Tax Minimization

[Marshac]

It's getting towards that time of year again, and I'm busy trying to figure out ways to pay as little in taxes as possible.

My main concern is $9000 (gross) that I made this year through my business. I only have about $1000 of possible deductions, so that leaves me with ~$8000 of horrible horrible taxable income. Since this is the first year of my "business" (and the last), I haven't had to deal with this problem before, so please, treat me like a n00b. What I would like to do is to set up a SEP-IRA and make two contributions: an employer contribution, and an employee contribution.... and then deduct those from my gross income.

I have been reading IRS publication 560 (a real thriller I might add), but just wanted to know if there were any BETTER ways to minimize taxes for a "small business" owner. I would also be interested to know of any possible "small business" tax credits that I could take advantage of.

Thanks for everyone's expertise.... you guys saved me a chunk of cash with the COBRA advice about 2 months ago!

 

[Martha]

Is this a sole proprietorship?

On the SEP IRA Fidelity seems to have a nice worksheet to see the maximum a sole proprietor can contribute. http://personal.fidelity.com/products/retirement/getstart/newacc/sepiracalc.shtml

You might want a self employed 401k plan instead where you don't have the same contribution limits.

 

[brewer12345]

Gotta be careful here. Marshac, I believe you contribute to some sort of DC plan at work, right? Then the 401k is out, since you are already covered. I don't know about the SEP, but check it out.

 

[Martha]

The 401k may not be out. If you have one employer, you can only get one 401k but if you have more than one employer (yourself as a sole proprietor and another employer?) you may be able to have more than one 401k.

Is complicated but worth checking out.

 

[wabmester]

Just buy a Hummer. It's practically free after the tax deduction.

 

[Whisper9999]

Just buy a Hummer.   It's practically free after the tax deduction.

A Hummer gets a tax deduction? And a large one at that?

 

[wabmester]

A Hummer gets a tax deduction?  And a large one at that?

Yup, if you're self-employed, you can get something like a $38,000 tax deduction for an H2. Is this a great country or what?

http://seattlepi.nwsource.com/local/104601_hummer17.shtml

 

[Whisper9999]

Yup, if you're self-employed, you can get something like a $38,000 tax deduction for an H2.   Is this a great country or what?

http://seattlepi.nwsource.com/local/104601_hummer17.shtml

Now that is hilarious!

 

[Martha]

Marshac, the one thing I didn't think about with the retirement plans is that if I recall correctly, 401ks and the Simple IRAs have to be set up by October 1 to go in effect for this year. The SEP IRA can still be set up for this year.

 

[retire@40]

Just buy a Hummer.   It's practically free after the tax deduction.

I know you are joking, but people need to be careful not to believe some of these stories if they don't have a good grasp of the tax system.

Some tax facts have a way of morphing into tax myths.

Everyone should have a team of experts, including an attorney and CPA if only to bounce ideas off or get a professional opinion or some constructive criticism. When it comes to a decision that could have a major or long-term legal or tax consequence, it is good to learn as much as you can on your own first, but it is also important to get some advice from a trusted professional with whom you have established a long-term relationship.

 

[brewer12345]

Marshac, a couple of thoughts:

- If you are indeed eligible for a solo 401k, you can still set it up for this year. You have to get the paperwork in before the end of the year, and then you can make contributions until April 15 (or later if you do extensions). Assuming eligibility, you could shelter basially the entire $8000 that way. I would call Fidelity Retirement ervices and ask about eligibility. They were most helpful last week when I filled out the paperwork for my wife's new solo 401k.

- I have been doing a little side consulting work this year as well, and it will likely bleed into next year. I was considering finding a way to shelter this, but I have decided not to do so. Why? Well, income taxes are at levels I do not expect to see for more than the next few years. More importantly, we already have the majority of our investable assets tied up in 401k and IRA accounts. Tax advantages are nice, but these accounts lack a certain amount of flexibility. You can't invest in RE, you can't mess around with futures and options, you have to play by the rules to make withdrawals, etc. Finally, having tax deferred accounts is an implicit bet on future tax rates. You take the deduction now, but agree to pay whatever future taxes turn out to be. That's fine, but I am not interested in making gigantic bets. So we have some assets in 401k and traditional IRA accounts, some in Roth accounts, and some in after tax accounts, all of which gain or lose in different tax scenarios.

 

[IDunno]

I know you are joking, but people need to be careful not to believe some of these stories if they don't have a good grasp of the tax system.

Very true -- because most people who are amazed at a $38K tax deduction on a $50K vehicle don't really understand how the tax system works for businesses.

Those same people would be amazed that most business expenses are 100% tax deductible (or the equivalent of a $50K tax deducation on a $50K vehicle).

The tax system for businesses is very different than for individuals (and for very good reason).
-Scott

 

[Tommy_Dolitte]

IDunno -- Care to explain?

 

[John Galt]

I'm not too sure where IDunno was going either, but
while we are waiting.................the Hummer example is not all that outrageous, but of course you would need
to use it in your business to get the deduction. Also,
since thus area is ripe for cheating, you should make sure you CYA if you take advantage. Now, tax
minimization is an area where I really lucked out in ER.
Most surprises were "gotchas" but income tax worries
disappeared for me. With a working spouse and total
control of how much income I receive, I basically
eliminate all personal income taxes, although my spouse
pays on her income, of course.

John Galt

 

[IDunno]

IDunno -- Care to explain?

[re: "The tax system for businesses is very different than for individuals (and for very good reason)." ]

Taxes for individuals are based on how much money you have coming in (gross income), with a few deductions for various things -- but you can't normally deduct essential items everyone has to buy such as food, clothing, and shelter.

Taxes for businesses are based on net income, after expenses are taken care of. Virtually every expense is deductible. If you buy a box of pens for $1.99, you deduct $1.99. If you pay $1,000 for an ad, you deduct $1,000. A notable exception is depreciation, so if the business buys a machine for $100,000, the tax deduction is spread over the number of years the IRS expects the machine to last.

So if it weren't for depreciation, a business would get a $52,000 deduction on that $52,000 Hummer (whereas an individual would get a $0 deduction on it). So from a business owner's perspective, getting a $38K deduction for a $52K purchase isn't necessarily as good as it sounds from an individual's perspective. The individual typically is amazed, whereas the business owner is not.

As for the "very good reason" why it works this way, imagine if businesses had to pay tax on everything they bought, without deductions. Let's say you're a typical business, selling $1 million worth of stuff, and have spending about $900K of expenses. If you were taxed on the $1 million of sales, taxes would wipe out any profits you may have made. Businesses would need to have a profit margin much, much greater than they do in order to survive, which would kill most businesses. Worse, it would have a "snowball" effect -- if all businesses buy less, more businesses go out of business, and the $20 tax on the $100 sale also gets the government another $10 from the wholesaler that sold it to you for $50 -- and the government gets another $7 from the manufacturer that sold it for $35.
-Scott

 

[haha]

With a working spouse and total control of how much income I receive, I basically
eliminate all personal income taxes, although my spouse
pays on her income, of course.

I don't really understand this. If you file a joint return, your income is her income, and her income would automatically push you into taxable brackets with your interest, capital gains, etc.

If you are married filing separately, you and your wife have the worst of all tax worlds, with higher brackets, smaller standard deduction, etc.

So what is the secret to having a tax paying wife, while paying no taxes yourself?

Mikey

 

[vicky]

We have started our own homebased side business this year. The main reason is that we are both W-2 earners with no debt or any deductions (kids, mortgage) and we were spending far more on the IRS than on ourselves. A W-2 earner can barely deduct anything but the opportunities with a home based business are almost endless.

The side business has been an excellent way to convert a huge percentage of our personal expenses (part of the house, car, cell phones, internet etc..) to business expenses. Without buying the hummer, we rack up lots of expenses that are deductible. My Corolla with 160K is good for $0.375/mile (I think that is it for 2004 but I can be a penny off) or $1000's a year. That hummer will not do you much good unless you were going to buy it anyway.

Unless you really don't want to run your side business any more, I would go to a good CPA for advice. Your may have lot of unused opportunities for deductions. I read up on a lot of the tax stuff before I met with him and this really helped.

Vicky

 

[John Galt]

I just noticed Mikey's question. Normally, I would agree
that married filing separately is not a good deal.
However, I pay no tax and my spouse pays very little as
she has little income. The main reason though is that
to date we have almost no commingling of our financial
affairs, and that includes taxes. This will gradually
disappear in time.

JG