Business Education Guide

5 Smart Tax Srategies For The Savvy Business Owner

by Salim Omar, CPA

How tax savvy a business owner you are has a great impact on how much money is in your pocket at the end of the year. You probably know that the tax code allows you to deduct costs of doing business from your gross income. What you are left with is your net business profit. This is the amount that gets taxed.

So knowing how to use business-expense tax deductions to your advantage can reduce, if not eliminate, your company's tax burden.

Here are 5 smart tax strategies for the savvy business owner:

Tax Strategy #1: Choosing the Right Business Structure
One of the most common questions that small business owners ask is: Which entity should I choose? The answer depends on a number of details; the exact nature and size of the business, the source and type of income, the number of family members, etc. The form you choose can make a big difference when it's time to pay taxes, respond to a lawsuit or split up the business.

Most businesses start off with little or no taxable income. The key word here is "taxable" income. That's because in the beginning, even if you're running a business that makes money, you're probably also discovering the hidden business deductions that can lead to more tax write-offs. The income is spent for staff, getting new technology and often, in discovering what doesn't work for product lines, customer fulfillment and marketing. In 95% of the cases, I will recommend one of two structures for the starting business: (1) An S Corporation or (2) An LLC (limited liability company.) You avoid the 15.3% self-employment tax with an S Corporation. With both legal structures, you protect your personal assets from business activities that go awry, have the most flexibility available as you make your business work and most importantly, get to offset the losses in those earlier years with other earned income as illustrated in the next paragraph.

Recently, I started working with a new client that was operating as a C-Corporation. The problem was they had been running losses. In fact, they currently had a Net Operating Loss of $150,000. This is the cumulative amount of the losses. Unfortunately, it was a C-Corporation which meant that there was no tax benefit to its shareholders. They had to keep pouring money into their business, but never got to benefit from the losses in their company. Even worse, they had been taking a salary from the company. That meant they had income from the C Corporation that they had to report, when there was actually a loss in the company. The wrong business structure had already cost them over $80,000 in taxes they shouldn't have had to pay. In this case, the right business structure would have been an S Corporation or an LLC.

Tax Strategy #2:
Full Home Office Write-off.
The rules allowing a taxpayer to claim the home office deduction have been loosened, beginning January 1, 1999. No longer is the home office required to be the “principal place of business” for the taxpayer. The home office test can now be satisfied if the taxpayer uses the home office for “administration or management activities” and there is no other fixed location in which the taxpayer performs such activities for his business. The home office still must be used exclusively for business purposes to qualify. This allows more taxpayers who conduct business outside of their office, but use their home to perform administrative tasks, to qualify for the home office deduction.

Tax Strategy #3:
Writing Off Family Medical Expenses.
This strategy is a little more complicated but is well worth the extra effort. To use this strategy, first you must hire a spouse or other trusted family member to work for your home or small business; either full-time or part-time status will work. Next, you need to set up and sign a medical reimbursement plan. You may require the advice of an accountant to help you. This plan allows any sole proprietor to convert all family out-of-pocket medical expenses into legitimate business deductions.

Finally, your spouse or family member pays all out-of-pocket medical expenses for the family, keeping receipts and documenting miles driven for medical purposes. At a specified time, your business reimburses your family member for these expenses and deducts them as a business expense.

Tax Strategy #4:
Writing Off Your Child's College Education Expenses.
If you frown at the high cost of a college education, this tax strategy is for you. You can put your child on the payroll of your business for performing office chores and other business-related tasks.

The most common way to utilize young children in your business is for them to provide cleaning services, or routine copying, filing and typing. These are jobs that even a 10-year-old is capable of performing, and jobs that you'd arguably have to pay someone to do if your child were not available.

In 2007, a child can earn up to $5,150 and pay no federal income taxes on the earnings because of the standard deduction. Your business can deduct wages paid to your child-provided the amount is reasonable and for bona fide work. Bottom line: You’ll escape federal income taxes of up to $5,150 of your business income, and if you are a sole proprietorship, you will eliminate self-employment tax on the income as well.

Any income your child earns over and above the $5,150 standard deduction is taxable at your child’s rate. Since the 10% tax bracket extends to $7,825 for a single filer, your child could earn an additional $7,825 and owe just $782.50 of federal income tax on the money. Because your marginal tax rate is likely much higher, the extra money your child earns may result in substantial family tax savings. Even better, if your business is not incorporated, you won’t have to withhold or pay FICA (Social Security and Medicare) payroll taxes on the earnings of a child under age 18.

Tax Strategy #5:
Make Your Kids Eligible For A Roth IRA.
This is an incredible tax saving that I often see being under-utilized. This tax strategy is related to Strategy Number 4 but takes it a step further. Hire your children, pay them at least $4,000 and put the proceeds in a Roth IRA. All earnings in a Roth IRA are tax-free! The U.S. Tax Court has validated a parent hiring his 7-year-old son to work for his business and allowed the deduction for reasonable wages paid. So if your child takes the yearly $4,000, from age 7 to 18, and invests it under the Roth IRA umbrella at 10% per year, compounded monthly, that child will have accumulated about $83,000 by age 18.

It gets even better. If you leave all the money untouched, but contribute nothing after your child hits 18, by the time the child is 60, he or she will have accumulated more then $6.1 million that can be withdrawn tax-free. Not a bad savings at all!

Salim Omar, CPA is a leading tax authority for small businesses in New Jersey. He is the author of the popular book titled, Straight Talk About Small Business Success In New Jersey, now available in all Barnes and Noble bookstores. More free information can be accessed on his website at www.OmarGroupCPA.com or by calling (732) 566-3660.

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