It is tax season, and everyone would like to know how to keep more money in their pockets rather than giving it to the Internal Revenue Service (IRS). As the old saying goes, there are only two things that we will do in life: pay taxes and die. Let us embrace what we cannot escape.
Paying our fair share of taxes is the only way that our country generates its revenue to pay for Social Security, Medicare, Defense, Veterans, Infrastructure, and Debt Interest which are its largest expenditures. All Americans benefit from these programs.
Here are tax tips to help you to pay your fair share of taxes and not a dime more:
- Select the correct filing status for your business structure. Entrepreneurs and small business owners often face the dilemma to file as an individual, as a limited liability corporation, or as a S-Corp. It is best to consult with a tax professional to determine which filing status would be most beneficial. You can deduct up to $5000 in start-up expenses.
- Track vehicle mileage as it is deductible at 58.5 cents per mile. Use a mileage tracker app to document the miles or save receipts to deduct actual expenses such as repairs and gas.
- Take a home office deduction if you primarily work from home. The standard deduction is $1500.00 per year (300 square feet at $5.00 per sq. ft.). You qualify for this deduction if your space is exclusive for business, not as an employee working from home. You cannot deduct a corner of the family room or master bedroom as this is family space. A dedicated space enables you to deduct a percentage of the rent/mortgage, internet, utilities, and deduct 100% of the cost of décor, furniture, and equipment.
- Depreciate 100% of equipment in the first year to reduce your income using the Section 179 deduction method instead of spreading the cost over three to five years.
- Contribute to a retirement plan. This is a great tax deduction! You may contribute up to
$58,000 for 2021 ($61,000 for 2022) or 25% of your annual compensation, whichever is less to a SEP IRA. Entrepreneurs may contribute the same amount to a solo 401(K). The coolest thing about a side gig is that you could contribute to a solo 401(K) even if you participate in an employer sponsored retirement plan. Imagine contributing to two retirement plans! You can contribute up to the filing date, including extensions of each year for the previous year. The deadline for 2021 contributions is April 17, 2022. Talk with a licensed financial professional to establish a retirement plan.
- Deduct 100% of the cost for software, cell phones, tablets, used exclusively for business.
- Office rent is one of the biggest expenses and 100% deductible including supplies.
- Deduct the cost of medical and dental insurance and long-term care premiums and contributions to a Health Savings Account (HSA). HSAs are normally associated with high deductible health insurance plans. The limits for 2022 are $3650.00 for individual and $7300.00 for family. The unique features of HSA account are it reduces your reportable income by the amount of your contribution, and it grows tax deferred. Avoid taxes if you use the funds to pay for legitimate medical expenses. Otherwise, there is a 20% penalty. Premiums paid for your children, younger than 27, spouse, or other dependents even if they are not dependents on your taxes are deductible.
- Deduct travel expenses. Business owners usually travel to grow their business and to expand their knowledge within their industry. Therefore, registrations fees, airline tickets and accommodations are 100% deductible; meals are 50% deductible; and entertainment is 0% deductible.
- Deduct gifts. Client and staff gifts are limited to $25 per person per year. Client meals are 100% deductible as long as the intent is to conduct business whether you “closed the deal” or not. Document the receipt with the client’s name and purpose.
- Use your business credit card for business expenses as you can deduct 100% of business interest. You cannot deduct interest on a credit card used for business and personal expenses. Get a business card to track your business expenses throughout the year.
- Deduct premiums for any type of insurance to protect your business such as fire, credit, liability, or umbrella insurance.
- Add your children to your payroll and deduct their wages. Their responsibilities must be age appropriate and documented. This would allow you to open a Roth IRA account for your child at early age as long as they have earned income.
I have shared with you tax tips to help you net more income in your pocket. The flip side of tax deductions is they can trigger an IRS audit. You want to avoid a tax audit because it can become a costly proposition with interest and penalties.
Here are red flags that could trigger an IRS audit:
- Claiming 100% business use if you do not have a second vehicle for personal use.
- Engaging in virtual currency transactions and not reporting it.
- Claiming excess rental losses. Passive loss rules usually prevent the deduction of rental real estate losses but if you actively participate in the rental of the property, you can deduct up to $25,000 of loss against income.
- Taking large charitable deductions disproportionate to your income. The IRS knows the average charitable donation for various income levels.
- Taking higher than average deductions, losses, or credits including bad debt and worthless stock.
- Failing to report all taxable income. Include all W-2s, 1099s for interest, dividends, retirement, self-employment, contract income and capital gains. The IRS receives all documents related to income and compares them across your tax return.
- Home office and business loss deductions poke the bear. The IRS expects a business to make a profit three out of every five years. Home office must be a dedicated space not used by family.
- Simply owning a business brings out the sleuth. It is a gold mine for IRS agents as they know from experience that self-employed individuals claim excessive deductions and fail to report 100% of income. The IRS scrutinizes cash intensive businesses such as beauty salons, taxis, car wash, and bars.
Cheers to a great tax season! If you are still in doubt, consult with a tax professional.