Tax Talk FAQ Section
Am I required to make estimated tax payments?
What new tax forms will I need for my tax return?
Can I deduct my car payment?
When are my meals deductible?
What new taxes do I need to worry about?
What entity form should I choose?
Can I deduct the value of services I provide free to my church?
Are damage awards taxable income?
Is the gain on the sale of my home taxable income?
Are my moving expenses deductible?
Are my health insurance premiums deductible as a self employed business owner?
As you probably already know, the IRS has a “pay as you go” policy for Federal income taxes. Most individuals accomplish this through withholdings on their payroll checks. For the self-employed individual, no such withholding typically exists and therefore, estimated tax payments are can be made to meet the “pay as you go” system. Therefore, if you have enough earnings from your business, you may very well need to make quarterly estimated tax payments. If you have enough withholding from the other jobs in your family to cover your tax position then you would not have to make the quarterly payments. In other words, whether or not you need to make the quarterly payments is a function of your family's total tax position and not just the business.
You may be required to make quarterly tax deposits in estimating your tax liability, however, there is no “filing” requirement and therefore, no reporting procedure that would allow the IRS to determine if indeed an estimated tax payment was due. That is, however, until the annual tax return is filed. Therefore, the payments are not required in the sense that you will get a late notice or a bill indicating that a payment is due. So, if you do not make the required estimated tax payments, there will be penalties and interest that will be due with your tax return. Choosing not to make the quarterly estimated tax payments is really a decision to, in effect; borrow money from the IRS at a very expensive rate of interest. So the real question is not should you make those payments each quarter but instead, how much should those payments be.
By definition, your estimated taxes should reflect your family’s expected tax liability but you should try and make sure that you pay in just enough to avoid any of those underpayment penalties and interest. Avoid paying in more than you absolutely have to in order to maintain access to your cash flow and the time value of money for as long as possible. In other words, it is better to have the money in your savings account rather than in the IRS’ savings account.
The IRS has a couple of safe harbors that we can rely upon to make sure we avoid any penalties and interest. The first is based on last year’s total tax liability per your tax return. This is not the amount of the check you had to write with your tax return, but the total tax per the return. If your four evenly paid quarterly payments equal at least that amount, then you will have no underpayment penalties or interest no matter how much you will end up having to pay. This is the strategy to use in years that you expect the earnings from your business to be higher than in the previous year. (If your adjusted gross income from the previous year is at least $150,000, then the safe harbor is based on 110% of last year’s total tax.)
The second safe harbor states that if you end up paying in at least 90% of the total tax that you end up paying, then you will have no underpayment penalties and interest. This is kind of like the IRS saying that as long as you get close in your estimate then we won’t charge you any penalties. The best way to determine how to meet this second standard is to prepare a comprehensive tax estimate. Try to determine how much money you will earn for the year, what deductions and other expenses you might have and estimate the tax liability for the year. This is kind of like preparing a tax return for the year based on estimated numbers. After you have completed the estimate then your estimated tax payments should be structured so that you have paid enough in estimated tax payments to avoid any underpayment penalties that the IRS might impose. Don’t forget any withholding payments that may be generated from another employee job where the employer withholds taxes and sends them to the government, including your spouse’s income. Also don’t forget that as a self-employed individual, you will be responsible for self-employment tax as well, which should be part of the estimated tax return.
Estimated taxes are typically paid on a quarterly basis with one payment due April 15th, the second on June 15th, the third on September 15th and the fourth on January 15th. (The fourth quarter estimated tax payment is due on January 15th of the following year.)
The IRS also has some good publications to help you with this information. One is called Publication 505, Tax Withholding and Estimated Tax.
If your new small business is operating as a sole proprietorship, the income and expenses related to that business will be included on a Schedule C, Profit or Loss from Business. The Schedule C is not a separate tax return but is attached to your personal income tax return, Form 1040. If you have at least $400 in net earnings from the business you will also need to complete IRS Schedule SE, Self Employment Tax, which will also be attached to your personal income tax return.
Many new small business owners operate their businesses from their home in which case you may be eligible for the Home Office Deduction. If so that calculation of that deduction is determined using IRS Form 8829, Expenses for Business Use of Your Home. The IRS also has a very good publication to help with this detail called Publication 587, Business Use of Your Home. If you have purchased a new computer for your business, furniture or other equipment you may also be eligible to recognize a portion of that cost as an expense via depreciation, which is calculated and reported using IRS form 4562, Depreciation and Amortization. As you would have guessed the IRS also has a publication for this detail as well, Publication 946, How to Depreciate Property.
The car payment that you make will not be directly deductible as a business expense, but the business use of your vehicle will certainly generate a tax deductible expense. As you might have guessed, the personal usage of your car, including commute mileage, would not be deductible.
There are two basic methods for determining the amount of the deduction, the standard mileage rate method and the actual expense method. The standard mileage rate method is just as it sounds. The total business miles driven are supported by a mileage log and are then multiplied by the standard rate allowed by the IRS. The total business miles times the cents per mile allowed yields the total business deduction. As you can tell, the type of vehicle, its cost, whether leased or owned, will not affect the calculation of the deduction. Under this method you are not required to keep receipts for the actual costs of operating the vehicle but you must maintain a log to support the business miles that you drive.
Under the actual expense method, total expenses related to the operation of the vehicle are accumulated. These expenses include gas, oil, insurance, repair and maintenance, depreciation, registration fee, lease payment, etc. The depreciation of the vehicle will be based on your cost basis in the vehicle. This is generally your actual cost in the vehicle less any depreciation that you have previously taken on the vehicle. If you lease the new car, there is no limit as to how much the lease payment can be, but there is a unique calculation that must be made called an inclusion amount. This amount is based on the value of the vehicle and in effect reduces the amount of the total costs that you can include. The IRS has a very good publication to help you with this information, called Publication 463, Travel, Entertainment, Gift, and Car Expenses.
The total expenses are then multiplied by the total business percentage of total miles driven. The number of miles must be substantiated by the maintenance of a detailed mileage log of all miles driven during the tax year. If the total business miles work out to be 75 percent of the total miles driven, for example, then 75% of all of those costs of maintaining the that vehicle will end up being deductible.
Keep in mind that both methods require the maintenance of a detailed mileage log. So if you do not currently maintain such a log, start today.
The expense for meals that are incurred primarily for business will be deductible. In order for the meal to be business related you must be able to support a business purpose and an expected business benefit. The key point in maintaining these two requirements is that you must have someone with you in order for the meal to be deductible. That could include a client, a prospective client, a banker, accountant, etc, but you must have another individual with you in order to be able to establish a business purpose and an expected business benefit.
If you are traveling away from home for business then the meal expenses that you incur will be deductible even if you are alone. Keep in mind that only 50% of the qualified amount will end up being deductible, therefore, if you spent $100 on meals while traveling, only $50 of the $100 is deductible. In providing support for your meal deductions it is a great idea to use the actual receipt from the meal. Turn the receipt over and write directly on the back, the name of the person you are with and the nature of the benefit. Keep those receipts and if the IRS ever asks a question about your meals deduction you will have all the answers.
The IRS has a very good publication to help you with this information, called Publication 463, Travel, Entertainment, Gift, and Car Expenses.
If you are new to self employment there are a number of taxes that you may not be aware of. If you have at least $400 in net earnings from your new business you will need to pay Self Employment Tax, which is reported and paid with your federal income tax return by included IRS Schedule SE, Self Employment Tax. Self Employment tax, or SE tax, is basically the same as FICA and Medicare tax that is paid by employees. The SE tax as well as FICA and Medicare specifically fund the Social Security System. The SE tax is 13.2% of net earnings from self employment, as defined, and represents the same tax as both parts of the employer and employee FICA and Medicare tax. The IRS has a good publication to help with SE tax called Publication 334, Tax Guide for Small Business. Check out chapter 10, Self Employment Tax.
Depending on the net earnings that you will have from your small business, you may also be required to make quarterly estimated tax payments. The IRS has a “pay as you go” policy for Federal income taxes. Most individuals accomplish this through withholdings on their payroll checks. For the self-employed individual, no such withholding typically exists and therefore, estimated tax payments are can be made to meet the “pay as you go” system. Therefore, if you have enough earnings from your business, you may very well need to make quarterly estimated tax payments.
There are certainly pros and cons to all forms of organization, however the tax implications will, in most cases for the small business owner, be materially the same regardless of the form of organization, including a C corporation, an S corporation, a sole proprietorship and an LLC. The best advice here, as you might have guessed, would be to sit down with your personal tax advisor and/or legal counsel to make sure that your specific facts and circumstances are adequately reviewed and that the choice of entity form will achieve the goals that you have set for your new business. But the key point here is that the decision should not be a tax decision.
There are many other reasons to consider one form over another. Among those, the most significant would be taking on a partner or other owner, and limited liability. If you are in a “high risk” business (roofing contractor, toxic waste, underground construction, for example) then, I would suggest you contact an attorney and discuss the personal liability you may have for business activity. The corporation and the LLC are entity forms that can potentially mitigate the personal liability and both forms can help accomplish this goal.
Take a good hard look at the issue before you make a decision. If you determine that you have a need to reduce potential liability then you can consider which form of organization that would best accomplish those goals. But the key point is that the specific form of organization should not be determined based on the potential for lower taxes.
The contributions of services to a charitable organization would not generate a tax deduction. This may seem unfair at first, but since there is no revenue recognized, there would be no deduction either.
Assume that you billed one client $1000 and then made a $1000 contribution to the charitable organization, a different entity. Your tax return would include $1000 of income and $1000 of deductible contributions and the net tax impact of these two transactions would be zero.
When the services provided and the contributions made are to the same entity, the net impact on your tax return should be the same. When you do not collect the $1000, but simply waive the fee, the net affect should also still be the same. In this case, you would not have recorded any income and no deduction would be allowed, so the net impact on your tax return is still zero. It wouldn’t make any difference that you had an invoice since as a cash basis taxpayer, the key is when cash changes hands, and in this case no cash would ever change hands. The good news is that you are still making a difference and your overall income tax liability will be the same, so keep up the good work.
The specifics of your question can be very complicated and will depend on the actual situation. My best advice to you is to sit down with your personal financial and/or tax advisors to make sure that your specific facts and circumstances are appropriately reviewed.
Whether or not the proceeds from the award are taxable income will be determined by what the damages are related to or in lieu of. As a general rule, damages for personal physical injury or physical sickness are not considered taxable income. Further, damages for medical expenses would not be taxable income to the extent that they did not exceed the actual medical costs incurred. Therefore, damages that are attributable to non-physical injury, such as emotional distress would typically be taxable income. Damages for lost wages or that are attributable to lost compensation would also be considered taxable income as would punitive damages.
Therefore, the total award needs to be allocated between punitive and non-punitive and should also be allocated between damages related to physical and non-physical injury. The damages that are non-punitive and are related to physical injury would not be taxable income. Damages that are punitive or relate to a non-physical injury would be taxable income. In many cases the settlement documents will indicate or at least provide some guidance as to the character of the amounts of the award. The best place to start may very well be the attorney who handled the case for you.
If the home that you sold qualifies as your principal residence then you can exclude up to $500,000 ($250,000 if you were single) in gain from your taxable income. In order to qualify as your principal residence you must have owned and occupied the home as your primary home for at least 2 out of the last 5 years. The two year requirement does not have to be two consecutive years, but only 2 out of the last 5.
The IRS has a very good publication to help you with this information, called Publication 523, Selling Your Home.
In order for your moving expenses to be deductible, the move must be directly related to starting a new job and you must meet both a time and distance test. The definition of that “new job” would include starting your new small business or even relocating an existing small business. The time and distance texts basically mean that you must start your new job within one year of your move and that the move must be at least 50 miles from your old home, and you must work at the new job for a certain period of time.
If you meet these parameters, you can deduct the costs of transporting your household goods and your personal effects along with your travel costs, not including lodging and meals. The deduction is included on form 3903 and reported on your form 1040.
The IRS has a very good publication to help you with this information, called Publication 521, Moving Expenses.
This is a tough issue and is difficult to find any specific guidelines from the IRS. Self-employed individuals are allowed a deduction for qualified expenses related to health insurance premiums. The amount of the deduction is 100% of the qualified expenses and is included on line 29 of form 1040. This deduction only applies to health insurance premiums and not to other medical expenses. If you are eligible for any other employer subsidized health plan, including one that your spouse would be eligible for, you cannot take the self-employed health insurance deduction even if you have elected not to participate. Further, the deduction is limited to net earnings from self-employment, so that if you have a loss from the business you could not claim the deduction.
The insurance must also be “established under your business” in order to qualify for the deduction, as stated by the IRS in the instructions for your form 1040 for line 29. If the insurance was maintained for personal reasons as opposed to in connection with the new business and your self-employment, then it would not qualify. If the insurance was selected in connection with your new status of self employment since you would no longer expect to have any employer provided coverage, then it would qualify. This doesn’t mean that the policy must be in the company name nor that the premiums are paid with a company check, only that the need for the coverage is directly related to your self employment.
I know this is vague, but the IRS does not provide any more specific guidelines other than being “established under your business.” The best advice here would be to sit down with your personal tax advisor to make sure that your specific facts and circumstances are adequately reviewed.