Deferring income
Shifting taxable income from the current to the next tax year is useful only if you expect your next year's income to be equal or less than your current year's one.
* Waiting for a bonus? Keep waiting. Applies only to Cash-Basis-Tax-Payers. See if you can receive it in January of next year. Doing so will exclude the bonus from this year W2 / 1099 (and taxable income) and reduce your taxes for this year.
* Postpone interest income - Transfer money market account balance (savings), to a Certificate of Deposit. Make sure that the CD pays interest only at maturity. Interest income generated by the CD will be taxable only when the CD matures, so you will still get interest income only it will be taxed next year.
* Selling gaining stocks - Sell gaining stocks (current market price is higher than your original cost) after January 1st of next year. There are two exceptions:
1. Exception that Price will decrease - sell now.
2. Own loosing stocks that can offset the gains.
* Converting regular income to long-term capital gain - In general, gains from selling stocks you hold for 12 months or more, are subject to a 15% long-term capital gain while gains from selling stocks you hold less than 12 months are taxed subject to your highest tax bracket.
Accelerate expenses
Cash-Basis-Tax-Payer will benefit from paying next year expenses before the end-of-the-year. Those expenses which will be paid anyways will be deductible this year if paid before December 31.
* Donation - if you are planning to donate cash or property, do it before December 31.
* Property taxes - pay next year real estate tax before the end of the year.
* State taxes - pay your state taxes on your capital gains and business income.
* Medical expenses - do so only if your overall medical expenses are over 7.5% of your Adjusted Gross Income, otherwise it is not deductible.
* Employee's unreimbursed expenses - only if they are over 2% of your Adjusted Gross Income otherwise it is not deductible.
Maximize tax credits
* College / high education tuition - Paying tuition for you or a dependant? make the payment before the end of the year and benefit from a credit (note that the credit has very strict income threshold which causes you to loose the credit) * Childcare credit - for two working parents (or students), you can get up to $480 per child. If you have flex plan to cover it - spend your unused "Flex" balance.
Retirement Planning
There are several retirement plans that allow self employed and micro business owners to make contributions and achieve both:
1. Tax deductions to offset self employment or business income 2. Financial planning for the future
(SEP) IRA
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A simplified employee pension (SEP) IRA allows an employer to make contributions toward his or her own (if self-employed) or employees' retirement. Employers can contribute a maximum of 25% of an employee's eligible compensation or $42,000, whichever is less.
Self-employed's contribution is based on the net profit from the business (self employment income and not the gross income).
Per IRS regulations employers must include all eligible employees who are at least age 21 and have been with a company for 3 years out of the immediately preceding 5 years.
For calendar year corporations with a March 15, 2006 tax filing deadline, SEP-IRA contributions must be made by the employer by the due date of the company's income tax return, including extensions.
The contributions are deductible for tax year 2005 as if the contributions had actually been contributed within tax year 2005.
Sole proprietors have until April 15, 2006, or to their extension deadline, to make their SEP-IRA contribution if they want a 2005 tax deduction.
Solo 401(k)
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Established by the Economic Growth and Tax Relief Reconciliation Act of 2001, Solo 401(k) plan provides a great tax break to micro business owners. In addition to the possibility to shelter from taxes a large portion of income, some Solo 401(k) plans offer a loan feature for cash-strapped small business owners.
Eligibility for a Solo 401(k) plan is limited to those with a small business and no employees, or only a spouse as an employee. This includes independent contractors with earned income, freelancers, sole proprietors, partnerships, Limited Liability Companies (LLC) or "S" corporations.
The key benefits of the Solo 401K plan include:
* High limits on contributions: elective salary deferrals and employer contributions allows sole proprietors to contribute up to $42,000 ($45,000 if age 50 or older) in tax year 2004, based on salary deferral plus profit sharing (see below).
* Contributions are fully-tax deductible and are based on compensation or earned income.
* Assets can be rolled from other plans or IRA's to a Solo 401K. There is no limit on roll-overs.
* The account holder can take a loan that is tax-free and penalty free from the Solo 401K, if allowed by the plan, up to the lesser of 50% or $50,000 of the account balance. The contribution limits depend on how the business is established. Overall, the total of deferred salary and profit sharing that can be put in one of these accounts in one year is limited to $40,000:
* For businesses that are not incorporated, the salary deferral and the profit-sharing contributions are based on net earned income. The maximum contribution limit is calculated based on salary (max deferral of $12,000) and profit sharing up to the current max contribution. Contributions are not subject to federal income tax, but remain subject to self-employment taxes (SECA). The owner receives a tax deduction for both salary deferral and employer contributions on IRS Form 1040 at filing time.
* For corporations, the maximum elective salary deferral amount for 2003 is 100% of pay up to $12,000 ($14,000 if age 50 or older). The maximum employer contribution (profit sharing) is 25% of pay, and is based on the W-2 income. It is not subject to federal income tax or Social Security (FICA) taxes. The salary deferral contributions are withheld from your pay and are excluded from federal income tax but are subject to FICA. The business receives a tax deduction for both salary deferral and employer contributions.
Keogh plan
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A Keogh plan is a tax-deferred retirement savings plan for self-employed. In general self-employed individual may contribute a maximum of $30,000 to a Keogh plan each year, and deduct that amount from taxable income.
Profit Sharing Keogh
-------------------- Annual contributions are limited to 15% of compensation, but can be changed to as low as 0% for any year.
Money Purchase Keogh
-------------------- Annual contributions are limited to 25% of compensation but can be as low as 1%, but once the contribution percentage has been set, it cannot be changed for the life of the plan.
Paired Keogh
------------ Combines profit sharing and money purchase plans. Annual contributions limited to 25% but can be as low as 3%. The part contributed to the money purchase part is fixed for the life of the plan, but the amount contributed to the profit sharing part (still subject to the 15% limit) can change every year.
Taxes are due when the individual begins withdrawing funds from the plan. Participants in Keogh plans are subject to the same restrictions on distribution as IRAs, namely distributions cannot be made without a penalty before age 59 1/2, and distributions must begin before age 70 1/2.
Setting up a Keogh plan is significantly more involved then establishing an IRA or SEP-IRA.
Tax USA Inc.
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Tax USA, Inc. is a complete tax, accounting and financial management firm specializes in small businesses, corporations and high income individuals. Tax USA Inc.'s mission is to exceed clients' expectation by providing superb tax, accounting & financial Management services. We offer our clients tax, accounting and bookkeeping services, CFO Outsourcing, Budget Review and Business Plans, Cash Flow Management, Payroll Services and Entities' Incorporation.
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