Tax Time: Small Business Tax Advice
Monday, March 2, 2009; 11:00 AM
washingtonpost.com's Sharon McLoone, who writes the Small Business Blog hosted an online discussion with Keith Hall, the tax adviser for the National Association for the Self-Employed on Monday, March 2 at 11 a.m. ET to answer tax questions from small business owners.
A transcript follows.
Sharon McLoone: Welcome, everyone. Thanks for joining us - I'm sure in this tough economy there are more questions than ever about how to make sure you're filing your business taxes correctly and efficiently.
Tax expert Keith Hall is here to answer your questions. He knows where you're coming from - he's not only the tax advisor to the National Association for the Self-Employed, he's also a small business owner.
So Keith I'll turn it over to you and let's start the Q&A.
Keith Hall: Hey Sharon. Thanks for taking care of the small businesses out there and for having me here today to hopefully provide some tax answers. The NASE is proud to be part of the small business community and is always here to help. For more detail and more tax information check out www.NASE.org and Tax.NASE.org!
Washington, D.C.: I "work from home," but it's an apartment and I rent it, not own. Can I still take the home office tax deduction?
Keith Hall: The fact that you rent your home or apartment will not preclude the home office deduction. The keys are that you use a space in your home "regularly" and "exclusively" for business. If you meet those parameters then you should definitely take the deduction.
Santa Fe, N.M.: My wife and I are artists. We share a home studio. Sometimes we even work on the same project. What is the most tax-advantagous way to structure our business?
Keith Hall: 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 and an S corporation and an LLC and even a sole proprietorship. 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.
There may be non-tax reasons to incorporate of form an LLC, however. 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 is a method (other than insurance) to mitigate the personal liability, but the key point is that from a tax standpoint the overall tax liability will be about the same.
Anonymous: I have a small buisness in North Caroline and got behind on payroll taxes but I have been making regular payments. My adjuster has come to my business several times and has been very nice, but I still get letters from the IRS that they can levy my bank accounts. I explained to my adjuster if you levy my accounts I can't pay you anything because my company works on commission. Does he have to work with me?
Keith Hall: Based on my experience the IRS has no interest or benefit in putting you or your business in a worse financial position by levying your accounts. They will typically only take that step as a last resort. The best advice is to make sure they know your situation. Keep them posted on where you are and if additional issues arise forcing you to miss agreed upon payments, let them know if advance. You also can solicit help from the TaxPayer Advocate, a service specific designed for issues with communication with the IRS. You can contact them through the IRS website at www.irs.gov.
Knoxville, Tenn.: Keith, I am a sole proprietor. My business is not incorporated. I buy individual health insurance through BCBS. Can I deduct the cost of my premiums as health insurance for the self-employed?
Keith Hall: The health insurance premiums that you pay for yourself as a self employed business owner are deductible but are not included on your Schedule C as with other business expenses. Instead, they are included on page one of your form 1040 on line 29, Self employed health insurance deduction. The deduction is 100% of the qualified health insurance premiums.
In order to qualify for the deduction, you cannot be eligible to participate in any other subsidized health plan, such as might be offered by another employer. Further, the deduction is limited to the earnings that you have from the business, so that if you actually had a loss, you could not take the deduction.
Other medical expenses are also deductible but are included on your Schedule A, Itemized Deductions and are subject to limitation. The expenses are limited by a 7.5% of Adjusted Gross Income floor. This means that only the amount that is in excess of 7.5% of your AGI will be deductible.
Anonymous: I have been advised not to use my home as a business tax write off. I actually use approx. 25 percent of my 4,500 square feet home as business. I sell my product on the Internet and ship to dealers. I have no public store front. Was told I or my family would have to pay the tax deduction back if the house was ever sold. Is this correct and or what is your advice?
Keith Hall: If you qualify for the home office deduction, or any deduction for that matter, you should certainly take it. There is a depreciation recapture issue whereby when the house is sold some of the gain, if any on the house, may be taxable, but only to the extent of an amount that you did get to deduct each year. So, there isn't a "payback" of benefit per se, but there could an effect when you sell the house. The benefit of the deduction will still outweigh any recapture in the future.
Marriottsville, Md.: Thank you for this forum. In '08, my wife started working for a private practice wherein the owner pays her with her personal checks. Her patient load is semi-stable with cancellations, new clients, etc. How do we estimate her taxes? Is it based on some annual forecast salary? Where do we send this? Federal and state? Thank you.
Keith Hall: If is difficult to answer your question related to estimate tax payments without knowing more about your personal circumstances. 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 required to meet the "pay as you go" system.
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. If you do not make the required estimated tax payments, there will be a penalty that will be due with your tax return. The penalty is a function of the amount that should have been paid.
By definition, your estimated taxes should reflect your family's expected tax liability. That tax liability will depend on a great many things such as how much money the family makes, do you itemize deductions, do you own a home, do you have children, what business expenses do you incur, etc.
The best way to determine how much your estimated tax payments should be 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 has some good publications to help you with this information. One is called Publication 505, Tax Withholding and Estimated Tax including where to send the payments and coupons that you can use. You can download the publication from the IRS for free from their website at www.irs.gov.
Boston, Mass.: I got laid off in June of last year from my job at Turner Diary, and now I drive a parts truck for Weaver Trucking so half of the year from July to December there were no taxes taken out at my new job, so what do I do as far as taxes on the second half of the year?
Keith Hall: Your tax liability for the year will still be based on the whole year, so you will need to consider the amount withheld during the first half of the year in your second half estimates. Since the year is over the best advice is to sit down and complete your return as quickly as possible. The income from your regular job will be included with the income from the new income from self employment and the combined income and expenses will determine your overall income tax liability. Then you will get credit for the money you paid in and any difference will be your refund or payment due.
For the next year you will need to make estimated tax payments on a quarterly basis in order to avoid any underpayment penalties. The NASE has an estimated tax calculator to help at Tax.NASE.org and you can also check out the IRS website at www.irs.gov for more detail on estimated taxes as you go through 2009.
Herndon, Va.: Gurus: my wife and I are retired, each with a government pension, but she is working as an artist full time. However, business expenses last year, as in the year before, far exceed income from the paintings she's been able to sell. At what point, if any, does her "business" become a "hobby"?
Keith Hall: The key for the business activity is that there is indeed a profit motive for the business. There is no rule that automatically will make the business a hobby simply because there are losses. Otherwise, General Motors might be considered a hobby. So as long as she maintains a profit motive, in other words the business is really trying to earn money, it will still be considered a business.
Denver, Colo.: I teach private piano lessons and I have a student that I am giving free lessons to for the moment because the family has suddenly lost their income. Is there a way for me to deduct the amount I would usually get from teaching this student?
Keith Hall: Unfortunately, the value of services that you contribute or don't get paid for, for whatever reason, will not generate a tax deduction. This may seem unfair at first, but keep in mind that the income related to those services was also excluded from your tax return. If you had collected $100 from the student for services rendered and then gave the money back to a qualified charity for example, as a contribution, your tax return would not be affected. You would have $100 in taxable income and $100 in deductible contributions, a net effect of zero. By providing the services for free, you do not include the income or the deduction, so that the net impact is the same. Sorry if this wasn't the answer you were looking for but I hope it was helpful anyway.
Alexandria, Va.: What is the most overlooked deduction or credit that small businesses miss?
Keith Hall: There are certainly a ton of deductions available, but perhaps the most common one is the home office deduction. It is easy to miss since the expenses don't show up in the business checkbook. Check out IRS Pub 587 for more detail. One other deduction to keep in mind is available options for retirement planning, IRAs, SEPs, etc. No one will remind you to invest in your own future, so don't forget.
Clinton, N.J.: A firm, Metlife retiree Services, sent me a 1099 for $3,400. The trouble is I have had no financial connection with Metlife and never received any such payment. How do I let federal and state tax agencies that this 1099 is in error? I have already written Metlife and challenged them to explain and provide a copy of the endorsed and deposited check.
Keith Hall: You first action is the best and that is to get the issuer of the incorrect 1009 to actually correct the mistake. Absent this solution, it is a good idea to include a note with your tax return when filed. Include a copy of the 1099 and your correspondence with the company. The good news is if you didn't get the money, the IRS won't make you pay tax on it.
District of Columbia: Hello, I started business last year and am operating from my basement. What expenses can I claim (rent, utility bills, etc.)? I am currently using 25 percent of my home expenses for my home office. Help appreciated. Thanks
Keith Hall: If you use a portion of your home "regularly" and "exclusively" for business, then you would qualify for the home office deduction. This is true even if you rent your house or apartment. The exclusive part is usually the more difficult of the two for small business owners. This means that the space can be used only for the business and have no other personal usage. For example, if the room that you use for your office has a TV in it that the kids use to play video games, then the space would not qualify for the home office deduction. If the space qualifies, then all of the costs associated with maintaining that portion of your home would be deductible including your rent and utilities that you mentioned along with other costs you incur to maintain your home.
The amount that would be deductible would be based on the business percentage of the use of the home which is determined by taking the percentage of the space used for business compared to the overall space of the home. Therefore, if you have an office used regularly and exclusively for business that was 200 square feet and your total apartment was 1200 square feet, then the percentage would be 16.7 percent, 200 divided by 1200. Therefore, 16.7% of the costs of maintaining the home would be deductible as a business expense.
The deductible expenses are reported on Form 8829, which is attached to your tax return. The IRS has a very good publication to help you with this information called Publication 587, Business Use of Your Home. You can download the publication for free from the IRS website at www.irs.gov. You can also download form 8829 along with instructions.
Fairfax, Va.: Please explain how owners who work for their corporations may be able to extract distributions on a FICA-free basis by arranging loans or rentals to the business and taking payments in the form of interest or rents.
Keith Hall: The first key point here is to always avoid any business transaction solely originated to avoid tax. These are usually bad ideas and most of the time don't accomplish the goal anyway. Having said that one key point is that the corporate form of organization has no favorable capital gains tax rate structure as individuals do. Therefore, having any real estate investments, such as the corporate office building, held or owned by individuals and then having the corporation make rent or lease payments to the individuals can be a good long term tax strategy. This is a complicated issue and the best advice here would be to sit down with your personal and legal advisors to make sure that your specific facts and circumstances are adequately reviewed.
Philadelphia, Pa.: Why can't small businesses with a home office have a flat deduction? It's so confusing trying to figure out how to deduct all the different percentages of utility use, etc. I have to spend money on a tax pro just for that.
Keith Hall: Your point is a very good one and is a great idea. There are a number of current proposals before Congress and its Small Business Committee to provide just such an option. Perhaps the best thing you can do at this point is to let your Congressional representative of your support for such a change and how much it can benefit small business.
District of Columbia: I have a new LLC with a partner. We had a little bit of income in the last month of 2008 which we need to pay taxes on. My husband worries that the taxes I owe will swallow up his refund. Should we file separately?
Keith Hall: Filing separately is an option, but in most cases will not end up saving you any money. In fact, in most cases filing using the married filing separately status will cause you to end up paying more tax combined. The best idea is to sit down and do the math both ways to see which is better for your situation.
Annapolis, Md: My domestic partner, who has the higher income, usually takes the interest on the mortgage but I am sole-proprietor and have a home office. Can I take any of the interest (e.g. HELOC) on my home office worksheet? Any suggestions on how to handle this would be greatly appreciated. Thanks. -TAL
Keith Hall: The key for your mortgage interest deduction, as with all deductible expenses, is who actually incurs the expense. If you pay a portion of the interest then that portion should be included on your tax return, either on Schedule A or included with your home office deduction, as applicable. So if you own the home and you pay the interest then it should be on your return.
Rest: Re: the hobby question. My understanding is that if you do not make money in two out of five years of running your own business, you have a hobby, not a business. This is also my CPA's understanding of the rule, so best to clarify your wife's situation on the IRS website and with your tax professional.
Keith Hall: The hobby loss rules are the reverse. If you have earnings from the business activity in 3 of the last 5 years, then the IRS CANNOT use the hobby loss rules to deny the business losses in the other years. The fact that there are no earnings never makes the business automatically a hobby.
Gaithersburg, Md.: I'm thinking of trying exporting to Europe as a way to get a new revenue stream. But would my taxes be a lot more complicated and do I have to follow other countries' tax codes?
Keith Hall: Simply having oversees sales will not automatically require any oversees filings. There are certainly potential issues if you have source income in other countries such as having a physical presence in those countries, i.e. an office, employees, etc. But an internet sale from a customer in another country will not change your US filing requirements. Foreign taxation is a bit outside the scope of our chat today, so it is certainly a good idea to visit with your tax professional to make sure your facts and circumstances are adequately reviewed.
Washington, D.C.: How often can a small business person buy computer equipment? I have a desktop purchased in 2007 that is still my primary computer for work. However, it would be nice to have the portability of a laptop and also to have a backup in case I ever have a problem with the desktop. I need particular software to do my job, so if it could be loaded on both computers as insurance, it would be wonderful.
Could I buy a laptop this year even though I still use the desktop as my primary work computer? If my husband would use the laptop sometimes, do I then say it is X percentage used for business for tax purposes?
Keith Hall: There is no limit on how many or what types of business equipment your business can acquire. The key point for each will be the extent it is indeed used for business. If there is personal usage of the laptop, then the cost for that item will need to be allocated between business and non-business usage. But there is no limit on how many computers the business can have.
McLean, Va.: Someone told me recently that IRS treats cell phones as "non business" deductions to extent that you cannot show business purpose. Can you explain further?
Keith Hall: The IRS does not automatically exclude business deductions in total. But at the same time they do require that ALL business deductions be supported. So if you use your cell phone for business purposes it will be deductible, but you will also need to be able to support that business usage if your return is every examined by the IRS.
Anonymous: What are/is the most forgotten tax write off/s that the self employed overlook?
Keith Hall: It seems like there are always things we forget. Common deductions that are overlooked include the home office deduction, the deduction for the business use of your car and retirement plan deductions. Check out Tax.NASE.org and www.irs.gov for more detail on common deductions and things that you might miss.
District of Columbia: I have shares in a publicly-traded partnership (MLP arrangement). Profits and losses pass through on a K-1. How am I supposed to report the quarterly cash distributions? They are not recorded on my broker's 1099.
Keith Hall: The cash distribution will also be included on your K-1 at the end of the year but will not be taxable income in most cases. The distribution will be a reduction in your tax basis in the partnership and will only be taxable income to you if the cash distribution exceeds your basis in the investment.
Portland, Ore.: I am a sole proprietor. I was unaware that credit card interest was deductible if there was a card devoted exclusively to business. Since we are into a new tax year, is there any way to salvage some of the interest I paid last year?
Keith Hall: You are exactly correct. If the underlying charges on the card are indeed business related then the related interest or finance charges will also be a business expense. If the card is only used for business then you will know that all the underlying charges are indeed business and therefore deductible.
As for last year, if you have already filed your return without including those expenses then you can certainly file an amended return and include the missing deductions. You would use IRS form 1040X which you can download at www.irs.gov.
Alexandria, Va: What's the best tax form for my new marketing consulting business?
Keith Hall: From a tax standpoint, the entity form will not make a material difference. For most small business owners, operating as a sole proprietor is the easiest way to go. The key point here is that the tax implications should not be the main reason for choosing an entity form. Liability issues, wanting to bring on a potential investor, etc. can be good reasons for choosing a corporation or LLC, but don't think of the entity form as a tax decision.
Alexandria, Va.: I am a freelance writer and make very different salaries every year which makes it hard to estimate my salary. Do I really have to pay estimated taxes throughout the year or can I just pay what I owe when I file each year? I don't understand why I would have a penalty if I pay what I owe when I do my tax return.
Keith Hall: The key point is that that system is a "pay as you go" system. Most people comply with this system through withholdings from their payroll check. Since the self employed have no such withholding, you do need to make the estimated tax payments. You don't HAVE to per se, but if you don't, as you mentioned there will be a penalty.
St. Louis, Mo.: How does the new stimulus package impact the taxes, etc., of the self-employed?
Keith Hall: There are a number of key benefits included in the package including extending some depreciation options and extending the carryback provisions for business losses. With so much news on the economy these may benefit many small business with increased case flow. Check out more detail at www.irs.gov and at Tax.NASE.org.
Sharon McLoone: That's all the questions we have time for today. A big thanks to Keith for sharing his expertise and time with us, and a big thanks to all of you for participating. I hope you found it helpful and learned a little from each other. You can read the entire chat online at washingtonpost.com. Good luck with all your businesses!
Keith Hall: Thank you Sharon and the Washington Post for helping small business with so many issues. I enjoyed being here today and I hope we made a difference. If we missed your question today, look for us at tax.NASE.org.
Editor's Note: washingtonpost.com moderators retain editorial control over Discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. washingtonpost.com is not responsible for any content posted by third parties.