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Business Use of a Vehicle

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.

Contact me to discuss this topic in further detail

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.

Education Planning & Tax Benefits

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.

Contact me to discuss this topic in further detail

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.

2020 Retirement Plan Relief – COVID-19

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?

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

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.