let’s focus on some specific deductions:
Deductions: An auto is considered "listed
property" which means that it is an item that is used both
personally and for business. Listed property is subject to certain
limitations for depreciation purposes. To deduct listed property,
the taxpayer should log the business usage of the item. For business
use documentation, a mileage log is required for all vehicles
that are multi-purpose in nature.
deductions can be taken in the form of the standard mileage deduction
or by taking the business percentage of actual expenses, plus
depreciation. The problem for most taxpayers is that you have
to keep both the mileage log and keep track of all of the actual
expenses to determine which way is best. (Too much paperwork!)
Once you've determined your method for a particular vehicle, you've
made your election and can't change back and forth. You can’t
use mileage for a vehicle depreciated using MACRS or Section 179
(we’ll discuss this later.)
rule-of-thumb is that if you use your auto less than 50% for business,
then you may be better off with mileage. That is not always the
case, but it is often true.
of which method you use, interest on auto loans is deductible
if you are self-employed. You are limited to the business percentage
usage of the automobile, which is why you will need to track total
miles driven, as well as business miles.
standard business mileage rate for 2008 was 50.5 cents per mile
from January 1 through June 30th and 58.5 cents per mile from
July 1 through December 31 2008. That rate changed to 55 cents
per mile effective January 1 2009.
and/or Section 179: Deduction for business equipment
and furniture is taken in the form of depreciation. The IRS provides
tables that determine how long an item is to be depreciated and
at what percentage. These items are considered Section 1245 or
personal property and qualify for a one-time election to be expensed
in the year of purchase. This is an election made under Code Section
179, and you will hear this term used often in business. (Please
note that real property does not qualify for Section 179. Real
property is considered Section 1250 property.)
2008 Economic Stimulus Act made several changes enhancing depreciation
and Section 179 for 2008. Under Section 179, you can write off
up to $250,000 of assets purchased in a given year as long as
your total investment is below $800,000 in 2008. If total asset
additions exceed that amount, total Section 179 allowed is reduced
dollar for dollar for the amount exceeding the investment limitation.
2009, the maximum write off under Section 179 is $133,000. In
2010, that number goes down to $125,000 and will be adjusted for
inflation. In 2011 and thereafter, this amount is reduced to $25,000
and is not adjusted for inflation. However, this will be an area
heavily reviewed in the next few years. We expect we will see
further changes coming in this category.
Depreciation: The 2008 Economic Stimulus Act revamped bonus depreciation for
2008. Congress has used bonus depreciation several times in the
past to encourage business investment. Bonus depreciation is a
deduction of 50% of the costs incurred in the first year, plus
depreciation on the remaining cost. Bonus depreciation is available
for depreciable items that normally are written off in 20 years
or less. To qualify, the property must be purchased AND placed
in service during 2008. The placed in service date was extended
to December 31, 2009 for property placed in service with a recovery
period of 10 years or more (i.e. Leasehold improvements!).
Example: You spend $100,000 on music equipment in 2008. Normally these
costs would be depreciated over 5 years for tax purposes. Under
the new Act, you can take $50,000 in bonus depreciation and write
off the remaining $50,000 of the cost over 5 years.
“Luxury” auto depreciation is increased if bonus depreciation
is used to $8,000 (up from $3,060) for a maximum first year depreciation
amount of $11,060 ($11,260 for vans and trucks.)
Phones and Other Telephone Expenses: Your first
telephone line for your home is considered personal. However,
any additional lines, additional features or cell phones added
for your business are deductible. No doubt, we all use our phones
for both business and personal purposes. The IRS can consider
a cell phone "listed property." However, if it is your
second line, then you may determine that it is business property.
or Studio in Home: If you have a room in your home that is used for business, you
may be able to reduce your taxable income by taking advantage
of the office in home deduction. It is most recommended for those
who earn self-employment income. Deductions taken against that
income reduces self-employment tax which has a larger effect on
the bottom line. Beware, however, that if you sell a home and
used the office-in-home deduction, you will be subject to recapture
on that portion of the sale and may cause a part of the gain on
the sale of the home to be taxable. Rule of thumb here is that
if you are in higher tax brackets and are paying self-employment
tax, you will likely be better off taking the office in home deduction
and paying tax on a future gain because of the self-employment
tax savings. If you are showing losses or are being compensated
through wages, it does not make sense to take this deduction.
Internet: Many taxpayers forget to include internet at home in their list
of expenses. Most of us work at home and must be able to use our
internet service for business. Some write off only a portion of
internet expense, but many take the position that they wouldn't
have it at home if it weren't for their businesses.
TV, Showcases & CD Purchases: All of these items serve as valuable research tools in the entertainment
industry. Therefore, a meaningful allocation between business
use and personal use is warranted. Your homework is to arrive
at a formula that makes sense based on your business usage. For
example, if you use Cable approximately 50% of the time for music
related purposes, then you would write off 50% of the cost associated
with Cable TV. Showcases and CD’s of other artists are also valuable
research materials. You may find a more aggressive percentage
is appropriate in these categories, but again, that formula should
be based upon what you deem ordinary and necessary.
& Promotion: This includes media, internet
and any other advertising that promotes your business. Novelty
items, shirts with your business name, gifts to clients for promotion
all fit within this category. And remember that when you give
away business items to a non-profit, if it is within the intent
to market yourself, deduct it as advertising. Charitable donations
are sometimes limited and don't have as much impact on tax savings
as deductions against your business income.
& Subscriptions: Don’t forget those magazines, newspapers and publications that
help you stay educated and on top of the industry. These are common
items overlooked but can add up before you know it.
& Entertainment: When you take your colleagues or co-writers out to lunch or dinner
to discuss business, you should be tracking these expenses to
deduct. They are only 50% deductible but a good deduction non-the-less.
You will need to document the business purpose of the meal, however,
which makes the paperwork a bit cumbersome. If you have difficulty
getting the notes written on the receipt, just keep a good calendar.
Your day planner or outlook reports have loads of information.
Don't throw those away. Keep them with your tax records so that
you can prove deductions for travel, meals, etc.
Diems: Those of you who travel over-night may
want to consider the use of the per diem tables as opposed to
keeping all the receipts for meals while traveling. IRS publication
1542 provides details on how per diems may be used. The standard
rate for meals in 2008 through September 2008 was $39 per day
and beginning October 1, 2008 was increased to $45 per day. However,
if you travel to metropolitan areas, use of the table by locality
may provide a more realistic deduction.
Travel: Business travel is deductible, but often we travel and end up
getting some personal time in there, too. If the trip is substantially
for business and you just extend it for a day for personal reasons,
the trip is fully deductible. However, if you take a trip that
is mostly personal and you end up doing business while you are
there, the travel expenses taken should be pro-rated for the number
of days business was conducted. Best practice is to keep information
proving the business nature of the trip. Brochures, listing information,
and seminar materials are all good sources of documentation.
of Business Deductions: Remember, this is merely
a summary of select deductions that are commonly misunderstood
or overlooked. There are also other items that are deductible
on Schedule A as itemized deductions and are not included in this
Are Some Items To Note Related To Personal Income Tax Issues:
This Year: Taxpayers can claim an addition to
the standard deduction amount, based on the state or local real-estate
taxes paid in 2008. Taxes paid on foreign or business property
do not count. The maximum deduction is $500 or $1,000 for joint
filers. This is available for 2008 only!
Debt Forgiveness: The Mortgage Forgiveness Debt
Relief Act of 2007 was enacted on December 20, 2007. Generally,
the Act allows exclusion of income realized as a result of modification
of the terms of the mortgage, or foreclosure on your principal
residence. Debt reduced through mortgage restructuring, as well
as mortgage debt forgiven in connection with a foreclosure, qualifies
for the relief. However, if you continue to own your residence
after the cancellation, you must reduce the basis of your principal
residence (but not below zero) by the amount excluded from income.
provision applies to debt forgiven in calendar years 2007 through
2012. Up to $2 million of forgiven debt is eligible for this exclusion
($1 million if married filing separately). The exclusion does
not apply if the discharge is due to services performed for the
lender or any other reason not directly related to a decline in
the home’s value or the taxpayer’s financial condition.
More information, including detailed examples can be found in
Publication 4681, Canceled Debts, Foreclosures, Repossessions,
and Abandonments. Also see IRS news release IR-2008-17.
Homebuyer Credit: This credit is a hot topic in
the new Economic Stimulus package being voted upon and is expected
to be substantially improved from this provision. Currently, those
who bought a main home recently or are considering buying one
may qualify for the first-time homebuyer credit. Normally, a taxpayer
qualifies if he/she didn’t own a main home during the prior three
years. This unique credit works much like a 15-year interest-free
loan. It is available for a limited time only –– on homes bought
from April 9, 2008, to June 30, 2009. The credit is equal to 10%
of the purchase price of a home up to $7,500 ($3,750 for married
individual filing separately.) The credit begins to phase out
for taxpayers with adjusted gross income in excess of $75,000
($150,000 of a joint return). (It is fully phased out for single
individuals with AGI of $95,000 and married individuals of $170,000.)
It can be claimed on new Form 5405 and is repaid in equal installments
over 15 years as an additional tax. Repayments start two years
after the year in which the residence is purchased. If the property
is sold before repaying the credit, the balance becomes due in
the year in which the residence is sold or is no longer used as
the taxpayer’s principal residence. However, the recaptured credit
may not exceed the amount of the gain from the sale of the residence
to an unrelated person. The credit does not have to be repaid
if the taxpayer dies. If the Stimulus package passes the way we
anticipate, the repayment provision in this credit will be lifted
and the credit is expected to increase to $15,000. Look for more
details on this as the Stimulus package unfolds.
Energy Credits: Federal tax credits for energy
efficient home improvements have been extended into 2009. The
recently-signed “Emergency Economic Stabilization Act of 2008″
included an extension of the residential tax credits for energy
efficient improvements. The previous tax credits expired at the
end of 2007. The credit is a maximum life time credit of $500.
new tax credits for installing energy efficient improvements are
only good for 2009 installations - there will be no tax credits
for improvements installed during 2008. Tax credits are available
for insulation, replacement windows, water heaters, and certain
high efficiency heating and cooling equipment. However, be aware
that not all Energy Star rated improvements are eligible for the
tax credit. Items that fall within this provision are: windows,
doors, metal roofs, insulation, air conditioning, tankless water
heaters, cars, solar water heating, solar power, and fuel cells.
Be sure to check EnergyStar.gov for rules and more details.
Minimum Tax: The alternative minimum tax (AMT)
is a separate method of determining income tax devised to ensure
that at least a minimum amount of tax is paid by high-income taxpayers
who reap large tax savings by making use of tax deductions. Without
the AMT, some of these taxpayers might be able to escape income
problem with AMT today is that the original thresholds that determine
who is subject to AMT were not indexed for inflation the way that
many other items in the tax code have been. This has caused many
middle income taxpayers to be affected by AMT, and now Congress
is in dispute over how to rectify the AMT problem.
calculate AMT, regular taxable income is calculated and then certain
items are added back to determine Alternative Minimum Taxable
tax-year 2008, Congress raised the alternative minimum tax exemption
to the following levels: $69,950 for a married couple filing a
joint return and qualifying widows and widowers, up from $66,250
in 2007; $34,975 for a married person filing separately, up from
$33,125 and $46,200 for singles and heads of household, up from
$44,350. Under current law, these exemption amounts will drop
to $45,000, $22,500 and $33,750, respectively, in 2009, unless
they are updated by Congress.
Savings Accounts: A health savings account is an account established
in conjunction with a high deductible health insurance policy.
Cash contributions to an HSA account are deductible similar to
the health insurance premiums for as self-employed taxpayers.
The maximum deduction for self-only coverage is $2,900 and the
maximum deduction for family coverage is $5,800 for 2008. In 2009,
these limits go to $3,000 and $5,950. Individuals who reach age
55 by the end of the tax year can increase their annual contributions
by $900 for 2008 and $1,000 for 2009. Contributions can’t be made
after the participant attains age 65, but withdrawals for qualified
medical expenses are excluded from income. Any contributions in
excess of these limits are subject to a 6% excise penalty.
high-deductible health plan is a plan with a minimum annual deductible
of at least $1,100 for self-only coverage and $2,200 for family
cover for 2008. These amounts increase to $1,150 and $2,300 for
2009. In addition, annual out of pocket expenses cannot exceed
$5,600 for self-only coverage and $11,200 for family coverage.
These amounts increase to $5,800 and $11,600 in 2009. Out-of-pocket
expenses include deductibles, co-payments and other medical expenses
(not including health insurance).
from the HSA account are not included in income as long as the
funds are used for qualified medical expenses. Amounts distributed
for other purposes are includible income and subject to a 10%
health savings account is a great vehicle to convert an otherwise
limited tax deduction to an “above the line” tax deduction. Medical
expenses are typically only deductible for those who itemize and
are only deductible to the extent they exceed 7 ½% of AGI. Most
taxpayers don’t spend more than 7 ½ % of their AGI on medical
expenses and thus are not able to reduce tax for medical related
expenses. The deduction for contributions to an HSA is reflected
as an adjustment to income on 1040, page 1 and avoids the AGI
limitation on Schedule A.
Taxes: Taxpayers are required to pay a certain amount of tax either
through withholding from wages or by making quarterly estimated
payments. If your tax is underestimated, there are penalties for
doing so unless:
you owe less than $1,000 for the current year, or
You had no tax the prior year.
Generally, the amount that should be paid in order to avoid penalties
90% of your current year tax (which is impossible to estimate
100% of the prior year tax (110% if your adjusted gross income
is above $150,000), or
Paying exactly what you would owe on a quarterly basis using the
annualized method. (This method is time consuming and least practical.)
The prior year tax exception noted in item 2 above is most often
used, but won’t be the best method should income go down.
One common problem is the predicament that taxpayers find themselves
in after a break-out year. They will pay estimates based on the
prior year even though they've made a tremendous amount more than
the year before. They may even call their CPA only to be told
to keep paying those estimates and they won't owe a penalty. What
they commonly fail to do is save enough to pay the tax on April
15th and to pay the revised higher estimate for the next year
which is also due on April 15th. Then, guess what happens? The
next estimate is due June 15th--before they've had time to recover
from the events two months prior. The taxpayer spends the next
year recovering, and if income declines after a break-out year,
it's even harder to recover.
order for your CPA to properly advise you, it is good to discuss
your expectations for the next tax year. You can agree to set
your estimates at a particular level, but then have a mid-year
evaluation to be sure you are on track to avoid risk of penalties.
Your industry is very unpredictable, which makes it essential
for you to stay on top of what you need to do to protect yourself
from paying unnecessary penalties.
recommend that you set aside between 20 and 30% of your income
into a tax savings account. The more you save, the more likely
you will be able to pay your taxes and perhaps even fund a retirement
payments are due: April 15, June 15, September 15 and January
is so difficult with everything one must balance to fit saving
for retirement in the mix. However, there are several options
available when you reach a point where you are ready to work it
in. Below are some of the retirement vehicles that can be used
to begin your retirement savings.
IRA: Individuals who received compensation, alimony
or other earned income who are below 70 1/2 and eligible to make
IRA contributions of up to $5,000 for 2008 ($6,000 if age 50 or
older). Contributions must be made by April 15th each year to
be deductible in the preceding year.
the individual or individual's spouse is an active participant
in an employer-maintained retirement plan, the deduction may be
reduced or eliminated. The phase out begins with AGI at $85,000
and is completely phased out at $105,000 for married filing jointly
taxpayers. For single individuals, the phase out begins and ends
at $53,000 and $63,000 respectively.
IRA: Roth IRA contributions of $5,000 for 2008
($6,000 if age 50 or older) as long as AGI for single individuals
is below $101,000. Once above that level, contributions are limited
until completely phased out at AGI of $116,000. For married filing
jointly taxpayers, the phase out begins and ends at AGI of $159,000
and $169,000 respectively.
Employee Pensions: A SEP is a plan whereby employers
may contribute to an employee's IRA account. However, the limitations
of IRA's do not apply and are replaced with rules similar to that
of other qualified retirement plans. Contributions of up to 25%
of a participant's compensation not to exceed $46,000 are permitted.
The annual compensation that may be considered in determining
the contribution is limited to $230,000. Self-employed individuals
are considered employers. Therefore, a SEP is a popular way to
fund retirement accounts for proprietors. Contributions for the
preceding tax year must be funded by the due date of the taxpayer’s
return, including extensions. This is unlike IRA’s which must
be funded by April 15th.
Retirement Plan: These plans are called "qualified"
because they are intended to qualify under Section 401(a) of the
Internal Revenue Code. These plans are governed by ERISA and basically
fall under two major types: (1) defined benefit plan and (2) defined
contribution plan. The most popular type of plan is the defined
contribution plan which includes profit sharing, money purchase,
target benefit and 401(k) plans. Another term you may have heard
in this area is the "Keogh" plan which is basically
a qualified plan for a self-employed individual. These plans offer
large benefit opportunities but require assistance of a qualified
Member 401(K): This plan is ideal for taxpayers
who are making self-employment income below $230,000, have no
employees, and don't need the cash until retirement. By having
a 401(k), the proprietor can elect to defer his or her salary
of up to 100% of pay not to exceed $15,500. In addition, since
the proprietor is the employer, he or she may fund up to 25% of
pay in the form of a profit sharing contribution.
example, a proprietor who has $152,500 in net income can elect
to defer $15,500 as an elective deferral amount and contribute
another 25% (20% based on certain limitation = $30,500) as a profit
sharing amount, for a total of $46,000. A SEP would have been
limited to $30,500, so this plan provides a $15,500 opportunity
not available in other plans. (This example is not precise and
used for explanation purposes only.)
burden of proof for positions taken on a tax return is on the
taxpayer. That is why it is essential to keep documentation of
every expense and income item taken on your tax return. There
are some items that should be kept indefinitely.
are many ways to do record keeping. Some prefer manual records,
others prefer electronic. There are no set requirements for format.
The best way to be efficient at record keeping is to choose a
method that works for you. Otherwise, the paperwork waits until
crunch time, and becomes a dreaded chore.
see everything from shoe boxes, to bags, to envelopes and hand
written notes. We work with whatever we are given, but most clients
who use a manual system often feel like they are missing out on
deductions and leaving money on the table. A computerized system
that is used on a regular basis can really improve efficiency
and the likelihood that things aren't getting overlooked.
are a few tips if you prefer using a computerized system of tracking
income and expenses: Start by getting Quicken, the easy-to-use
record keeping software program. It's simple to learn. Once you've
set up the categories you need, recording income and expenses
is less cumbersome than writing in your checkbook. You can do
it daily, weekly, or monthly. You can also import data on-line
eliminating the data entry part and streamlining the process.
beware--the computerized system doesn't eliminate the need to
keep receipts. You'll still need a way to maintain receipts. You
could set up an accordion file with one pocket for each of the
tax-related categories you created in Quicken. As receipts come
in, just slip them into the appropriate pocket of the file.
sure to keep your receipts that support credit card charges. The
credit card statement isn't enough and the IRS can disallow expenses
taken without those specific receipts.
your day timer or outlook calendar printouts with your tax records
too. If you ever need to substantiate a meal or travel, that is
your best source of information.
those who have multiple Schedule C businesses, QuickBooks may
be better software to use than Quicken. QuickBooks is the business
version of the software and has a feature called "classes"
that can substantially improve efficiency when tracking income
and expense for each business.
year-end, use Quicken to run a final report for each category,
and your tax records are in order and ready for calculation. Use
QuickBooks to print reports by class. Better yet, make a backup
of either and provide them with your other tax records to your
CPA so they can extract what they need for your tax return. Hopefully,
they can also give you pointers on how to enhance the use of the
software in the future as well.
you are really up on technology and want to eliminate paper, you
could purchase a scanner and software to scan all of your receipts.
Don't eliminate contracts, however. Even in today's technology,
an original signature on contracts and wills are still very important
documents that must be retained.
be sure to have a good backup system if you go paperless. Once
the receipts are gone and your computer crashes, there will be
no way to recover that data. Even a backup system kept at home
can be a problem in the event of a fire or catastrophe. That's
why it's important to have backups off sight. There are now services
that you can obtain to backup your files on line and they are
store in an offsite facility. Technology is moving in amazing
Comments: Please remember that the most important
deductions lost are those not properly tracked. Be aware of what
you can deduct and establish a method to capture those deductions
that will work for you. Align yourself with a professional who
understands your industry and will spend the time empowering you
By Cathy Werthan, CPA Consulting