Tax Savings Tips for the Self-Employed
If you are anything like me and you are tired of paying Uncle Sam so much of your hard-earned money, then this is for you! Do you want to know how the wealthy don't pay as much taxes? I'm going to break down five tax-saving tips for the self-employed.
So the number one thing to do is keep up, this can be overwhelming, but it's super important in order to stay on your taxes. You should be looking into your finances weekly and monthly at a minimum. If you don't know what's going on in your bank account, you have no idea what's happening in your business because the bank account tells the story and helps you understand what products are making the most money when or your expenses are too high and where you can make changes to increase your profit margins. Long gone are the days of keeping things in a shoebox and adding it at the end of the year. Let's work together to keep accurate records.
What am I talking about by records? Let's start with receipts. Anything that you spend $75 or more on, you're required to keep a receipt. Attach those transactions in Google Drive so you can check out that blog or that tab. You shouldn't have boxes of paperwork, we're in the age of the digital world so make sure that you're converting things to digital! You also want to pay attention and keep your personal and business records separate. You really should have a separate credit card and bank account if you're a business. You should keep your personal things in your personal accounts and your business things in your business account. And again, there's a blog post on this.
1 - Keep Organized
The number one thing I want you to do when you're looking at saving on your taxes is to keep organized because once you're organized you can really see some things going on in your business that you can make changes on and you're taking advantage of all the deductions that are out there.
2 - Fund Retirement Accounts
The second tip is going to be for you to fund retirement accounts. This is one that's often missed by entrepreneurs. We're so busy trying to make a business we also forget about funding retirement accounts. Entrepreneurs who have businesses and work their entire lives, but they don't put up retirement. They depend on that Social Security and then it's not there when they retire or it's not as high and they have to continue to work because they have nothing saved. So there are a few options for retirement accounts for the self-employed.
The first is going to be IRAs which are individual retirement accounts. You have two options for an IRA, you actually have traditional IRAs and Roth IRAs. With a traditional IRA, you're going to benefit from the tax savings in the year that you contribute to the IRA. So for example, if I were to contribute $3,000 to a traditional IRA, I would actually not pay taxes on that $3,000 in the year that I made the contribution. Okay, now with a Roth IRA, you will pay the taxes now and you will not pay the taxes when you withdraw the funds. So traditional you save on the taxes on the front end and on a Roth you save on the taxes on the back end and there's all different ways you can look at this.
If you anticipate your tax rate being higher now than it will be when you take out the distributions from your retirement account, then a traditional may be best for you now, but if you anticipate your tax rate to be higher when you retire, then it may be best for you to go with a Roth. There's so much about these retirement accounts we could talk about so if you have any questions about them, please send me a message.
As a reminder, most of these high tax rates increase over time, that is the history of tax rates. You can also fund a SEP plan, which is called a self-employed retirement plan. These plans are provided only for those who are self-employed and those are based on the profit of your business and you can only contribute a percentage of those profits. So that is something that you can figure out at the end of the year when you go to file your taxes, you're able to figure out how much you can put into a SEP plan and you can do that before you file your taxes and get tax benefits from that in the year that you put the money aside.
So lots of options for self-employed individuals, but I highly recommend that you set aside some money for your retirement - not only to help you with your tax liability but also to help you to have the nest egg so that you can retire one day.
3 - Pay Wages to Your Children
Number three is something I've talked about several times before, but I don't see as many people taking advantage of this particular tax deduction, and that is to pay wages to your children. So many of us have children that we pay an allowance because they take out the trash or they do other things in your business. I know my children work in my business and they are younger. They help with taking out the trash, they help vacuum, sweep, and mop my office area. They help with making copies and scanning things. So when you're looking at paying your children for work that they do in your business (I have to say they have to really do work for your business, you can't just be using this as a loophole) you can hire your child and have them on payroll and pay them up to an average of $12,000 a year based on the standard deduction for the year and that money is tax-free.
What do I mean by that? Well, that means that you can pay your child $12,000 out of your business and it is a business deduction and your child does not have to pay any income tax on the standard deduction for the year. Now a couple of things. One, you have to be taxed as a sole proprietor for this. There's no payroll tax for employing your kids and they have to be under the age of eight. So many ways to maximize all this.
So the first thing is going to be that you're saving - you're not paying taxes on the $12,000 per child that you're paying to help your business and they can be doing a multitude of things. So we'll talk about that too. Not only are you able to claim this as a deduction against your income, which means you're paying taxes on less money (because you pay taxes on profits). You can also maximize that so go ahead and use that money and set up retirement contributions for your child.
So the $12,000 for your child is tax free and then you can double up on the tax savings and actually contribute that money into a Roth IRA and some to a traditional IRA for your child so that it's saving for them to retire. Just imagine if you had a 10-year-old or 15-year-old and you're starting to pay them at an early age. They’re working for you anyway, and instead of paying them in video games or cash or whatever you're paying them this way. It's a deduction for you on your business, but also you can help them by starting their retirement! Again, this only works if you're self-employed. There are ways that you can claim this deduction if you have an S or C Corp. It just takes a little bit more work. But you can do it in all the different cases.
Now, what’re your children doing for you in your company? Well, they can be an advertisement for you. So maybe you use your children in social media advertising. Maybe they help you like I was saying with janitorial duties, maybe they help you with administrative work. They're helping you file it helping you make copies or scan. There are so many things that your kids can be doing and helping you in your business but they have to be really working in your business to be able to claim.
4 - Take Advantage of Tax Deductions
So we're gonna move on to number four and number four is all about taking advantage of different tax deductions. I'm gonna talk about four different ones here. So the first one is making sure that you deduct your home office expenses. If you are working from home or have a home office you should be deducting home office expenses. There are a few rules for this:
The room must be exclusively used for business. So you have to have a room that's not part of the bedroom, not part of the living room or whatever and it's exclusively used for business purposes.
Deduct a percentage of your home expenses such as utilities, mortgage interest, or your rent, that type of thing is based on the percentage of the square footage of your office versus your home. So when you have your office space and the square footage of your home and you're able to deduct the percentage of that on your taxes. You could just use the simplified method that the IRS offers and not need to keep up with your utilities.
The next tax deduction that I want you to be aware of is mileage. And this is one that is often overlooked because a lot of times we feel that we really don't go anywhere for our business, but you'd really be surprised how much this can add up. So think about the trips that you make to the bank or the post office. Maybe to pick up supplies, meet clients for meetings, or even go out to dinner or drinks with your client. All the mileage there is going to be deductible on your taxes based on the mileage rate set for that particular time period. Those are rates change and it really depends on the economy, how much gas prices are, and so forth.
Now I really like an app called MileIQ for mileage expenses. It helps you really keep track of things without doing anything, like there's an app on the phone and it will record when you leave when you come back and you're able to decide whether it was business or if it was a personal trip and it will total everything up for you for your taxes on your end.
The third tax deduction I want to talk about is travel expenses. So all business-only travel is going to be deductible. So if I was going to Vegas, let's just say for for a business conference, then all the travel expenses would be deductible. For me that would include airfare, that would include hotel expenses, and then I'd have meals while I was there too. What about when you're traveling with family and you're meeting clients or attending conferences at the same time. There's deductions here too, if they meet certain rules. Oftentimes, we don't deduct any of these because we're confused on what can be deducted.
The rule is that the trip must consist of mostly business, you figure that based on the number of days, so if most of the trip which means more than 50% of the days were spent on business, you can deduct the trip. Let's say I am going to Florida for a conference and I'm going to be gone for seven days and I'm taking my family along with me.
I’m going for seven days, so as long as I am in a business conference or doing business for four of the seven days, it is considered a business trip. Now, the next thing it has to meet is the trip must be ordinary and necessary and this is the same for all business deductions. So nothing new here, but ordinary for business means that it's given in the industry. So in my industry, its given that I have to go to conferences. It's a normal thing for me to do. It's ordinary for me to go. It also has to be necessary for the sake of carrying out business activities.
A conference for me would be necessary because I have to keep up with the tax law and different things. So for you and your business you have to decide is it ordinary, is it something that most people in my industry do? And is it necessary for me to carry out business activities by doing this particular thing? Is it necessary? And you know, honestly, if you're meeting other entrepreneurs and you're networking - to me, that would be ordinary in every business and that will be necessary because you're trying to get more business.
Also, the trip needs to be planned in advance and this proves professional intent behind the trip. So I can't just wake up tomorrow and say, oh, let's go to Florida for seven days while I'm there I’m going to talk to a couple of people and strum up business - that would not be planned in advance. So make sure that you're conducting business on a trip and it meets those three golden rules. One, it must consist mostly of business two it must be ordinary and necessary and three, the trip needs to be planned. If the trip meets all those rules according to the IRS regulation, that trip is going to be deducted.
Now the fourth tax deduction that I want you to pay attention to is called the Augusta rule, it was actually born for those who live in Augusta, Georgia to be able to rent out their home during Masters Week and not pay any income tax. Now there's several rules to this but in a nutshell, you are able to deduct the cost of renting your home up to 14 days tax free. So very similar to what I was telling you about your kids working for you. You can deduct renting your home to your business for up to 14 days tax free so it's a deduction for your business, but you do not have to pay taxes on the money. Now, so many things on this one. For example, if you work from your home, if your main place of business is your home, you are not able to use the Augusta rule deduction.
If you have a place of business outside of your home then you can rent your home to your business for 14 days tax free. Again, lots of different rules for this. So if you're interested in the Augusta rule and how that would work make sure you reach out and we will talk about it specifically for your business.
5 - Use the Correct Business Structure
The next tax savings tip is to make sure that you are using the correct business structure. Many times when we start our business we will start off as an LLC that's taxed as a sole proprietor. Once you're in business for a while and you're making profit, you may be better to switch from a sole proprietor to an S Corporation. Now every tax situation is different so I want you to make sure that you seek a tax professional for this one, but you can change your tax structure and oftentimes is very important that you do that in business so that you are saving on your taxes. So if you're at that point in a sweet spot, usually to switch from being taxed as a sole proprietor to being taxed as an S Corp is a profit of about $45,000-$50,000 in your business. Make sure you seek out guidance before you do any entity restructuring yourself. So reach out to a tax professional for them to help you look at your books. Remember you have to know the profitability of your company and keep up with that on a regular basis so that you know when is the perfect time to change your business!
Now those are my five tips. So number one, be organized. Number two, fund retirement accounts. Number three, pay wages to your kids. Number four, take advantage of those tax deductions. And number five is to change your business structure.
As a bonus, I'm going to tell you the number one way to really save on paying Uncle Sam is to hire a tax professional. Not only do you want a tax preparer, you want a tax professional who is very familiar with tax planning because once December 31 happens, you can't make any changes to that year. So don't wait until tax time when you give all your documents to your tax preparer and they tell you how much you owe. You have to start planning before the year is up so that you are taking advantage of all these different tax savings. So again, make sure that they know about tax planning, and I actually have a blog on when it's time to hire a professional and what questions you should ask when you are hiring. So I hope these tax tips help, if you have any questions about your bookkeeping are how to strategize on your taxes or your profits of your business make sure to reach out. I'm here to help!
