expense for your business? Now in the case of my iPad guy, he’s a computer programmer and he had been hired to develop some apps specifically for the iPad. Although he felt confident that he could develop the apps without an iPad, he thought it might be useful to own one. (Okay, duh! I think he just wanted me to okay his iPad purchase to his wife.)
But you don’t need to be a programmer to justify the expense; there are plenty of really good uses of an iPad for your business. I could just set up a video camera and let my husband do a 20 minute infomercial about why every business person in America needs an iPad. He actually bought his for fun and found that it’s great for his business; he uses it all the time. I think many businesses would pass the “ordinary and necessary” requirements for the write off of a tool like that.
Second, you need to consider how much you’d use it for business. This is really important because the iPad counts as “listed property.” Listed property is the fun stuff. Cameras, computers, and stereo equipment—basically the fun stuff that you can get at Best Buy. Cars are also considered to be listed property.
So here’s the deal—if you buy business equipment that is not listed property—like a file cabinet, and then you quit using it—the IRS doesn’t really care too much about that. But if you buy some fancy video equipment “for business” and then don’t use if for business—well the IRS has some ideas about that and those ideas will all cost you some money! Basically, anytime your business use of listed property falls below 50%—then you’re going to have to “recapture” (that means pay tax) on the deduction that you took earlier on your next tax return. Yuck!
Let’s take that iPad for example. A new iPad costs $500. You buy it this year and you take the Section 179 deduction for it and write off the whole $500 as a business expense for your sole proprietorship. (A Section 179 deduction is what you call it when you buy a piece of equipment and expense the whole thing instead of depreciating it. Depreciation is where you buy something expensive and write off the expense over a couple of years—it depends upon the equipment to determine how long the write off is for.)
That’s all fine and dandy if you use the iPad 100% for business and you keep using it for business. But let’s say you buy it, write it off, and then next year you give it to your daughter for school. Now it’s not a business tool anymore. If you do that—the IRS will make you “recapture” the unused depreciation. So next year, you’d have $400 of extra income to pay tax on. (Because they’d let you keep the $100 expense deduction for the year you used the iPad for business.)
Now I realize that I’m oversimplifying things—but that’s the basic gist of it. It’s okay to buy cool stuff for your business. It’s okay to write it off. But if you’re not going to be using it for the full term of its use (most things are 5 years) then you might want to think twice before writing off the whole thing.
I recently received an email from a client about a bad debt. It’s the second time I’ve gotten that same question in one week, so it seemed like a good idea for a blog post.
Here’s the question: “I’ve had trouble collecting on a $500 invoice and I’m not sure it’s worth any more time and effort dealing with it. Is there a way to write it off and get some kind of tax advantage?”
Now most of my clients, including the person asking the question, are on what’s called a “cash basis accounting” system. If you’re on a cash basis accounting system, it means that you don’t record income unless you actually receive it. Same with expenses, you don’t count an expense that you’re going to pay, only ones that you’ve already paid. In a case like this–you don’t have to make a special line item adjustment for a bad debt–it’s just not counted in your income in the first place. So for this particular client, she doesn’t have to do anything (except fume over the dude who didn’t pay him for his work.)
But some businesses are on what’s called an “accrual” accounting basis–that’s where you count income as soon as it’s billed, not when it’s actually paid. Usually, businesses that have inventories, like stores for example, use an accrual basis method of accounting. With an accrual method of accounting, you’d report income as you billed it. Using the example from above, if the business owner billed the $500, he would have already counted it as income, even though it didn’t actually reach his pocket yet. For a business like that, you’d write the bad debt off as an expense. There’s actually a line right on the corporation forms for “bad debt expense”. While there’s no special line on the Schedule C for bad debts, you would just make your own line item for “bad debts” in part V–other expenses.
And that’s all there is to writing off a bad debt for a business. Now if you’re dealing with a personal bad debt–like a loan to a relative that’s never going to get paid, that’s a whole other story. I’ll write about those in my next post.
Sometimes it’s a little eye opening to hear how someone else describes your job. I got that little “aha moment” the other day when my daughter explained my business as, “My Mom does taxes for people with weird businesses.” Now that’s not entirely true–I have lots of clients with perfectly “normal” jobs, but it’s also fair to say that I have a higher percentage of clients with “non-traditional” businesses than some of my peers.
My foray into weird businesses started years ago, back when I was the “newbie” at the big tax company. Basically, the way things worked there was that the senior preparers got their choice of the new clients and I got tossed the dregs–anybody they thought was an oddball that they didn’t want to deal with became my client. And they were pretty picky–artists, actors, exotic dancers, magicians–they were mine. When the circus came to town and one of the clowns called up asking if he could get his taxes done while they were in St. Louis– his call got put straight through to me. He shouldn’t have even been my client (all he had was a W2) but the receptionist heard “circus” and “clown” and obviously the call had to go to Jan. I did the return anyway. How could I resist doing a tax return for a real live clown from the circus? Too cool!
And that’s the thing–these business returns that nobody else wanted to work on–I loved. I got to meet really interesting people and solve some interesting problems. Quite frankly, if you can make your bird disappear in front of a live audience, then I’m inclined to write off the birdseed as a business expense. And while the IRS generally frowns upon claiming “make-up” as a business expense deduction, if you’re purchasing eye lash glue by the gallon and using it to glue your costume in place so that you don’t violate local decency ordinances–well then I think it is an ordinary and necessary cost of doing business.
It doesn’t matter whether you’re a lawyer, you own a flower shop, or you do standup comedy–at the end of the day you want to make enough money to put food on the table and a roof over your head. Business is business and you want to make a profit or you starve.
One of the biggest problems people with non-traditional businesses face is the perception that they’re going to starve if they go forward with that business idea. Let’s face it; if everybody tells you your idea is bad–it kind of puts doubts into your head, doesn’t it? And doubt can kill a business.
What if American Idol was around back in the 60s? Picture Bob Dylan singing his heart out and Simon Cowell saying, “Well Bob, you seem like a nice enough young man and you play the guitar fairly well, but this is a singing competition and you’re just not cut out to be the next American Idol.” (Go ahead, take a minute and insert your own favorite rock icon in there and how they get rejected, it’s kind of fun.) The point is, Bob Dylan didn’t quit and he went on to make an indelible mark on American music. (Okay, if you’re too young to know who Bob Dylan is–check out this link: http://en.wikipedia.org/wiki/Bob_Dylan
So what about you? What’s your idea? Is it crazy? I would have thought Facebook was a crazy idea. How much money did Mark Zuckerberg get out of that IPO? Billions! Are you old enough to remember pet rocks? Pet rocks are the gold standard of dumb, yet profitable, ideas. Someone took plain old rocks, stuck them in a box and sold them as pets. Everybody was buying them, it was nuts! It was a totally stupid idea and I’m sure that guy laughed all the way to the bank. http://en.wikipedia.org/wiki/Pet_rocks
One of the advantages of having a non-traditional business is that you have to be twice as organized to come across as being half as legitimate. This is an asset. An attorney walks into a bank, says he’s an attorney, and everybody thinks, “Oh, this guy knows something.” While an attorney should know a lot about the law–some of them don’t know diddly squat about business. You walk into a bank, say you’re a professional geese herder and you sure as heck better have your ducks in a row (couldn’t resist the pun) if you’re going to get financing from them. (Yes, I know a professional geese herder–real business. Awesomely cool.) No one will take the geese herder seriously if she doesn’t know her stuff. Sometimes that uphill battle gives you the extra edge you need.
The bottom line is–if your business idea is a little strange, it doesn’t mean it’s not good. It could even be great. But you’ve got to do your homework. Know what it is you’re selling, who’s going to buy it, and how you’re going to get the product to the customer. A lot of new businesses get tripped up in the idea that they are “unique” and they don’t fit the basic mold. Here’s a tip for you–everybody is unique; everybody. Here’s my other tip–if you can’t answer the questions, what do I sell, who do I sell to, and how do I get the product to the customer? Then your business isn’t ready yet.
But if you know what you sell, who you sell it to, and how you get the product to your customer–then you’re in business!
Right now, I’m sitting in my comfy chair in the corner by the window of my home office and drinking a freshly brewed cup of coffee from my favorite mug. The dog has done her security patrol of the perimeter, deemed me to be safe from the local deer and bunny rabbits, and has settled in for her morning nap. I’m having one of those, “This is why I’m doing this,” kind of moments and it’s nice.
As a tax person who specializes in small businesses, I get asked a lot of questions about different business practices–Should I set up an LLC? I always answer, “That depends.” Should I lease a car or buy it? That depends. Should I set up as a sub-chapter S corporation? That depends. You get the picture. But when people ask me about a home office I always say, “Yes! Every small business owner who files a schedule C should have a home office.” My answer has nothing to do with the comfy chair and coffee either. As usual with me–it’s all about the money.
A home office is good for your tax return. First, you get to use a portion of your living expenses (that you would already be paying anyway) to offset your self employment income. Remember–your self employment income is taxed at 13.2% more than your regular income tax so even something like your mortgage interest-which is already deductible, is a better deduction when it goes against your self employment income. Kaching!
a home office is foThe other reason you want r your mileage. Yes, you read that right–you want the home office deduction to claim mileage. Here’s the deal–let’s say you’re a contractor, you drive to jobs all over town. You probably put close to 20,000 miles on your truck a year for business. You claim that on your tax return and get audited. (Side note: claiming exactly 20,000 business miles on your tax return will get you audited it’s a red flag.) Anyway, you go through the audit process and the IRS disallows all 20,000 miles because you’re commuting to those job sites from your home and commuting miles are not tax deductible. That’s over $3800 worth of tax money that you just lost right there. Add the fines and penalties and you’re well over 5 grand in tax debt.
But if you had a home office–all of that mileage becomes deductible because ou’re traveling from your office to a job site.
But what if I don’t really have a home office? Seriously, you need to set something up. It doesn’t have to be a whole room–it can be a corner of a room (like my comfy chair spot although most people have a desk or table.) You can’t just say you have a home office on your tax return and not really have one. (You’ve heard of fraud, right?) Be be realistic. If you have a small business–you’ve got something–files, or a computer, or make up, or something–and it needs to be put someplace. You need a spot to make phone calls from, pay the business bills, do your adminsitrative work–that’s your home office.
Aren’t I more likely to get audited if I claim a home office? To be honest, I keep hearing that, but my experience says no. The only time I’ve seen home office expenses audited was when they really were wrong and it was part of a broader audit. (Oh yeah, and when I redid those numbers correctly the taxpayer got a bigger home office deduction.) Be honest about it and you’ve got nothing to worry about.
But what if I have a real office in a business building that I go to every day? Can I still have a home office? Yes you can. You make your home office your administrative office. Like I said, pay bills, balance the business check book. I never meet clients in my home office, they always come to my “business office” location. My business office doesn’t prevent me from having an “administrative” office at home.
If you’d like more information about claiming a home office, try this link: http://robergtaxsolutions.com/2010/09/can-you-claim-a-home-office-deduction/ It has more information about the rules and what the IRS is looking for. But seriously, if you’re a sole proprietor, you need a home office.
Filed under: Earned Income Credit, Self Employed, Small Business
Now some people may be wondering, “Why would I want to prove I have more income than I have to?” But for many small business owners, that’s exactly the problem—you have income, you want to report it to the IRS, and you’re having a hard time proving it. This post is for you.
The number two reason for reporting your non-1099 income (number one of course being basic honesty) is qualifying for the Earned Income Tax Credit. 2011 sort of hit small business owners who normally qualify for EIC with a one-two punch. We had the new 1099 reporting requirements that upped the ante for so many businesses, and we had the new EIC tax preparer due diligence rules with one of the questions being “Do you have forms 1099-MISC to support the income?” With the next question being, “If not, is it reasonable that the business type would not receive Form 1099-MISC?” Here’s a clue: if you answered NO to the first one, you have to answer YES to the second.
So what types of businesses wouldn’t normally receive a 1099? Bunches of them! Face it, if you’re reading this—I’m guessing that your business doesn’t receive 1099s. Generally, it’s reasonable to expect that anybody who works for other people, as opposed to other businesses, would not receive a 1099. House cleaners, dog walkers, handymen, lawn mowing services, daycare providers, interior decorators, and even income tax preparers are all types of business that could easily never see a 1099. (Yeah, me too! Although I’m now getting 1099k forms because I take credit cards, I don’t get 1099-MISC for preparing personal tax returns. Maybe I’ll see some 1099-MISC forms from some of my business clients this year, but I never used to get them in the past.)
So, how does a small time personal service provider prove his or her income to the IRS? There are a couple of things you can do. I’m going to start with my favorite: the business bank account. This is what I do and several of my clients do it too. (Okay, because I’m their accountant and this is what I tell them to do.) Get an Employer Identification Number (EIN) for your business and set up a separate bank account for your business in your business name. Only business income goes in, only business expenses go out. You may have to put some of your own money in for a start up, and once you’re making money you’ll take out a draw, but you’ll label those as such. Other than those two items, your business checking account is pretty much your profit and loss statement as well. Now for a bigger company that would be over simplifying things, but for us little folks–I’m spot on. See this post for more information about getting an EIN number: Free EIN
Why does this make good proof? Because you’ve got a monthly record of your income and expenses. I also have deposit slips to back it up: Mary Jones paid me $200, Fred Smith paid $250. It’s a good solid audit trail. Here’s another post about bookkeeping and your business bank account: Banking and Bookkeeping
But what if you don’t have a separate account? Maybe your business is just too small to bother with the expense of an extra account. What if you’ve just got something really simple like watching the little neighbor kid for a couple of hours after school every day. There’s no contract, no business cards, no advertising. You get $100 a week from your neighbor friend. She pays you in cash—it never sees the inside of a bank because that’s your grocery money. It’s not much but it supplements your child support. How do you prove that kind of income?
The easiest way to prove your income if you provided child care is to have the person you provided it for claim your services on their tax return. You make them a daycare receipt, just like the ones regular day cares do showing the name of the child, how much they paid you and your EIN number. (You can use your social security number but I never recommend that. You can get an EIN number for free. Protect yourself.) This is doubly good because the IRS will get confirmation of your income from an outside source. You prove income, your customer gets a tax deduction, it’s a win/win situation.
But what if your business isn’t day care? What if you did something like mow lawns around the neighborhood and shoveled snow in the winter? Nobody’s going to be claiming you on their tax return, what can you do? In your case, I like receipt books. You can find different kinds at Office Max or any office supply store. I like the ones with a carbon copy—one for you, one for your customer.
Now if you have just one customer and you’re always going to the same place—you can just use the little one that just has a couple of lines and the amount on it. You might write, “Mowing, Mr. Jones, $30, 5/15/2012” on it. You know what you did, who you did it for, how much you got paid, and when. If you have multiple customers you’ll want the larger receipt books that include the address and phone number of the customer. If you do different types of jobs for different people, you might need the bigger ones so you can write down the type of work that you did for them as well.
You don’t have to have a 1099-MISC to prove your income to the IRS. You just need to have a system in place to document your income and you’ll be fine.
Did you get a 1099K form in the mail? Are you wondering what to do with it? I was a little confused when I saw the first one because I was told they weren’t going to be happening. Oops. Somebody didn’t get the memo.
Anyway, if you’ve gotten a 1099K – that’s the form from your credit card company that says how much money was charged on credit cards to your business – you’re probably wondering how to report it. If you’ve been looking for information, you may have noticed that there’s conflicting information out there. It’s because there isn’t a definitive “this is what you’ve got to do” answer from the IRS. So here’s how I will be doing it on my returns; I think it makes sense and will be good with the IRS.
You’ll note that the line that says 1099K income doesn’t work when you try to input it into your software. That’s because the IRS won’t be using that line. Your computer’s not broken, the software isn’t broken. The change came sometime in August and the new line was already put into the forms. The IRS decided that since the line was coming back for 2012, they’d leave it there but just blank it out for now. You’re not crazy, it’s the way it was set up.
Even though you don’t get to use that line, you still want to report that income. This is how I say you should do it:
Make a worksheet for your income line. Show the 1099K income reported as one number. Show your other income reported as another. The total should read as the total income for your business.
Here’s an example: let’s say you took in $50,000 in revenue for 2011. You know your total revenue figure. You receive a 1099K that says you were paid $20,000 with credit cards. On your income worksheet you list:
- Credit card income reported on 1099K – $20,000
- Other revenue not on 1099K – $30,000
Easy enough, right? That’s my recommendation. In fairness, the CPA down the hall says to just ignore the 1099K and report the $50,000 straight. Here’s why I disagree. I do audit work for a living. If this comes back to bite you in the butt, you’re going to be glad you listed the 1099K as a separate line item. It’s not that the CPA dude is wrong, it’s just a covering your behind kind of thing.
If your credit card company is sending you an IRS reporting form, it’s highly likely that they’re sending that same form to the IRS. If the IRS pulls your return up for audit, don’t you think they’re going to ask about the $20,000 on the 1099K? If you’ve already listed it separately, well, that’s an audit letter they might not need to send.
Here’s some other issues you may have with the 1099K:
- The credit card company reports the full amount of the charge, not the amount less fees withheld. For example: lets say you charge your customer $300. The credit card company withholds their fees and only sends you $292.50. You’ll have to think about how you’ve been reporting that. Lots of businesses record their revenues as the actual income that comes into the bank – charge less the fees. Your 1099K will report the income as $300–you’ll need to make sure that you expense those fees out.
- Same issue with sales tax. Many retailers just record sales and keep the tax separate. Your 1099K will give the whole dollar amount charged – you’ll need to remember to back out your sales tax.
- Restaurant owners, beauty salons, anyplace that accepts tips: if a customer charged a tip, you’re going to have to back out the tips paid to your workers. The entire charge is being reported on the 1099K.
Are you starting to see how this could be a bit difficult? Don’t forget places that give “cash back” to customers, that’s going to be another expense you’ll have to remember.
Bottom line – there will be a lot of forgiveness this year in the reporting of your 1099K income. People are going to be confused and the IRS is fully aware of it. But if you’re already getting 1099K statements, you’ll want to do your best to report it correctly now. It’s so much easier to do it right the first time than to be “forgiven” for doing it wrong.
I know what you’re thinking: “Come again? You must be out of your head! Don’t I always want to reduce my income for tax purposes?” Sometimes, the answer is no. Actually, I got the idea for this post from Howard, one of my readers with an accounting background and an owner of a struggling restaurant.
I’m walking on a tight rope here so I want to make sure that I explain this carefully. Under tax law, a small business owner is required to report all of his income and expenses accurately. I’m always telling people “don’t make stuff up” – that’s my rule and I stand by it. That said, there’s some leeway, like prepaying expenses at the end of the year to reduce your business income and stuff like that.
Where I’m going with this is there are some people who don’t want to reduce their business income for the tax year. One category is people who are applying for a home loan—you want your net income to be as high as possible, even if you’re paying self-employment taxes because the bank will be looking at your net income. The other category of folks who might not want to reduce their business income is people who may qualify for an Earned Income Credit (EIC).
Since leaving the big box tax company, I haven’t filed a lot of EIC returns; most of my clients are small businesses owners and have incomes that are too high to qualify. But last year, I had 5 EIC returns for people who had never even heard of EIC before, basically small businesses that had hit a rough spot with this economy. (I do lots of returns for people who don’t own businesses too. But I’m on a business roll right now.)
So here’s the thing: as a small business owner, you’re taxed 13.3% for your self-employment tax for 2011. If you make a net profit of $10,000 your self-employment tax is about $1,330. (Not exactly, it’s a funky equation, but that’s pretty close.) If you’re single with no children, the Earned Income Credit would be about $278, so it would make sense for you to lower your net income if you can so that you reduced the self-employment tax. But, let’s say you’re filing as head of household with 2 children – in that case your Earned Income Credit would be around $4,010 so reducing your net might not be such a good idea.
Bottom line: the tax strategies for a business owner who is a parent may be different than the strategies of a business owner with no children.
The IRS website has an Earned Income Tax Credit Calculator to help you determine how much of an Earned Income Credit you can receive if you qualify for one. Here’s the website: http://apps.irs.gov/app/eitc2010/SetLanguage.do?lang=en.
Remember, that’s just the EIC and it is an estimate. Remember that for your-self employment income, there’s also self-employment tax – the quick and dirty calculation for that is 13.3%. It will help you figure out where you stand with the EIC compared to self-employment taxes.
If you’re married and your spouse has income, that income will be included in the overall calculations, so EIC may not be a factor for you.
There are so many things to think about when you own your own business. It’s a good idea to get some professional help at least once every three years to make sure you’re on track and getting every deduction and tax credit you deserve. If you have made mistakes in the past, a professional can amend your prior year returns and get you refunds for what you’ve missed as long as you’re within that three year time limit.
Your read a lot of news stories about year-end tax tips, but you don’t see a lot of things specifically targeted at Sub-S Corporations, and there’s nothing out there for the single owner S Corporation. It’s kind of sad because most people with Sub-S Corps are set up that way for the tax advantage of the Sub-S, but then they miss out on other tax benefits that they would have had if they remained a sole proprietor. If you own a Sub-Chapter S Corporation, then you need to make sure that you maximize your deductions just as much as any other type of business. These tips are especially for you:
First, and most importantly, if you’ve got a profit this year, you want to make sure that you are paying yourself some type of payroll. This is one of the most common mistakes that S Corps make. The point of having an S Corp is to protect some of your income from self employment taxes. In order to do that, you need to pay yourself a salary. In the early years of a business, there’s often a loss and the salary isn’t important, but once the business is in the profit side, the owner should be paying a wage that is commensurate with what he’d be earning if he worked the same job for someone else. If you don’t do this, the IRS can come back and assess self-employment tax on 100% of your S corp profit. So that’s the first thing you want to handle.
Reimburse yourself for your employee expenses: Write yourself an expense report and have the S Corp write you a check. For example: let’s say you took a business trip for a convention and your travel expenses cost $1000. You paid it out of your own pocket because it was easier at the time and you just figured that you’d write it off later. Because you are an employee of the S corp, you would put the $1000 on your schedule A as an employee business expense and it would be subject to the 2% limitation rules (you can only deduct as an employee business expense what you spend over 2% of your adjusted gross income). Putting the expense on your schedule A gives you a much smaller tax benefit than if it’s on your S Corp return. If you pay Alternative Minimum Tax, you could get zero benefit from putting it on your schedule A.
Pay your health insurance through your S Corp: This is not the big deduction you would want it to be, but it’s better than nothing. As an employee of the S Corp, you can’t claim the self-employed health insurance deduction like you could as a sole proprietor. Your health insurance would go on your schedule A subject to a 7.5% limitation before anything could be deducted (for most people that’s a zero deduction.) If your S Corp pays your health insurance, then it comes to you as a taxable fringe benefit so you still have to pay FICA on it, but then you get to deduct the cost of your health insurance on page 1 of your tax return—a much better place to put a deduction.
Reimburse yourself for your home office deduction: It’s hard to claim a home office deduction on a Sub-S corporation. Like other employee expenses, it would go on your Schedule A and be subject to the 2% limitation rules like any other employee business expense. Many accountants won’t even touch a home office for a Sub-S Corporation. Some people charge rent to their S Corps for their home office, but that’s just moving your income from one taxable entity to another so you don’t really save anything. What you want to do is reimburse yourself for your home office deduction in a fully accountable plan. That’s a phrase that you want to remember: fully accountable plan. Prepare a form 8829 Home Office form like you were doing it for a sole proprietorship. Use that report to determine how much you should reimburse yourself for your home office. Remember, it’s a reimbursement, not a rent payment. It reduces taxable income to the company, but it is not taxable to you because you have “accounted” for the expenses. For more information about home office deductions, you might want to read this post: http://robergtaxsolutions.com/2011/07/how-to-boost-your-home-office-deduction/
I’ve listed some other year end tax tips in my other blog post: 2011 Year End Tax Tips for Tiny Business Owners. Not all of the tips there work for Sub S corporations, but some of them do so it’s worth checking out.