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Tax Deduction & Strategy Guide 2019:
What are the best tax strategies for consultants? In this article we will show you some of the most important tax deductions and strategies that contractors and consultants are using in 2019. What can independent contractors deduct?
Tip 1: Convert Your LLC to an S-corporation
Now that you have your business entity, it is time to change how it is taxed. Most independent contractors use an S-corporation. The main benefit is a savings on self employment tax.Self employment tax is an additional tax of 15.3% that all contractors have to pay unless they are an S-corp. This is a very large tax.
For example, lets say your net income for 2018 was $40,000 and your taxable income after itemized deductions was a little less than that ($28,000). Your self employment tax would be around $6K. That is then added to your personal income tax (around $3K) and you end up owing a big number. Look at how self employment tax is much larger than your personal income tax.
Tip 2: Entity Type
If you have setup an LLC or corporation already, then you are in good shape. But if you have not, you need to. And before you say “Yeah, I am just not big enough to need that yet” let me tell you why that excuse will not fly.
So, before you think about any of the tax deductions we lay out below, you need to open an LLC or corporation.
People don’t wait for you to get big to sue you. We have been advising small business for 15 years, and the worst lawsuit we have ever seen usually involve very small businesses.
LLCs don’t cost much. A couple hundred dollars usually.
When you have a business entity, you can set up a separate checking account. This allows you to keep business funds and personal funds separate. Really big deal.People don’t wait for you to get big to sue you. We have been advising small business for 15 years, and the worst lawsuit we have ever seen usually involve very small businesses. LLCs don’t cost much. A couple hundred dollars usually.When you have a business entity, you can set up a separate checking account. This allows you to keep business funds and personal funds separate. Really big deal.
Tip 3: Accountable Plans
Now that you have your LLC and S-corp setup, time to figure out how to maximize your home office, cell phone, and automobile expenses.
One of the trickiest deductions for business owners is getting full benefit for your home office expenses. When you are a sole proprietor, this is easy with form 8829, but not really worth it since you have to pay that massive self employment tax if you are a sole proprietor.
This is why we have the accountable plan. This is like making a monthly expense report from you (the owner) to your business. The business then reimburses you. Setting up and accountable plan is easy and you can reach out us on how to do that.
Important parts of your accountable plan:
Make sure you measure the dimensions of your home office space and use an accurate square footage in calculating the deduction.
Only deduct a portion of your phone bill. The IRS knows you use your phone for personal reasons too. Just be reasonable and you will be fine.
The accountable plan establishes that for your automobile expenses, your home office is always your point of origin, so when you leave, you are using the car for business. Without a plan, that is not always the case.
You can still choose between actual auto expenses and the standard mileage rate
Include part of your mortgage interest in the home office deduction of the plan.
Tip 4: SEP IRA
SEP IRA’s rock. They just do!!
They allow you to put money into investments, not pay tax on them when you contribute, and let the money grow tax free until you pull funds at retirement.
SEP IRA’s are very flexible. So you can wait until your tax return is ready, see if you are going to owe tax, and then make a contribution that reduces your tax for the prior year. It is not very common to have tax deductions you can implement after the year ends.
SEP IRA’s are easy to set up, usually don’t cost anything (unlike a 401k which can cost you up to $100/month for even small plans) and can be managed yourself with no compliance testing.
Tip 5: Health Insurance Deductions
Health insurance premiums are deductible to business owners. However, for S-corp owners, they are a really big benefit. S-corps have to run payroll for their owners. Any time you run payroll, you have to pay payroll taxes like FICA. However, health insurance premiums you pay are looked at by the IRS as wages you paid yourself. They ask they the premiums be grossed up on your payroll and then deducted on your personal return.
However, that gross up is not subject to FICA. So its like you get out of the FICA for part of your wages.
Here is an example:
Lets say your business makes 90K a year and you need to pay wages to yourself of about $40K a year to be an S-corporation. Normally that 40K of wages would have to pay about 15% in payroll taxes ($6K). But, your health insurance premiums are $1K per month or $12K per year. That means you don’t have to run 40K of wages, you only need to run $28K of wages, then gross up your payroll for the other $12K to get your W-2 to show $40K. By doing that, you saved about $1,500 of the $6K you would have paid in payroll taxes! Woo Hoo!
Tip 6: Section 199A Deduction
2018 was the first year we got to see just how great the new 199A deduction was. It is the best SMB tax deduction in a lifetime. Really, it is big.
The way it works is simple. If you own a small business, something other than a C-corporation, then you get to take 20% of your income and take it as a deduction. Don’t have to spend money, no money out of pocket.
Here is an example:
Lets say you are married and your total income was $200,000. Of that, your business income was $150,000. In prior years, you would pay tax on the $200,000 you made because, well…, that is just the way it was. But now, you get to take 20% of your business income and make that a deduction. So instead of paying tax on $200K, you take 20% of $150K ($30K) and deduct that from the $200,000 income and only pay tax on the $170,000 amount after the $199A deduction.
Sweet right? Just one catch. If you are a consultant or professional of some kind and you make over $315K, you can’t take it. You are considered rich so the law excluded you. That would put you in the top 2% of taxpayers so the other 98%, enjoy the 199A deduction!
Tip 7: Employ Your Children
Have kids? Good, they can be a major benefit at tax time when you own a business.
For your children that are between 7 years old until they are earning over $12K per year on their own (usually after they graduate high school or college) you should be having them work for your business.You will pay them up to 12K in wages. You take the write off on your business taxes, but since their income is below their standard deduction, they don’t pay any tax on the income. It is a free deduction.
You might say “I can’t afford to pay my kids that money, we need it to live on”....
I get it, so now after you have paid the kids, tell them they are in charge of the grocery bill, or utility bills, or other spending for the household. I never said they get to keep the money, and it is a great way to help educate your kids on budgets, work, and spending.
Each of your kids can be paid this. So if you had 3 kids, you can pay them each $12K for a total tax deduction of $36,000 every year!
Be Aware of Deadlines
One of the most important parts of small business tax preparation is taking note of every deadline. From paying quarterly estimates, to sending out forms, to actually filing your taxes, you need to know when everything is due so that you don’t fall behind. Being even one day late can cause a lot of trouble and stress. Reach out to us and we can help you with all of your needs, especially how we can make this whole process as easy as possible!!