[progressally_note note_id=’1′ allow_attachment=’yes’]
[progressally_note note_id=’2′ allow_attachment=’yes’]
[progressally_complete_button text=’Mark As Done’ objective_id=’all’]
This Module discusses concepts around expenses
Here comes the disclaimer! I am not a CPA or a tax attorney. I am a business guy that looks at the tax code a part of doing business. This module will do more to help you make the most of your business and increase wealth than any other part of the program.
TASKS FOR MODULE
We talked about categorizing expenses in the categories section of module seven. Please refer back to that module for category placement. The rest of this module will talk about available expense deductions and how to use the tax code to maximize pre-tax and post-tax dollars.
When categorizing expenses I suggest the following
Capture Book costs such as covers, editing, proof copies in material costs or cost of good sold. This will help us to get the cost of getting the product to market. Advertising can go into COGS or into a separate advertising expense category. I personally have it as a separate operating expense.
All of your other expenses are Operating Expenses.
Starting with the draft categories that Wave provides begin categorizing your expenses. Everything will be 100% deductible except for Meals & Entertainment. The IRS feels that your portion of the dinner doesn’t count. Those are the rules.
TAXES, PROFIT THEN EXPENSES
A dollar's Journey through your business
The journey of $1 from revenue to you as Capital is an arduous one. It must not be consumed by the cost of goods sold, operating expenses, or taxes If it makes it past all of those it is yours to spend or reinvest how you see fit. We would like to get as many of those dollars through that maze and back to you now or later in retirement as we can.
Now once you have Capital you can spend it how you like, but there are some dollars that you plan to spend that may be best spent as a pre-tax expense. LET ME BE ABSOLUTELY CLEAR all you are saving is your effective tax rate and that dollar spent while not taxed is gone.
That being said you now have the flexibility to expense some items that in the past you couldn’t expense and by doing so your reducing the sales you have to get to achieve certain perks.
Let’s talk about the IRS, Audits, and Expenses. I am in no way saying shirk the law. In fact, I suggest you spend time learning more about it so you see how your circumstances fit it. The tax code only gets bigger and that mean more special rules and loopholes for you to exploit.
If you are ever audited and they identify items that they may deem not deductible and you decide not to fight it then you will be assessed a tax amount, penalty and interest. Just write the check. The won’t lock you up unless your excessive in what you do.
Most Entrepreneur’s mistake is not that they take ineligible deductions it’s that they take too many deductions. They don’t get in trouble with the IRS, they have trouble showing proof of income to finance a home or other property.
This gets back to planning. If you are going to buy a new home in a couple of years figure out the ideal income and work your business to that. It may mean more taxes for a few years but you achieve the life goal of getting that home you dreamed of.
Your Payroll will be your biggest expense to your business
When you are determining what to pay you versus what to take as a dividend planning is critical. We want to strike a balance between the right salary dividend mix for your revenue and not be adjusting every pay period. While waiting 60 days for your money sucks you do know what you will have coming in and can adjust. I think a quarterly assessment will be best to minimize payroll changes and to keep tax withholdings in line with revenue. If the is forecasted properly you will be able to save on taxes and keep the right balance between wages and dividends.
The IRS would like you to take as much as wages because you will be required to pay your portion of social security and Medicare and the business will have to pay its portion as payroll tax. The problem indie businesses face is that revenues are variable so we need to be conservative. The picture to the left has the general rules to follow.
Here is an example, $50,000 of profit, 50% comes out as salary, the other as dividends. You would start to pay yourself $2,083 a month in salary and take the other 2083 as a dividend. I suggest making payment of dividend and salary different frequency. A quarterly dividend is an accepted interval.
Look to adjust every three to six months based on income fluctuation up to a maximum salary of $128,700, where FICA caps.
Now you will need to set up a payroll service or run payroll yourself. payroll service will cost you around $40 a month in fees and should take care of all the filing and distribution of wages and taxes. This does two things
- automates payment to your personal account
- automates tax and benefits payments
Your personal income tax will get paid two ways. First through withholdings on payroll and secondly through quarterly estimates. If you set your withholding correctly it should result in little or no need for quarterly estimates. This takes some juggling and math but will, in the end, have you on top of your taxes and not surprised at the end of the year.
Worker’s Compensation Insurance
You will need to check the specific laws of where you incorporated and pay payroll. Each state has different guidelines for worker compensation and many have an insurance exemption if the owner is the only employee.
This can be a confusing space and who knows how it will change but here is the current IRS rules about healthcare.
As an owner of an S corp, if the company pays for your healthcare benefits as part of a group plan it qualifies as income for you and must be reported on your W-2. Although exempt from Medicare and Social Security Tax, this rule means pre or post-tax dollars are the same so you will need a different strategy.
Next, you cannot contribute Company pre-tax HSA or QSEHRA dollars to yourself.
Here is the best solution at this time
- Enroll in a high deductible HSA (Health Savings Account) compliant plan. HDHP must have a deductible of at least $1,350 for self-only coverage or $2,700 for family coverage.
- Get an HSA account
- Contribute post income tax dollars to HSA deducting those contributions on your personal return, thereby offsetting the tax effect.
Using this method you will be able to have for yourself $3,450 or $6,850 for a family with $1,000 as the catch-up contribution if you are over 55 moves tax-free to you for healthcare. This structure will give you more flexibility with preventative and alternative treatments that you would see with putting all of the money in premiums.
A Qualified Retirement Plan is the single biggest category where you can manage your taxes, moving tens of thousands of dollars tax-deferred and out of the business.
My opinion is that you set up a 401k Plan for your business. you can do a SEP and achieve the same levels of tax-deferred investment, however, you what you can not do with a SEP is borrow money.
A 401K has a loan feature where you can pay yourself back with interest and no penalty. This helps to ease concerned about moving money into plans and not being able to access it later.
You can contribute up to $55,000 per year and if your spouse is an employee or partner there is another $55,000. Contributions can come from your wage contribution as well as profit sharing from the business. This allows you an opportunity in windfall years to move significant amounts into retirement and manage your tax burden.
As far as selecting a plan, The company plans are all similar what you need to decide is how you feel about money management. You could set up a 401k at Etrade or a similar discount broker and then just balance the money within index funds. Your performance will be to the market and you will save in fees. You can also use money managers that select investments within your 401K. This will cost you money but give you access to a fund manager. Your Choice.
TRAVEL & VEHICLE EXPENSES
Let’s begin with your home
Your “tax home” is your house travel away from that place for business purposes is considered travel. Let’s discuss using your care for travel and then longer distance overnight travel.
Since your business life is nomadic meaning you don’t have a set office to go to where you work is your office. Just about everything can be research. Your travel the museums you visit, the books you read you just need to keep adequate records. I suggest a journal noting words logged per day, where you wrote, and the research you are doing. Who can argue that You sitting in a cafe in Paris eating Creme Brulee wasn’t the perfect solution to working through the plot points of an upcoming series?
There is a range of options for dealing with your car from simple to complex. Over time you may transition from paying mileage on your current car to when the company has the cash to having it buy a vehicle that you use.
The simplest, If you own your car personally, is to expense mileage at the prescribed IRS rate of $0.535 per mile. You will need to keep track of mileage driven for the business and then charge the company as an expense. You then reimburse yourself.
Remember you still deduct parking fees and tolls on top of the mileage.
The second option you have is to take all the expenses associated with your car and then determine the percentage you use the vehicle for business use and the company can reimburse you for the cars use. This monthly reimbursement is deductible to the company and tax-free to you.
Business Ownership of the Car
Another option is for your business to buy or lease the next car.
In a lease option, your business would lease the car and pay all of the expenses, fuel, insurance, tolls, and taxes. All 100% deductible.
You will need to determine the percentage the car is used for personal use and then claim the personal use as a fringe benefit on your W-2. Even it the personal use is 80% you still save 20% income tax.
Buying a Car
If your business buys rather than leases you may include depreciation.
Depreciation is a way to allocate an assets use within a period. If you bought a car for $10,000 and the depreciation schedule was $1,000 a year for ten years it would look like this;
You are out of pocket $10,000 of after-tax dollars on day 1
The business has an asset on the books for $10,000 a car day 1
At the end of the year, you take one year’s depreciation so $1,000 of non-cash expense is applied to your profit and the asset is depreciated to $9,000 of book value (this keeps the balance sheet balanced)
Depreciation is a non-cash expense meaning it creates a tax shield. Furthermore, there can be special depreciation rules from year to year in the tax code to cause more depreciation.
All of these are permissible and have tradeoffs. Let’s take the business buys the car. It is an asset of the business (that can be good) but the IRS will want you to account for the part of the business car that you are using for personal use and that will become a benefit that you will need to pay tax on. We don’t need to do the math to figure out that buying a car with pretax dollars is better than post-tax dollars and if you use your car a lot for business then the personal portion would be low.
Where do you buy your office supplies Costco maybe? Do you expense the five-pound bag of coffee beans? Yes. if you can justify the items as supplies you would have in your office if you had one then it can fly for office expense. Just like your computer, printer and other tools you need for your trade can be expensed.
You should have three categories.
Travel meals those meals you consume when traveling. 100% deductible
Meals & Entertainment: Take a customer out for dinner and drinks it is 50% deductible so keep this separate and be clear as to what is. Whenever you do entertain customers you should put the expenses in this category.
Office Meals/Events: If you are doing a book launch or an event or a Christmas party for your contractors that is not meals and entertainment if it is for team building and training. 100% deductible.
- All courses
- Computers & Hardware
- Your phone bill
- Retirement contributions to qualified plans
Personal Itemized Deductions
Having your business showing a profit with that income carrying over to your personal return is important. Remember you get another bite at the cherry when you start applying family deductions, itemizing your personal deductions, including mortgage interest, HSA contribution and other items. You should minimize your tax liability significantly.