Here are the Answers to Small Business Owners’ 5 Most Burning Tax Questions
TriNet and inDinero are each dedicated to empowering business owners with the right knowledge to help them run healthy companies with happy employees and happy bank accounts. Last month, both teams put their Twitter handles and LinkedIn profiles to work to find out what burning tax questions small-to-medium businesses (SMBs) have as they prepare for tax season.
You asked, inDinero Answers!
The type of feedback we received from SMBs is essential to giving us the opportunity to proactively tackle any problems that hinder business owners’ momentum this time of year. After all, taxes are complex and the deeper you get into your personal and business tax filing, the more questions arise (and the more specific they become).
We received a wide array of questions, from what types of insurance you can and cannot write-off on your taxes to strategies for anticipating and planning tax-related annual fees as activities arise throughout the year. inDinero’s tax experts dove right in to explain the concepts, best practices and actions business owners should know.
Without further ado, here are our expert answers to your business tax questions...
1) What employer-required expenses can be written off?
Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business operates to make a profit.
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.
Take employer-related expenses, for example. Workers compensation insurance expenses are deductible, as are bonuses. Both of these expenses are a part of your employee compensation package. An employee recognition event, such as the annual holiday party or a summer picnic is also a deductible business expense.
On the flip side, some business costs must be capitalized, rather than deducted. The costs related to remodeling a waiting room or lobby may not be immediately deductible because they are considered an investment in your business and are called capital expenses. Capital expenses are considered assets in your business. Capital expenditures include the costs of acquisition or construction of buildings, machinery, equipment, furniture and fixtures. Generally, if a cost extends the useful life of property or adds to its value, it must be capitalized.
What can be deducted in the case of capital expenditures is the depreciation of value. It’s possible to actually accelerate depreciation and move a large portion, or all of the deduction related to the capital asset, into the current year but the rules are complex.
Businesses cannot deduct personal, living or family expenses. However, if the expense is something that is used partly for business and partly for personal purposes, you can divide the total cost between the business and personal parts and deduct the business portion. This could include your cell phone, car or even tools.
2) If a business owner or employee works from home, what type of overhead costs (i.e. internet, electricity, heating) can they apply to the home office deduction?
In order for any part of your home to be deductible, the "work space" needs to be used regularly and exclusively for business. The “exclusive” test is what disqualifies most taxpayers from being able to claim their home. If there is a TV or anything personal in the room, it likely is not “exclusively” used for business. Hallways/kitchens/bathrooms or other similar rooms would almost never pass the exclusive test. An office, garage or other space set aside for no other reason than work would be considered exclusive.
Once you have determined the portion of your home that is used exclusively and regularly for business, you can determine which expenses are deductible.
Example: if you’re a graphic designer who works from home and uses 10 percent of the square footage of your home exclusively and regularly for business, then 10 percent of your rent or mortgage, utility bills, property taxes, etc. would be a business expense. In addition to your normal living expenses, 10 percent of the applicable depreciation for any capitalized fixed assets, such as the home itself, would also be deductible.
As a business owner you need to be careful with how you reimburse yourself for these expenses. The three main options are:
- Have the company pay you “rent” for use of the space. This would be deductible to the company and rental income to the individual homeowner.
- The individual could claim the home office deduction for the use of their home. This would be an additional filing with their individual income tax return and would give the homeowner a deduction at the individual level. The business would not be affected.
- The company could reimburse the employee through an accountable plan through payroll. As long as this was set up properly and the expenses qualified, the reimbursement would be deductible to the company and come through tax-free to the employee.
3) What type of business travel expenses can be deducted? First, determine your tax home. Your tax home is the primary location where you produce income. If your business is located in the San Francisco metropolitan area, then that is your tax home. You must travel away from your tax home to incur deductible travel expenses (read more about determining your tax home).
Like all business expenses, business travel expenses must be “ordinary and necessary.” In this case, “traveling away from home” would be a trip that requires you or an employee to be away from your tax home overnight. The following travel expenses are deductible:
- Travel by plane, train, bus or car between your home and your business
- Using your car while at your business destination (standard mileage rate, tolls and parking fees, car rental)
- Fares for taxis or other types of transportation
- Meals and lodging
- Service tips
- Dry cleaning and laundry
- Business calls while on your business trip (this includes business communications by fax machine or other communication devices)
- Shipping of baggage or other materials
- Other similar ordinary and necessary expenses related to your business travel (these expenses might include transportation to and from a business meal, public stenographer's fees, computer rental fees, and operating and maintaining a house trailer)
As always, keep detailed records and receipts. The IRS closely scrutinizes these types of deductions.
4) What insurance costs can a business owner write off? Almost all insurance costs that are ordinary and necessary to a person’s business are deductible. One unique exception being life insurance. This is because the premiums for life insurance are not deductible. This may seem unfair but if the company were to collect on a life insurance policy, the proceeds would also not be taxable.
5) How can self-employed taxpayers (sole proprieters, s-corp shareholders, contractors or partners) manage money throughout the year to budget for tax expenses?
The biggest thing here is just knowing that, unlike W-2 wages of an employee, self-employed earners don’t have anything withheld from the income they earn.
Every time a W-2 employee gets paid, their employer is required to withhold a certain amount from their paycheck and pay that to the various taxing authorities before they receive their wage. Then, at the end of the year, the total amount of tax that has been withheld is fairly close to the total tax due (which will likely result in a small refund or small amount due).
Self-employed individuals don’t have any withholdings so unless they make estimated payments throughout the year, they will be liable for the entire year’s tax when they file their tax return. This can result in a very alarming bill if you’re not prepared.
Unfortunately, because of the various tax brackets and additional self-employment taxes applicable to self-employed individuals, calculating how much to pay each quarter can be very complicated.
Safe Harbor Alternative – What to Know:
A quicker solution is to just pay the safe harbor tax each quarter. Safe harbor involves paying 25 percent of the prior year’s taxes each quarter or, if your income was greater than $150,000 in the prior year, 27.5 percent of the prior year’s tax each quarter. As long as you pay on a quarterly basis, you will avoid interest and penalties throughout the year.
But do your homework! Because the safe harbor is based off prior year income, it’s not always the best solution for taxpayers with a much smaller tax liability compared to the prior year. Using the safe harbor in this scenario would result in paying way more tax than you need to and essentially giving the IRS an interest-free loan until you claim your refund when you file your tax return. If your prior year liability is substantial and you think you will fall into this scenario, it may be wise to hire a tax professional to calculate your quarterly tax due each quarter.
Note: The safe harbor rule is for federal taxes. Many states have a similar safe harbor rule but each state is different so you should research those rules specifically.
Do you have more questions about business taxes?
We just gave you a lot of information and sometimes the answers to your original tax questions have a tendency to stir up even more questions and curiosity. If you’re feeling inquisitive about any of the topics above, throw your questions in the comments for us to answer or contact us to speak with a financial consultant about your specific business’s tax concerns.
And if you haven’t yet, download our business tax kit for helping entrepreneurs like you meet your biggest tax season objectives: getting books organized, meeting deadlines, and lowering taxable income. Our team has weeded through the different tax prep tactics and strategies to create the three-piece resource pack including a checklist for tax-ready financial reports, a guidebook with 8 strategies to save, and a worksheet to organize your company’s essential tax data.
This communication is for informational purposes only; it is not legal, tax or accounting advice; and is not an offer to sell, buy or procure insurance. If legal or accounting advice is required, the services of a competent attorney or accountant should be sought.
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