Recent changes to the law include valuable breaks for a wide range of small businesses. What follows are the highlights of several good-news provisions.
Health insurance deductions for the self-employed. Self-employed individuals can deduct 100 percent of their payments of medical insurance premiums for themselves and their spouses and dependents.
First-year expensing deduction. There are two ways small businesses can write off their outlays for equipment purchases. One is the “standard” route—recovering the cost through depreciation deductions over a period of years—or they can opt for the often overlooked tactic of “expensing,” under tax-code Section 179, and deduct a specified amount of equipment expenses in the year of purchase.
Let’s say you are self-employed and your equipment purchases include $10,000 for computers, copiers and the like. Instead of depreciating the cost of that equipment over five years, expense it immediately. A $10,000 write-off lowers taxes by $3,000 for an individual in a top federal and state bracket of 30 percent. There’s a cap on the deduction, which is indexed, that is, adjusted annually to reflect inflation. The ceiling is $108,000 for 2006, up from $105,000 for 2005.
For first-year expensing, businesses have to complete Form 4562 (Deprecia-tion and Amortization). Self-employed individuals carry the Form 4562 deduction to, and enter it on, the line for “Depreciation and Section 179 expense deduction” on the two-page Schedule C (Profit or Loss From Business), which is where they report receipts, along with equipment costs and other expenses, to arrive at a net profit or loss. Once that has been accomplished, Form 4562 and Sche-dule C accompany Form 1040 to the IRS.
The IRS becomes vexed when its in-structions are not strictly followed, as the following United States Tax Court case illustrates. A business owner decided not to fill out Form 4562. Instead, he listed the Section 179 deduction on Schedule C. The Tax Court agreed with the IRS that he had forfeited his right to first-year expensing and was liable for many thousands of dollars in additional taxes, penalties and interest.
Profit from paying your kids. A savvy way to take care of your children’s allowances at the expense of the IRS is to pay them wages for the work they do.
This tactic keeps income in the family but shifts some of that income out of your higher bracket and into their lower one. For 2006, a child sidesteps taxes on the first $5,150 of earnings, a figure that is scheduled to increase in later years. For this business expense to stand up under IRS scrutiny, your children must actually render services and you must pay them reasonable wages.
Internal Revenue Code Section 3121(b)(3)(A) exempts the wages you pay your children under the age of 18 from Social Security taxes, provided you do business as (1) a sole proprietorship (IRS lingo for the lone owner of a full-time or part-time business that’s not formed as a corporation or partnership) or (2) a husband-wife partnership.
Write-offs for equipment purchases and wages also reduce self-employment taxes owed for 2006 on the first $94,200 of net (receipts minus expenses) earnings.