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8 Tax Deductions Every Small Business Owner Should Know

As a small business owner, managing your finances is crucial to ensuring the success and growth of your venture. One of the most effective ways to optimize your financial strategy is by understanding and leveraging the various tax deductions available to you. By taking advantage of these deductions, you can significantly reduce your tax liabilities, increase your bottom line, and keep more of your hard-earned money. In this blog post, we’ll delve into the top tax deductions that every savvy business owner should be aware of.

1. Business use of your home

Running a business from home? You’re in luck. The home office deduction allows qualifying taxpayers to deduct a portion of their home-related expenses when part of their home is used exclusively for business purposes. This includes expenses like rent, utilities, insurance, and property taxes. To qualify, you must have a designated space used solely for business activities and meet specific IRS criteria. Qualified taxpayers can use the simplified method or regular method of calculating their home office expense deduction. Remember, accurate record-keeping is key to support your deduction claims.

2. Business use of your car

If you use your car solely for business purposes, you may deduct the entire cost of owning and operating it, although there are some limits to this deduction. However, if you use the car for both business and personal use, you can only deduct the expenses related to its business use. There are two main methods for calculating deductible car expenses: the standard mileage rate method and the actual expense method.

Under the standard mileage rate method, you can deduct qualified business miles using the rate provided by the IRS. Under the actual expense method, you’ll need to calculate the precise expenses associated with operating the car exclusively for business purposes. This generally includes costs such as fuel, oil, maintenance, tires, insurance, registration fees, licenses, and even depreciation directly linked to the portion of total mileage driven for business miles. Please note that what the IRS considers commuting miles is not tax deductible; only business miles are. Reach out to your advisor to make sure you’re classifying your miles correctly!

3. Supplies and equipment

Your taxable income could be reduced significantly by deducting expenses related to supplies and equipment. The cost of supplies, such as office supplies, cleaning materials and other consumables crucial for day-to-day operations, can be deducted as legitimate business expenses. Equipment purchases, such as computers, machinery and essential tools, however, must be deducted over time through depreciation unless they qualify to be deducted in full. To ensure you can substantiate these deductions, it’s essential to maintain precise records and keep track of receipts. By making the most of these deductions, you can effectively manage your business finances and optimize your tax liability, ultimately contributing to the financial health and long-term sustainability of your venture. Remember to consult with a tax professional or accountant for tailored advice based on your specific business circumstances.

4. Cost of goods sold

As a small business owner, you can benefit from deducting the cost of goods sold (COGS) as a tax deduction. COGS encompasses the direct expenses associated with producing or acquiring the products you sell, such as raw materials and inventory purchases. By deducting COGS, you have the opportunity to lower your taxable income and potentially reduce your tax liability. It’s important to maintain accurate records to potentially claim this deduction.

5. Business related meals

Despite the changes brought about by recent tax reforms, meals continue to hold value. Business-related meals, whether with clients or during business travel, may still be deductible. However, it’s essential to maintain proper documentation, such as receipts and records that establish its business purpose. Remember, meals must meet the criteria of a qualified expense for it to be considered deductible. It’s also worth noting that the regulations governing these deductions have become stricter, so it’s advisable to collaborate with your advisor to stay informed about the latest rules.

6. Employee-related expenses

Having employees involves various costs, many of which are deductible. This includes wages, bonuses, payroll taxes and benefits like health insurance. Ensuring proper worker classification (employee vs. contractor) is vital and the first step in avoiding scrutiny.

7. Travel expenses

Expenses for business travel can quickly accumulate, but many of these costs are deductible. This includes transportation, lodging, most meals and incidental expenses. Keeping records and receipts is essential to substantiate your claims and establish its business purpose as opposed to a family vacation with a bit of work sprinkled in.

8. Health insurance premiums for owners

For small businesses, covering the health insurance premiums of its owners and their families can be a significant expense. The IRS allows for different ways to deduct these premiums depending upon your business’s tax entity type. Meeting the eligibility criteria is essential to claim this deduction.

Conclusion

Navigating the realm of small business taxes can be complex, but the potential benefits are undeniable. By being aware of these top tax deductions, you’re better equipped to make informed financial decisions that can have a positive impact on your business’s bottom line. However, tax laws and regulations change, so staying up to date is crucial. Consult with a tax professional to ensure you’re maximizing your deductions while staying compliant with the latest rules. By strategically utilizing these deductions, you can pave the way for a more financially efficient and prosperous small business journey.

Remember, the information provided here is intended for general informational purposes only and should not be considered as professional tax advice. Contact your local Padgett advisor for personalized guidance tailored to your specific situation

Tax Tips for Self-Employed Individuals

Being a solo entrepreneur or independent contractor has its perks – flexible schedules, creative freedom, and the ability to be your own boss. However, it also comes with its fair share of responsibilities, particularly when it comes to managing your finances and taxes. Self-employed individuals are generally treated as independent contractors, which include freelancers, gig workers, sole proprietors and the like when it comes to paying taxes. These workers often face unique tax considerations that can be quite different from traditional employees. In this blog post, we’ll dive into some essential tax tips that can help these individuals navigate the world of taxes with confidence and help ensure they are making the most of their income.

Understanding Your Tax Obligations

One of the key differences for self-employed individuals is the absence of employer withholding. Unlike traditional employees who have their taxes deducted from their paychecks, self-employed workers are responsible for calculating and paying their own taxes. This means that understanding your tax obligations is crucial to avoiding any unpleasant surprises come tax season.

1. Self-Employment Tax and Income Tax

If you are considered self-employed by the IRS, you are generally responsible for paying both the self-employment (SE) tax, which consists of Social Security and Medicare taxes, and income tax. Unlike individuals employed by someone else, self-employed individuals are responsible for the full 15.3% tax rate. But don’t worry, there is an SE tax deduction we’ll talk about that could be a big tax saver.

2. Estimated Taxes

Since self-employed people don’t have taxes withheld from their income throughout the year, it’s important to make estimated tax payments on a quarterly basis. This prevents a significant tax liability from accruing at the end of the year. There are several ways to approach calculating estimated taxes, depending on the other activity expected on your return and what your tax goals are. Remember, underestimating your payments might lead to penalties, so it’s wise to consult a tax professional for accurate estimations.

3. Record-Keeping

Be sure to keep track of all your income, expenses, invoices, and receipts. This will make it easier to calculate your taxable income and claim deductions when the time comes. Numerous digital tools and apps are available to simplify record-keeping and expense tracking.

Maximizing Deductions

Self-employed individuals can take advantage of various deductions to reduce their taxable income, ultimately lowering their tax liability. Here are some common deductions self-employed folks should explore:

1. Home Office

If you use a portion of your home exclusively for business purposes, you might be eligible for the home office deduction. This deduction allows you to write off a percentage of your home office repairs, utilities, and other related expenses.

2. Business Expenses

For a business expense to be deductible, it must be both ordinary and necessary to the business. Per the IRS, “An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business.” It’s important to keep in mind that even though some expenses may be both ordinary and necessary, they may not be eligible for a deduction. That’s why it’s essential to maintain receipts and document the business purpose of each expense. It can be tempting to overestimate your eligible expenses, but there may be consequences for doing so. Not only do you risk underpaying your taxes, but it could also distort your overall financial picture. This could have an impact on things like getting a mortgage.

3. Self-Employment Tax

As mentioned earlier, self-employed individuals are generally responsible for the SE tax, which includes both the employee and employer portions of Social Security and Medicare taxes. The good news is that you can deduct one-half of the SE tax when calculating your adjusted gross income.

4. Self-Employed Health Insurance

With the Small Business Jobs Act self-employed individuals may deduct up to 100% of their insurance premium. This includes premiums that cover the self-employed individual and their families. Be careful, not all premiums will be considered tax deductible so reach out to your advisor for guidance.

Consulting a Tax Professional

Given the complexity of being self-employed when it comes to taxes, it’s wise to work with a tax professional. A tax expert can help you navigate the intricacies of tax law, help you take advantage of all available deductions, and provide guidance on estimated tax payments.

As a recap, being self-employed offers a world of opportunities, but it also requires diligent financial management, especially when it comes to taxes. By understanding your tax obligations, making timely estimated tax payments, keeping meticulous records, and maximizing deductions, you can set yourself up for financial success.

Remember, consulting a tax professional can provide personalized guidance tailored to your unique situation, making tax season a less daunting experience. Remember to prepare for tax season today with your local Padgett advisor.

Facing a future emergency? Two new tax provisions may soon provide relief

Perhaps you’ve been in this situation before: You have a financial emergency and need to get your hands on some cash. You consider taking money out of a traditional IRA or 401(k) account but if you’re under age 59½, such distributions are not only taxable but also are generally subject to a 10% penalty tax.

There are exceptions to the 10% early withdrawal penalty, but they don’t cover many types of emergencies.

Good news: Beginning in 2024, there will be new relief for some taxpayers facing emergencies. The SECURE 2.0 law, which was enacted late last year, contains two different relevant provisions:

1. Pension-linked emergency savings accounts. Employers with 401(k), 403(b) and 457(b) plans can opt to offer these emergency savings accounts to non-highly compensated employees. For 2024, a participant who earned $150,000 or more in 2023 is a highly compensated employee. Here are some more details of these new type of accounts:

Contributions to the accounts will be limited to up to $2,500 a year (or a lower amount determined by the plan sponsor).
The accounts can’t have a minimum contribution or account balance requirement.
Employers can offer to enroll eligible participants in these accounts beginning in 2024 or can automatically enroll participants in them.
Participants can make a withdrawal at least once per calendar month and such withdrawals must be made “as soon as practicable.”
For the first four withdrawals from an account in a plan year, participants can’t be subject to any fees or charges. Subsequent withdrawals may be subject to reasonable fees or charges.
Contributions must be held as cash, in an interest-bearing deposit account or in an investment product.
If an employee has a pension-linked emergency savings account and is not highly compensated, but becomes highly compensated as defined under tax law, he or she can’t make further contributions but retains the right to withdraw the balance.
Contributions will be made on a Roth basis, meaning they are included in an employee’s taxable income but participants won’t have to pay tax when they make withdrawals.

2. Penalty-free withdrawals for emergency expenses. This new provision is another way to get money for emergencies. As mentioned earlier, taking a distribution from an IRA or 401(k) before age 59½ generally results in a 10% penalty tax unless an exception exists. SECURE 2.0 adds a new exception for certain distributions used for emergency expenses, which are defined as “unforeseeable or immediate financial needs relating to personal or family” emergencies.

Only one distribution of up to $1,000 is permitted a year, and a taxpayer has the option to repay the distribution within three years. This provision is effective for distributions made beginning in 2024.

Guidance likely coming soon

These are just the basic details of the two new emergency-related provisions. Other rules apply and the IRS will need to issue guidance to address certain details. Connect with your local Padgett office if you have questions and want to explore the most tax-efficient ways to tap one of your accounts.

Tax Relief Provided by the CARES Act

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) signed into law on March 27, 2020, not only provides significant financial relief to individuals and businesses, but it also contains tax law changes to help everyone coping with Coronavirus. Below is a summary of the key provisions impacting individuals and businesses.

Individual Provisions

Waiver of 10% early distribution penalty: The additional 10% tax on early distributions from IRAs and defined contribution plans, such as a 401(k), is waived for distributions made between 1/1/2020 –12/31/2020 by a someone who (or whose family) is infected with or is economically harmed by the Coronavirus.
Waiver of required distribution rules: Required minimum distributions that otherwise would have to be made in 2020 from defined contribution plans, such as 401(k), and IRAs are waived.
Charitable deductions: Individuals will be able to claim a $300 above-the-line deduction for cash contributions made to public charities in 2020. Also, the limitation on charitable deductions based on adjusted gross income doesn’t apply to cash contributions made in 2020.
Break for nonprescription medical products: Beginning in 2020, amounts paid from HSAs and MSAs are to be treated as paid for medical care even if they aren’t paid under a prescription plan. The same applies to reimbursements from Flexible Spending Arrangements and HRAs made in 2020.

Business Provisions

Employee retention credits: Eligible employers can qualify for a refundable credit against their portion of the Social Security payroll tax for up to 50% of certain wages paid to employees during the COVID-19 crisis.
Delay of employer payroll tax payments: Employers can defer payment of the employer portion of Social Security and RRTA taxes and self-employed individuals can defer payment of certain self-employment taxes through the end of 2020.
Advance refund of credits for sick and paid leave: Employers, who paid qualified sick and family leave wages under the Families First Coronavirus Response Act (FFCRA), are eligible for an advance refund of credits against certain payroll taxes paid on those wages.
Changes to net operating loss (NOL) rules: For NOLs arising in tax before 2021, taxpayers can now carryback 100% of NOLs to the prior five tax years. Also, for tax years before 2021, taxpayers can take an NOL deduction equal to 100% of taxable income, rather than the present 80% limit.
Temporary increase in the deductibility of interest expense: Businesses may increase the interest limitation from 30% to 50% of adjusted taxable income (ATI) for 2019 and 2020 and elect to use 2019 ATI in calculating their 2020 limitation. For partnerships, the 30% of ATI limit remains in place for 2019 but is 50% for 2020.
Bonus depreciation now available for interior building improvements: The CARES Act makes a technical correction to the 2017 Tax Law that retroactively treats a wide variety of certain building improvements as eligible for bonus deprecation, allowing for a 100% write-off.

For more information, contact your Bothell Accountant at Padgett Business Services in Bothell, Washington at (425) 408-1695. We handle your bookkeeping, accounting, personal tax preparation & business tax preparation, and payroll needs – so you can focus on what makes you money. Serving Bothell, Lynnwood, Kirkland, Kenmore, Mill Creek and surrounding areas.

Understanding Cash Flow

A healthy cash flow is an essential part of any successful business. Face it – if you fail to have enough cash to pay your suppliers, creditors, or your employees, you’re out of business! No doubt about it, proper understanding and management of your cash flow is a very important step in making your business successful. Despite what some may think, there’s more to it than just a fancy term for the movement of money into, and out of, your business checking account.

Inflows – Inflows are the movement of money into your cash flow. Inflows are most likely from the sale of your goods or services to your customers. If you extend credit to your customers and allow them to charge the sale of the goods or services to their account, then an inflow occurs as you collect on the customers’ accounts.

Outflows – Outflows are the movement of money out of your business. Outflows are generally the result of paying expenses. If your business involves reselling goods, then your largest outflow is most likely to be for the purchase of retail inventory. Purchasing fixed assets, paying back loans, and paying accounts payable are also cash outflows.

Cash flow is typically measured by analyzing the amounts of cash received versus the amount of cash paid out. The report most often used to look at where your cash comes from and find out where it’s going is called the “Statement of Changes in Cash Position (or “Statement of Cash Flows”).

If all is well, you will not be agonizing over the fact that the outflows are larger than the inflows!

Importance of Accountable Plans

If you often reimburse employees for job-related expenses they incur, accountable plans can offer a significant measure of safety. Reimbursements under an accountable plan aren’t taxable to the employee and (with the exception of meal and entertainment expenses) are fully deductible by the employer. For the accountable plan to qualify, reimbursements must be for job-related expenses that the employee would reasonably expect to incur, and the employee must provide substantiation and return any excess reimbursements within a reasonable period of time.

Consider this scenario: A courier business employees picks up and delivers packages using their own vehicles. The company’s reimbursements aren’t based on the employees’ actual expenses but instead, their commissions is split between wages and equipment rental (i.e., use of the employees’ vehicles). The employees aren’t required to submit mileage or expense documentation to the employer. The employees’ wages are reported on their W-2s and the expense reimbursements on their 1099-MISCs.

In this situation, since actual expenses aren’t reported to the employer, the reimbursements aren’t part of an accountable plan. As a result, the “reimbursement” must be included on the employees’ Forms W-2 and subject to employment taxes.

While this scenario involves a delivery service, the rules apply to all businesses. Although some exceptions exist, it’s best to either include the full amount in wages or require employees to submit detailed expense reports for reimbursement under an accountable plan.

For more information, contact your Bothell Accountant at Padgett Business Services in Bothell, Washington at (425) 408-1695. We handle your bookkeeping, accounting, personal and business taxes, and payroll needs – so you can focus on what makes you money. Serving Bothell, Lynnwood, Kirkland, Kenmore, Mill Creek and surrounding areas.

Tips for Paying Estimated Taxes on Income

Estimated tax is a method used to pay tax on income that isn’t subject to withholding. You may need to pay estimated taxes during the year depending on your sources of income. For example, income from self-employment, interest, dividends, alimony, rent, gains from the sales of assets, prizes or awards, may require you pay estimated tax. For Sole Proprietors, Partners and S Corporation shareholders, you generally have to make estimated tax payments if you expect to owe $1,000 or more in tax when you file your Form 1040 return.

As a general rule, individuals must pay estimated taxes for 2019 if both of these statements apply:

You expect to owe at least $1,000 of tax on your Form 1040, after subtracting your tax withholding (if you have any) and credits, and
You expect your withholding and credits to be less than the smaller of 90% of your 2019 taxes or 100% of the tax on your 2018 return. If you own a business, often calculating estimated tax on a quarterly basis is a better choice. We can help you determine the safest route to go.

With the passage of the Tax Cuts and Jobs Act, estimating income for 2019 may be more challenging than in the past. In these uncertain times, you need someone you can trust for timely and accurate advice. We are knowledgeable and available to help, so call us to schedule an appointment.

Estimated tax payments are generally due April 15, June 15, Sept. 15 and Jan. 15. The easiest way to pay estimated taxes is electronically through the EFTPS, however; you can also pay by check or money order using the Estimated Tax Payment Voucher or by credit or debit card.