Three Tax-Reduction Strategies for Pros
An improving housing market could translate into higher income for painting professionals in 2015 and 2016. This creates a high-class problem: potentially more taxes. We say ‘potentially’ because the smart painting professional will structure his or her business to earn more and pay less in taxes. Here are three strategies to put more dollars in your pockets and fewer dollars in the pockets of the IRS.
There are thousands of items that are allowed as business expenses. You want to make sure as many expenses as possible are deducted as business expenses. For example, I rarely take vacation because vacations are not tax deductible. However, I do take a lot of business trips, which are tax deductible. Look for ways to make your trips tax deductible by having a business purpose for the trip, such as attending a painting convention or setting up appointments with business contacts prior to your trip. Another deduction you may not be taking full advantage of is medical expenses. Within a sole proprietorship or an S corporation, there is a limit on deductible medical expenses. With the right provisions in a C corporation, you can deduct all medical-insurance premiums and all out-of-pocket medical expenses for copays, medications, first aid items, etc.
One way the IRS allows you to defer income is by contributing to a retirement plan. A retirement plan that works well for many professional painters is a Simplified Employee Pension Individual Retirement Account (SEP IRA). The IRS allows you to contribute 18.587% of net profit (maximum of $50,000 per year) to your SEP IRA for retirement. If you have $100,000 net profit in your business, you would be able to contribute up to 18.587% (or $18,587) to your retirement account. You would get to deduct the contribution, saving you thousands in federal and state taxes. The money goes into your SEP IRA tax-free and grows tax-free. SEP IRA funds are taxed at ordinary income tax rates when qualified withdrawals are taken after 59.5 years of age.
Proper use of entities
The tax rules are different for S corporations, C corporations, and sole proprietorships. You want to use the entity or entities that require you to pay the least amount of tax. For example, if you operate your business as a sole proprietor, all profit (up to the taxable maximum) is subject to Social Security and Medicare taxes. In an S corporation, profits are distributed through a K-1, a tax document like a W-2 used to report income, and are not subject to Social Security and Medicare taxes. Having your profits flow to you as K-1 income, instead of as profit from a sole proprietorship, could save you thousands each year in Social Security and Medicare taxes.
For example, if a sole proprietorship has a profit of $100,000, a 15.3% tax (12.4% Social Security tax and 2.9% Medicare tax) would have to be paid on the entire $100,000, totaling $15,300. In comparison, if an S corporation has a profit of $100,000 and you pay yourself a reasonable salary of $40,000, the other $60,000 would flow to you as profit (K-1) and is not subject to Social Security and Medicare taxes. You only pay Social Security and Medicare tax on the $40,000 salary, for a tax of $6,120. In this scenario, using an S corporation would save $9,180 in taxes each year. While it would be nice to have the whole $100,000 excluded from Social Security and Medicare taxes, the IRS requires that owner-employees of an S corporation be paid a salary that is a ‘reasonable amount’ for the work being performed.
Reducing your taxes to the legal minimum can greatly increase your ability to build wealth. Supreme Court Justice Sutherland wrote, “The legal right of the taxpayer to decrease the amount that would otherwise be his taxes, or altogether avoid them, by means that the law permits, cannot be doubted.” Now is the time to get the proper legal entities in place to reduce your 2015 taxes and set yourself up for tax savings in 2016.
For more information, call (800) 848-9238 or visit: AmericanSocietyForAssetProtection.com