Tax Advantages for the Self-Employed

There are some great advantages to being self-employed. Being self-employed allows for plenty of opportunities to minimize your taxable income by turning expenses you would have even if you weren’t self-employed into tax-deductible business expenses.

This article will give you some of the information you need to dramatically reduce your taxable income with a little work and planning.

Here are some of the great tax deductions that are available to the self-employed

1. Home office. This deduction is not the simplest one to pull-off. Fortunately, it is largely on the honor system; however, you should be prepared to defend it in the case of an audit. It is a deduction that is commonly attacked by the IRS because the requirements are difficult for many to maintain.

* Basically, any square footage that is used both regularly and exclusively for your business is tax deductible. This would include that portion of your home’s rent / mortgage, property taxes, insurance, utilities and home maintenance. So if your office is 20% of your home’s square footage, you could deduct 20% of all of those expenses.

2. Health insurance premiums. While this is technically a personal deduction, it is only available to the self-employed. In a nutshell, if you’re self-employed and not eligible to enroll in your spouse’s health plan, you can deduct your premiums from your income. This would include health, dental and long-term care insurance.

* This also applies to premiums paid for your spouse and dependants.

3. Automobile. This is a nice deduction that can really add up. You have 2 options available:

* Mileage method: In this case, you would simply keep track of the number of miles you drive for business related purposes. Then simply multiply the number of miles by the mileage rate provided by the IRS.

* Actual Expense method: You will have to determine the percentage of your mileage that was spent on business and then multiply that percentage by the total expenses related to your automobile. This would include, gas, repairs, oil changes, and more.

* Which method is best? The one that gives you the greatest deduction is best. In general, if you have an inexpensive car or a car that is paid off, then the mileage method is best. Otherwise, the actual expense method is usually the best.

4. Entertainment and meals. This expense is only deductible at 50%, but includes things like tickets to sporting events and the cost of a round of golf. You must be with a client or business partner and discuss some business, but this deduction can be used frequently with a little planning.

5. Self-Employed retirement plans. Contributions to self-employed retirement plans are tax deductible. This include retirement vehicles such as SEP-IRAs, solo 401(k)s, Keogh plans, and SIMPLE IRAs. In 2010, you could contribute up to 20% of your net income plus $16,500 to a solo 401(k). Based on the maximum allowable net income, that totals over $49,000 of contributions!

* It really pays to be self-employed when it comes to retirement deductions. Be sure you’re taking full advantage of your opportunities!

Being self-employed isn’t just about freedom from your boss and someone else’s time clock. It’s also about more freedom from the IRS. While this freedom isn’t complete, there are tax laws in place that really offer significant advantages to the self-employed.

Let the IRS help pay for your housing, car, food, entertainment, insurance, and retirement! It can take a little foresight and planning to really reap the benefits, but the benefits are certainly there.

Tax Tips for Homeowners

You may already know that you can deduct the mortgage interest you pay on your home, but what other tax advantages are lurking in that house?

One of the biggest challenges of owning a home is dealing with the tax laws, especially those around points and cost basis. Just a little bit of knowledge can really clear up these frequently confusing terms. Here’s the scoop on mortgage basis points and how they’re used in your home’s value, cost basis, and tax burden.

What are Points?

Points are fees that you pay in order to enter into a mortgage. Points are considered to be prepaid interest, and as such, you can deduct them. The issue is, can you deduct the full amount up front, or must you divide your deductions out over the life of the loan?

You can deduct all the points the first year if all of the following are true:

* The loan is used to purchase or build your primary home.
* Paying points is customary in your area.
* The points aren’t paid for appraisal fees, title fees, property taxes, or similar fees.
* You didn’t borrow the money to pay the points.
* The points were based on a percentage of the loan and that fact is easy to see.

Cost Basis

Cost basis is the original value of an asset for tax purposes. The cost basis is quite easy to calculate; it is simply the price you paid for the home plus any capital improvements that have been made. Then you would subtract any seller-paid points, depreciation, and losses.

Capital improvements would be anything that increases the home’s value. Capital improvements would include such things as swimming pools and adding a room.

Understanding the Tax Burden When You Sell

If you owned the home (and lived in it) for at least two out of the last 5 years, you most likely don’t owe any tax at all. A single person doesn’t pay tax on capital gains of less than $250,000; for married couples the limit is $500,000. So as a married couple, you could purchase a home for $100,000 and sell it for $600,000 and not owe any tax on the proceeds.

There are circumstances under which the two-year requirement is waived, such as health issues, divorce, change of employment, and more.

In these cases, the amount of the exemption is based on the number of months the home was lived in. So if you were single and lived there for 12 months, you would be entitled to an exemption of $125,000, or half of the deduction allowed if you had lived there the required two years.

Inherited Property

The cost basis on inherited property is the market value at the time of the owner’s death.

This is great, because it doesn’t matter how much your grandmother paid for her home back in 1960. If you inherited the home she paid $20,000 for, and it’s now worth $175,000 (when she died), you would not owe any tax on the proceeds even if you were to sell the home immediately.

While it’s likely that the related tax laws will change again (they always do), it’s always a good idea to understand your home’s cost basis and your potential tax liability. Sooner or later the information may be pertinent to your tax situation, so keep abreast of the tax implications and deductions for your home.

529 Plans – Send Your Kids to College and Save a Ton on Taxes

Paying for a child’s education is certainly one of the greatest gifts you can give. But the costs of higher education have been rising at a shocking rate. With in-state expenses at a public school averaging just below $20,000 per year, you may be wondering what you can do.

One excellent solution to ease the financial challenge of paying for college is the 529 College Savings Plan. These are state sponsored savings plans that allow for tax-free earnings. Contributions are not deductible for federal income tax purposes, but are deductible in many instances for state tax purposes.

To open a plan, here are some basics you’ll need to know:
1. Tax write offs can be huge. Every five years, account holders can write off up to $55,000 from their estate per beneficiary without having to pay federal gift tax. For married couples, the limit is $110,000.

* As an example, a wealthy couple with 5 grandchildren could deposit $550,000 ($110,000 x 5) towards their grandchildren’s education and eliminate that amount from their estate. They could do that every 5 years until the maximum is reached ($300,000+ per beneficiary in many instances).

2. You maintain control of the assets. If you decided to close the account, you would have to pay a 10% penalty and income tax on any earnings. The balance is yours to do with as you wish.

3. The beneficiary can be changed. If your son decides that he’s not going to college, the account can be reassigned to someone else. The account must be transferred to an eligible individual within the same family.

4. Different states, different plans. Each state has its own plan(s), and some are much better than others. But you can invest in nearly every other state’s plans.

* In theory, you could be an Arizona resident, invest in a Connecticut 529 plan, and send your child to school in Florida. A lot of flexibility is available, so be sure to shop around before you open an account.

The fees associated with the various plans are also important to consider. Some will be much higher than others. In fact, many experts consider the extra charges to be the most important criteria when choosing a plan. Some fees are incurred when opening the account; there are also annual maintenance charges.

If you know for certain where you want to send your child to school, many universities offer prepaid 529 plans. This would allow you to lock in the cost of future credit hours at the current rate. Unfortunately, there are penalties should you decide to later send your child somewhere else. So if you choose this option, be very sure where you’ll be sending your kid to college.

On the down side, investment options are rather narrow, and the ability to switch between available investment options is also limited. The tax code currently curtails changes to once per calendar year.

Like any investment, 529 plans may or not be right for you. There are numerous other options to finance a college education, each with their own benefits and limitations.

However, if you’ve evaluated your investment options thoroughly, you may find that a 529 plan is an excellent option to ease the burden of paying for a college education. The tax benefits are considerable, and you always maintain control of your account. With the rising cost of college, your kids will thank you for investing in their futures.

Investing and Tax Considerations

Managing the tax implications is a hallmark of good investing. But let’s face it, investing can be complicated and taxes are always complicated. Putting them both together doesn’t make it any easier. This article covers the basics, so you can keep as much of your investment earnings as possible.

Tax efficiency is simply how much of an investment’s return still remains after all the tax obligations have been taken care of.

A good general rule to remember is that the more an investment’s return is dependent on income rather than an increase in share price, the worse the tax burden usually is, or the less tax efficient it is.

Taxable or Non-Taxable

Investment accounts are classified as either taxable or non-taxable. If an account is taxable, then the taxes must be paid on investment income in the same year in which it is received. This would include bank accounts, money market mutual funds, and your basic individual or joint investment account.

Non-taxable accounts are free from taxes as long as the money stays in the account. When you start taking money out, your tax liabilities kick in. This would include any type of retirement account, like your 401(k) and IRA.

A good rule to follow is to use your non-taxable accounts for the less efficient investments and the taxable accounts for the more efficient investments.

The Effect of Your Tax Bracket

If you’re going to invest with taxes in mind, be aware of your tax bracket. You must determine your marginal income tax bracket and also whether or not you’re subject to the alternative minimum tax. The higher your tax bracket, the more important it is to be in tax efficient investments.

Current Income versus Capital Gains

There are also differences between taxes on current income and taxes on capital gains. Any current income is usually taxed at your tax bracket rate.

Capital gains are categorized as either short-term or long-term. Short-term investments are those held less than a year; long-term would be anything longer than a year. Typically, short-term gains are taxed as income and long-term gains are at the preferential rate.

Tax Treatment for Typical Investments

Consider these tax treatments for the investments you’re considering:
* Dividends are normally taxed at a lower preferential rate. So dividends are likely to be a better for an investor in a higher tax bracket than for one in a lower bracket.

* Bonds provide interest and are usually taxed at the marginal (income tax bracket) rate. This would not be a tax efficient investment for someone in a higher tax bracket.

* The gains realized from stocks that are held for over a year and then sold would be taxed at the preferential rate.

* Some investments with poor tax efficiency would include junk bonds and preferred stock. This is due to the high interest received and the high, fixed dividends that are received, respectively.

* High tax efficiency investments would include stocks and municipal bonds. Municipal bonds are not taxed at the federal level and the yields are quite low. Stocks are typically held for more than a year, so the gains are taxed at the preferential rate. Both can be held in retirement accounts, which would make them even more tax efficient.

Minimizing the tax burden on investments is well within the reach of any investor, even beginners. Simply take a look at your marginal tax bracket and the preferential tax rate and make a plan. If your marginal tax rate is relatively low, you have a lot more flexibility. If it is high, then more planning will really pay off.