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Home Office Deduction

Post author By John Sutton, CPA
Post date September 20, 2021

Self-employed individuals and business owners that use an area of their home for business may be able to take a tax deduction for costs associated with a home office.

In order to claim the home office deduction, the area in your home must be used exclusively for business on a regular basis. The area does not need to be physically separated from areas used personally. A dinning room table use for both personal and business use would not count as the area must be used exclusively for business.

To claim the home office deduction, you’ll need to determine the square footage of the area used for business and the square footage of your entire home. A portion of the costs of your home can be deducted in proportion to the business square footage relative to the total square footage of your entire home.

Common Home Office Expenses Include:

-Rent payments or mortgage interest and real estate taxes if you own your home

-Utilities (electric, water, and gas)

-Homeowners insurance or renters insurance

-Homeowners association or condo dues

-Depreciation if you own your home – a portion of the cost of your home allocated to the area used for business is deducted over a number of years.

Don’t include: amounts where the business use is not representative based on the square footage of the home office relative to the entire home, such as internet access, telephone, etc.

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Please note: the information on this website is intended to provide general advice to start the discussion with your tax professional. The information on this website may not apply to your specific situation. Only an experienced professional with the details of your specific situation can advise you on making the best decision. Contact me or your tax professional to discuss the information on this site to make an informed decision.

Backdoor Roth IRA Contributions

Post author By John Sutton, CPA
Post date August 23, 2021

There are income limits on contributing to a Roth IRA. Taxpayers whose incomes are above these limits can get around these limits with the backdoor Roth IRA strategy. Using this strategy, a taxpayer contributes to their traditional IRA account and converts the amount to their Roth IRA account. There are no income limits on contributing to a traditional IRA account (though such a contribution may not be tax deductible). Under the current tax law, and for the past 10 years, there are no income limits on converting an amount from a traditional IRA to a Roth IRA, though this may result in recognizing income tax as discussed below.

It’s important to note, when you convert an amount from a traditional IRA to a Roth IRA account this is a taxable event that may result in recognizing taxable income.

If you have a traditional IRA, SEP IRA, or Simple IRA that has an existing balance, that balance is likely from making tax-deductible contributions and earnings in the account. When converting an amount to a traditional IRA to a Roth IRA, you must look at it as if you’re converting a portion of all the balances in your traditional, SEP, and Simple IRA accounts to the Roth IRA, even if the traditional, SEP, or Simple IRA accounts are held at a different brokerage. You’re not able to pick and say the amount you’re converting is only X amount from Y account.

As a result, the backdoor Roth IRA strategy is best suited for taxpayers that don’t have existing balances in traditional, SEP, or Simple IRA accounts.

As an example if you have $100,000 in a traditional IRA account from tax-deductible contributions and earnings from prior years, and you contribute $6,000 to the traditional IRA for the 2021 tax year (which you don’t plan on deducting on your income tax returns), and convert $6,000 to your Roth IRA in 2021: the majority of the $6,000 converted to your Roth IRA is taxable. You should view this amount as a portion of the $100,000 of pre-tax contributions and earnings. The actual calculation to determine the taxable amount of the conversion is $100,000 / $106,000 X $6,000. The non-taxable amount of the conversion is $6,000 / $106,000 X $6,000. In this example, $100,000 is also the ending balance of the traditional IRA account on December 31, 2021, which is used in the calculation shown.

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Health Savings Accounts (HSA)

Post author By John Sutton, CPA
Post date August 16, 2021

Health Savings Accounts (HSA) allow taxpayers with qualifying health insurance coverage to make tax deductible contributions to fund their accounts to be used for medical expenses. Often, taxpayers without an HSA are not able to receive any tax benefit from their out-of-pocket medical expenses, as they’re required to reduce their medical expenses by a percentage of their income, and it’s only the amount leftover (if any) that they can benefit from deducting as an itemized deduction.

With an HSA, it doesn’t matter how high your income is, you’re able to deduct amounts you contribute to an HSA on your federal income tax return. This deduction is in the adjustment to income category to arrive at federal adjusted gross income (AGI) and is not an itemized deduction.

Eligibility Requirements: As mentioned above, in order to contribute to an HSA, you must have an HSA compatible health insurance plan. Compatible health plans often contain HSA in the name of the plan to indicate they are HSA compatible. If your plan does not contain HSA in the name, you should contact your health insurance company to inquire whether it is an HSA compatible plan. While many taxpayers are aware of the requirement for the health plan to have a high deductible, there are lesser known requirements that may make the health plan not HSA compatible.

Unlike a Flex Spending Account (FSA), HSAs are not “use it or lose it” accounts. The amounts you contribute to an HSA can stay in the account for any number of years.

Some HSA providers allow you to invest in mutual funds or index funds in the HSA account. Similar to a retirement plan, these earnings grow tax-free.

An HSA account is like a special kind of bank account that many different banks and other institutions offer.

Amounts paid from an HSA are tax-free if they are used for qualifying medical expenses.

There are the HSA contribution limits for the 2021 tax year (these amounts assume a full year of HSA compatible health coverage):

For a health plan that covers only one taxpayer (and not their family): $3,600

For family coverage: $7,200

Additionally, taxpayers that are 55 years of age or older at the end of the tax year are able to contribute an additional $1,000. Bringing the total annual contribution to $4,600 for self-only health coverage and $8,200 for family health coverage).

Due Date: Contributions to HSA accounts can be made as late as the due date for your tax return. Extensions do not extend this deadline. This means a contribution for the 2021 tax year can be made as late as April 15, 2022.

Additional details on HSAs can be found on the IRS website here: Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans

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2021 Child and Dependent Care Credit

Post author By John Sutton, CPA
Post date August 2, 2021

Part of the Coronavirus tax relief for the 2021 tax year includes changes to the federal Child & Dependent Care tax credit.

Generally, this credit allows taxpayers with children under 13 years of age to reduce their tax liability for expenses they incur for the cost of care for their children that allow the taxpayers to work. Qualifying expenses do NOT include private school for children in grades K through 12.

Here is a list of major changes to the Child & Dependent Care Credit for the 2021 tax year:

-Eligible expenses for care are increased from $3,000 for one child ($6,000 for two or more children) to $8,000 for one child ($16,000 for two or more children).

-The credit is refundable, meaning that if your federal income tax liability is reduced to zero, the credit can create an overpayment on your tax return that can be refunded to you.

-There are income limits on receiving the credit. The amount of the credit is reduced for a taxpayer with adjusted gross income between $125,000 and $438,000. If your AGI is above $438,000, you’re not eligible to reach the credit.

Additional details on the 2021 Child & Dependent Care Credit are available on the IRS’ FAQ page here: https://www.irs.gov/newsroom/child-and-dependent-care-credit-faqs

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Launch of my Own Accounting Firm

Post author By John Sutton, CPA
Post date September 25, 2020

After over 10 years of working as an employee, I am excited to announce the launch of my own accounting firm. I have advised hundreds of new business owners over the years and I’m looking forward to taking the leap myself. If you or someone you know could benefit from my services in the areas of income tax filings, tax minimization, bookkeeping, payroll, and business consulting, don’t hesitate to give me a call at 301-857-1725.

Estimated Tax Payments

Post author By John Sutton, CPA
Post date September 10, 2020

Taxpayers are required to make estimated tax payments to avoid owing penalties for underpayment of taxes. Uncle Sam and states want taxpayers to pay in taxes throughout the year on their incomes and enforce compliance of making estimated tax payments by imposing penalties for underpaying taxes throughout the year. This post provides helpful information for taxpayers to minimize underpayment penalties.

Business Owners

New business owners are often surprised to learn that they are required to make quarterly estimated tax payments to avoid penalties. A major difference between being employed and being self-employed is no one withholds income tax from your income when you are self-employed. In fact, your income for the year is TBD until the end of the year, as you could incur additional expenses in your business between now and year-end that would reduce your income. However, this does not mean you won’t owe penalties for underpaying your taxes.

If you have a loss from your business you may not owe any penalties. You’re only required to make estimated tax payments when you owe taxes (generally meaning have taxable income).

Estimated tax payments are also required for self-employment taxes (Social Security and Medicare taxes) due on net income from businesses. Self-employment taxes are included with your federal tax liability and are included in estimated tax payments. No separate reporting is required for self-employment taxes when it comes to estimated tax payments. Simply combine the amount of your payment.

Employees, Retirees, & Other Taxpayers

Underpayment penalties don’t just apply to business owners, they apply to all taxpayers. It’s easy to overlook penalties included in your tax liability. IRS letters and tax returns are difficult for most taxpayers to understand. I had a client that wrote a check for over $5k of federal underpayment penalties for a single year (before becoming my office’s client) tell me they have never owed underpayment penalties, I later came across the check in their business’ QuickBooks file and brought it to their attention.

Safe Harbor

Taxpayers can avoid owing penalties by making the minimum requirements payments needed pay in a percentage of their prior year tax liability during the current year. Single taxpayers that had less than $75k of taxable income in the prior year (and joint taxpayers that had less than $150k of taxable income in the prior year) can meet safe harbor by paying 100% of their prior year tax liability during the current year. Taxpayers with taxable incomes above these thresholds are required to pay 110% of their prior year tax liability to reach safe harbor.

For example, if your filing status is single and your 2019 taxable income was $70k, you can avoid owing penalties for underpayment of estimated taxes by paying in 100% of your 2019 tax liability throughout 2020. Any additional tax is due with your 2020 tax return by April 15, 2021.

Safe harbor offers a guide taxpayers can use to avoid owing penalties for underpayment of estimated taxes. Additionally, taxpayers that expect to have significantly more income in the current year can benefit from the time value of money by holding on to any additional required tax due until the due date of their tax return (before extensions).

90% Rule

If you pay 90% of your total tax liability during the current year (by the required due dates), you will not owe penalties for underpayment of estimated taxes. The remaining tax is due with your return by April 15th.

Federal Income Tax Withheld

By default, federal income tax withheld (including tax withheld on wages and retirement plan distributions) is assumed to be withheld evenly throughout the year. Taxpayers can use this to their advantage by recognizing a shortfall of withholding or income tax payments and increasing federal income tax withheld from their income by year-end to compensate for the lack of withholding and estimated tax payments earlier in the year.

Annualized Installment Method

By default, your income is assumed to be earned evenly throughout the year, however; if a large portion of your income is earned later in the year, you may benefit from electing to use the annualized installment method by reporting how much income is earned in each quarter in order to minimize penalties.

Due Dates:

April 15th – for income earned between January and March

June 15th – for income earned between April and May

September 15th – for income earned between June and August

January 15th – for income earned between September and December (of the prior year)

How to Make Estimated Tax Payments

The IRS allows you to schedule estimated tax payments directly on their website. The IRS offers a payment feature called IRS Direct Pay that allows individual taxpayers to schedule electronic tax payments from their bank accounts. An added benefit is you receive a payment confirmation as proof of payment.

Here are instructions on making 2020 personal estimated tax payments using IRS Direct Pay:

Go to https://www.irs.gov/payments/direct-pay and click “Make a Payment.” On the next page, select “Estimated Tax” as the “Reason for Payment”, select “1040ES” as the form to apply the payment to, and “2020” as the “Tax Period for Payment.” On the next page, it will ask questions to verify who you are in order to apply the payment to your account correctly. You can select “2018” or “2019” as the prior tax year to verify information from.

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Business Use of a Vehicle

Post author By John Sutton, CPA
Post date September 9, 2020

Business owners have a number of options available to deduct costs of a vehicle used in their business. Here, I provide an overview of tax incentives currently in place and options available to deduct the cost of a vehicle.

Tax Incentives for Large Trucks & SUVs

Currently, there are tax incentives in place for trucks & SUVs that have a gross vehicle weight of 6k pounds or more. Typically, you have to deduct the cost of a vehicle over 6 years, however, vehicles that meet the gross weight requirements qualify to be deducted in full, to the extent the vehicle is used for business based on mileage, in the first year the vehicle is used in the business. The vehicle must be used greater than 50% for business use to qualify for this treatment.

The tax incentives for trucks & SUVs that meet the gross weight requirements are available even if you chose to finance a vehicle with a loan over several years. This allows business owners to get upfront tax savings while paying for the full cost of the vehicle over a number of years. Leased vehicles do not qualify for the upfront tax deduction.

Deducting Vehicle Expenses

There are two methods to deduct the cost of a vehicle: taking actual expenses or using the standard mileage rate. For 2020, the standard mileage rate is 57.5 cents per business mile. For new vehicles that meet the gross weight requirements, it is generally best to use actual expenses since you are able to receive an upfront deduction for the cost of the vehicle. In addition to the cost of the vehicle, actual expenses include gas, insurance, and repairs.

Commuting Miles

It is important to note that business miles do not include driving to/from home and your usual place of business, such as an office. These miles are considered commuting miles and should not be included in business miles.

Business Miles

Examples of business miles include driving from one business location to another, driving from home to run an errand for your business, meet with clients outside of your office, and attend networking events.

Mileage Log

You are required to keep a log of your business miles in order to deduct the business use of your vehicle whether you take the standard mileage rate or actual expenses. The easiest solution is to use a mileage tracking app on your phone. Some apps are able to sense when you have traveled somewhere using sensors built into your phone to prompt you to indicate whether a trip was for business.

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Education Planning & Tax Benefits

Post author By John Sutton, CPA
Post date September 8, 2020

There are a number of tax saving options and strategies to help you save for college expenses. Below is an overview of some of the most important options available to you. For additional information, please view the IRS’ Q&A on education credits and IRS Publication 970 – Tax Benefits for Education.

Tuition Tax Credits

There are tax credits available for qualified expenses (such as tuition, course-related books, supplies, and equipment) that are needed for attending college courses. The American Opportunity Tax Credit (AOTC) allows eligible taxpayers to receive up to $2,500 in tax savings (a portion of the credit can also be refunded to you if you don’t have a tax liability). There are income limits that apply to claiming this credit. For taxpayers using the single filing status, the amount of the credit is reduced if your income (modified AGI) is greater than $80k. For taxpayers using the married filing jointly filing status, the amount of the credit is reduced if your income (modified AGI) is greater than $160k.

Scholarships & Grants

There are a number of scholarships available to students for a range of different criteria. The amount of scholarships received will reduce the amount of educational costs eligible for tax credits, but it’s better to not pay for the educational costs rather than receiving a tax break for only a portion of these costs.

529 College Saving Plans

529 College Saving Plans allow taxpayers to save for college costs over a number of years. There are various state and private 529 plans available. Some 529 plans allow you to prepay for courses at today’s prices and some others allow you to invest in the 529 plan to save for educational costs you incur in later years. 529 plans can be used for tuition, room & board, books, supplies, and required equipment. If 529 plans are used for something other than qualified educational costs, or if you withdraw more from the plan that you incurred in qualified educational costs, you can face a penalty and income taxes on a portion of the amount withdrawn. Amounts withdrawn from 529 College Saving Plans cannot be used for the same educational costs used for the tuition tax credit when excluding the earnings on amounts withdrawn from taxable income (see details below on combining strategies).

529 Plans – Tax-Free Growth

Some 529 plans allow you to invest is stocks, mutual funds, and/or index funds in the plan. A major tax benefit of these plans is the earnings grow tax-free. If you were to save for college expenses by investing outside of a 529 plan you would owe income taxes on gains from stock sales, dividends, and capital gain distributions. When the funds are used for qualified educational costs such as tuition, room & board, books, supplies, and required equipment, you can avoid owing penalties and income taxes on the amount withdrawn. As with all investing, it’s best to start early to maximize the growth of investments.

529 Plans Tax Deductions

Some states allow you to deduct contributions to their own state’s 529 plans. For example, if you are a Maryland resident, you can contribute to a Maryland 529 plan and receive a tax deduction on your Maryland tax return for the contributions. This can result in immediate tax savings by saving for educational costs you expect down the road. Combined with the tax-free growth on the investments, you can minimize the financial burden of these costs. States have varying rules about how much of the 529 plan contributions can be deducted each year. Generally, if you contribute more than the allowable deduction for the current year, the excess is carried-forward and can be deducted on the state return in later years. For some states, married taxpayers can benefit from setting up multiple 529 plans, one in each spouses’ name, to deduct a larger portion of the contributions earlier on. For instance, each spouse contributing $2k, rather than one spouse contributing $4k.

Combining Strategies

It’s generally best to combine these strategies as applicable. For instance, if your income is expected to be below the income limits that apply to the tuition tax credits, you’ll want to pay for up to $4k of tuition expenses out-of-pocket (meaning not paid from a 529 plan or other educational savings plan) in order to have these costs qualify for the maximum amount of the AOTC. Pulled from the IRS’ Q&A on education credits, “You calculate the AOTC based on 100 percent of the first $2,000 of qualifying expenses, plus 25 percent of the next $2,000, paid during the tax year.” Additional educational costs can be paid using amounts withdrawn from 529 or other education savings plans. Since room & board does not qualify for the tuition tax credits, it is generally a good idea to pay this amount from an education savings plan. I recommend taking out the same amount from education savings plans as used for educational costs during the year (excluding amounts used for the tuition tax credit) to avoid having to pay penalties and income taxes on earnings from education savings plans.

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2020 Retirement Plan Relief – COVID-19

Post author By John Sutton, CPA
Post date September 6, 2020

The CARES Act included several changes to retirement plan contributions, loans, and withdrawals to provide relief to taxpayers as a result of COVID-19. Below is an overview some of the major changes. Please view the linked IRS pages for additional details.

No Age Limit on IRA Contributions

There are no longer age limits on contributing to IRA accounts. From the IRS’ website, “For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs.” For 2019, taxpayers 70 ½ years of age and older could not contribute to a traditional IRA. There was no age limit on Roth IRA contributions for 2019. For now, this appears to be a permanent change that will apply to later tax years as well.

RMDs (withdrawals) NOT required for 2020

For the 2020 tax year, taxpayers are not required to take required minimum distributions (RMDs) from IRA, 401k, and other defined benefit plans. According to a June 23, 2020 IRS News Release, “The CARES Act enabled any taxpayer with an RMD due in 2020 from a defined-contribution retirement plan, including a 401(k) or 403(b) plan, or an IRA, to skip those RMDs this year. This includes anyone who turned age 70 1/2 in 2019 and would have had to take the first RMD by April 1, 2020.”

Relief for taxpayers that need Withdrawals or Loans from Retirement Plans

The remaining topics below apply to qualified individuals meeting certain criteria spelled out in this IRS News Release, simplified here to be taxpayers with family members either diagnosed with COVID-19 or had work hours or income reduced as a result of COVID-19.

Avoid the 10% Early Withdrawal Penalty on Distributions: Qualified taxpayers can avoid the 10% early withdrawal penalty. Otherwise, taxpayers that withdraw funds from retirement plans before turning 59 ½ years old face a 10% early withdrawal penalty in addition to the amount withdrawn being taxable income.

Spread Tax on COVID-19 Related Withdrawals Over 3 Years: Qualified taxpayers have the option to include the taxable income from COVID-19 related withdrawals over 3 years (one-third each year) rather than paying taxes on the full amount of the loan in the first year.

Loans from Workplace Retirement Plans: The IRS’ News Release says, “Individuals eligible to take coronavirus-related withdrawals may also, until September 22, 2020, be able to borrow as much as $100,000 (up from $50,000) from a workplace retirement plan, if their plan allows. […] For eligible individuals, plan administrators can suspend, for up to one year, plan loan repayments due on or after March 27, 2020, and before January 1, 2021. A suspended loan is subject to interest during the suspension period, and the term of the loan may be extended to account for the suspension period.”

Are taxpayers able to take Loans from an IRA?

No. The IRS’ News Release reiterates “Loans are not available from an IRA.” Individuals are able to make 60 day rollovers of funds withdrawn from an IRA. It is possible the IRS may extend the 60 rollover window or otherwise allow taxpayers to re-contribute the amount withdrawn to their IRA account, but without further guidance from the IRS, it may not be worthwhile to withdraw amounts from your IRA.

Discuss this Information with your Tax & Finance Professionals

Please note: the information on this website is intended to provide general advice to start the discussion with your tax and finance professionals. The information on this website may not apply to your specific situation. Only a experienced professional with the details of your specific situation can advise you on making the best decision. Contact your tax and finance professionals to discuss the information on this site to make an informed decision.

Should your business be an S-Corporation?

Post author By John Sutton, CPA
Post date September 2, 2020

S-Corporations are one of the most commonly recommended forms for new business owners to save taxes, however; it’s important not to rush into structuring your business as an s-corporation as you may not realize these benefits until your business reaches significant profitability. You should weigh the tax savings of having an s-corporation with the additional costs associated with the business.

Tax Savings

The S-Corporation structure allows business owners to avoid self-employment taxes on the net income from their businesses.

What are Self-Employment taxes? These are Social Security & Medicare taxes on the net income of self-employed individuals. These same taxes, at the same rates, apply to employees’ wages but with some important differences. With employees, the employer withholds the employee share of Social Security tax (6.2%) and Medicare tax (1.45%) of the employees wages and pays the employer share of these same taxes at the same rates on the employees’ wages. Self-employed individuals, on the other hand, pay both the employee share and employer share on the net income of their businesses. This adds up to a significant amount, 15.3% of the net income from their businesses. Further, these taxes are in addition to income taxes on this income.

Understandably, if you can avoid giving up 15.3% of your net income it would be a no-brainer to do it. However, you shouldn’t rush into structuring your business as an s-corporation as there are additional costs associated with having an s-corporation. You should make sure the tax savings of the s-corporation structure outweigh the additional costs.

There is a limit on Social Security taxes that apply to employees’ wages as well and self employed individuals’ net income. The wage limit for 2021 is $142,800. This means the 12.4% tax savings on Social Security taxes included in self-employment taxes only applies on net income up to this amount. As discussed in more detail later, s-corporation owners are required to pay themselves wages for services performed in their s-corporations that will be subject to payroll taxes including Social Security and Medicare taxes, further reducing the tax savings.

Costs of S-Corporations

Increased tax preparation Fees: Having an s-corporation makes your tax situation more complex compared to sole proprietorships. With a sole proprietorship, the activity for your business is reported directly on your personal tax return on a Schedule C. With an s-corporation, your business is required to file an s-corporation tax return, separate from your personal tax return. This will result in additional tax prep fees and cost to meet compliance.

State formation and annual registration fees: An S-Corporation requires you to have either an LLC or a corporation that elects to be taxed as an s-corporation with the IRS. This means additional costs in fees paid to your state to form the business as well as annual fees your state charges in order for your business to stay registered with your state. Additionally, aspiring business owners often pay professionals to help them with forming their business and obtaining tax ID numbers, payroll accounts, and other registrations for their future businesses as it’s typically less costly to do things correctly the first time around.

Payroll Costs: owners of s-corporations are required to be paid wages for services they perform in their businesses. This requires using a payroll service to file payroll reports and making payroll tax payments for the s-corporation.

What if my business has a loss?

Many new businesses are not profitable their first year in business. If there is no net income, there are no self-employment taxes that would be due. The additional costs of having an s-corporation compared to a sole proprietorship can weigh heavy on new business owner struggling to grow their business and make ends meet.

Compliance Requirements of S-Corporations

Owners that perform services in their s-corporations are required to pay themselves a reasonable salary for the services they perform in the business. A good rule of thumb to use for determining how much of a salary is reasonable is to ask, “How much would I have to pay someone with the necessary experience to perform the services I perform in my business?” You should take into account the same factors that would apply to compensating any employee, such as educational background, professional experience, hours, and cost of living for your area.

Is an S-Corporation Owner able to Limit their Wages to the Net Income of the Business?

Yes, you’re not required to create a loss in your business just to pay yourself enough wages to meet the compliance requirement of paying yourself a reasonable salary.

When to Treat Your Business as an S-Corporation

As you may expect, you should make the switch when the tax savings of the s-corporation structure outweighs any costs of having the s-corporation. This means waiting until a level of profitability from your business in excess of the reasonable salary you would be required to pay yourself for services you perform in your business.

Planning the Switch to Treat Your Business as an S-Corporation

You can start with a different business structure, such as a sole proprietorship, and make the decision to form an LLC or corporation in a later year, when the business reaches a level of profitability that makes sense for the business to be treated as an s-corporation.

By default, an LLC that has only one owner is treated as a sole proprietorship for tax purposes until electing to be an s-corporation. This can result in a number of advantages; you won’t be required form a new entity later on when you decide to make the switch to an s-corporation, you’ll start with a business structure that may offer limited legal liability in the case of legal issues, and it keeps your tax returns simple and associated tax prep fees down since the activity is reported directly on your personal tax return until making the switch to be an s-corporation.

Contact me to discuss this topic in further detail