Taking a customer to lunch, dinner or the theater is part of doing business. And often, a lot of fun. But company owners may find that claiming such entertainment expenses as income tax deductions is complicated, and maybe painful.
Many owners find out when they're compiling their income tax returns that they can't deduct the full amount of a meal or event. Maybe they can't deduct any of it.
IRS Publication 463, Travel, Entertainment, Gift and Car Expenses will give you a good grounding in deductions for entertainment expenses. And, as with any tax matters, it's always a good idea to consult a tax professional like an accountant or an attorney to be sure you're following the rules.
Here's an overview of what the IRS allows, and doesn't allow, for business entertainment deductions:
WATCH OUT FOR UNPLEASANT SURPRISES
If you took your client out for a $300 dinner and consoled yourself with the idea that at least you got a big deduction, the truth is, you can claim only $150 on your return. The tax code allows only 50 percent of an entertainment expense to be deducted.
And, if $300 would be considered a lavish expense considering the line of work you're in and where your company is located, the IRS might limit how much of the check you can deduct. The amount the government allows will still be subject to the 50 percent rule.
Let's say the meal takes place during a business trip. While your airfare and hotel bill may be fully deductible, only half of the restaurant check can be claimed.
WHAT'S THE REAL REASON YOU'RE ENTERTAINING CUSTOMERS?
It's so common for business associates, especially when they're friends, to get together for dinner or a drink and compare notes about how things are going. Or ask each other for advice. But according to the IRS, the bills for these occasions can't be deducted.
In order to claim an entertainment deduction, the government requires that the main purpose of a dinner or other form of entertainment be "the active conduct of business." And an owner must have "more than a general expectation of getting income or some other specific business benefit at some future time."
In other words, if you're getting together just to network with a client or add some goodwill to the relationship, it might not pass the IRS' test. If you talk about a specific project or contract, you've got yourself a deduction.
Here's an exception: If the entertainment takes place before or after a business discussion, then you can deduct it. So let's say you make a presentation to a client and then go out to dinner and you don't discuss business during the meal. It's still deductible.
It's common for owners to bring their spouses and a customer's spouse to a big night out. Unless the spouses are an essential part of the business discussion, their meals and/or tickets aren't deductible.
TICKETS AND GOLF GAMES
If you take a customer to the theater or a baseball game, the same rules generally apply. But there can be exceptions, and that's why you need to read Publication 463. For example, if the ticket is to an event that will benefit a charitable organization -- local golf tournaments are often held for charitable reasons -- then you can deduct the full amount.
Many business owners will treat clients to a round of golf at the club they belong to. The fees they pay for a guest are deductible. But yearly or monthly membership dues for the club are not.
RECORDS, RECORDS, RECORDS
Many accountants say the biggest problems their clients have with entertainment expenses is that they don't keep good enough records. Many have a pile of receipts and credit card statements at the end of the year. But that won't be good enough for the IRS if it questions your deductions.
The government and tax professionals recommend that business owners keep a log or diary where they can enter their entertainment expenses. That's where you need to keep track of the business purpose of the meal or other event. If the expense is more than $75, you also need restaurant checks, hotel bills and other receipts to document the amount you're claiming.
Friday, March 4, 2011
Thursday, March 3, 2011
10 Tax Benefits For The Self-Employed
How would you like to reduce your taxable income while simultaneously increasing your financial independence? Starting your own business, whether on the side or full time, can be a great way to turn costs that you would incur anyway into legitimate, tax-deductible business expenses.
As an added bonus, the income you derive from your business can help make you less dependent on your employer (if not totally self-sufficient) and help you retire sooner. In this article, we’ll explore some common tax deductions available to the self-employed.
Some Common Tax-Deductible Expenses: Many self-employed tax benefits soften the blow of having to acquire things that an employer normally provides. In this way, the tax code helps to encourage entrepreneurship.
Self-Employment Tax Deduction: The self-employment tax refers to the employer portion of Medicare and Social Security taxes that self-employed people must pay. Everyone who works must pay these taxes, which for 2010 are 7.65% for employees and 15.3% for the self-employed (7.65% x 2). In 2011, taxes for self-employed filers are being reduced to 13.3%. Many people view the self-employment tax as a discouragement to entrepreneurship, but the IRS does a couple of things to reduce the sting.First, you get to deduct half of your self-employment taxes from your net income. Essentially, the IRS treats the self-employment tax as a business expense and allows you to deduct it accordingly. Second, you only incur self-employment tax on your net business income, or what’s left over after you subtract your business expenses.Finally, you only pay self-employment tax on 92.35% of your net business income in 2010. Thus, someone in the 25% federal tax bracket ends up with an effective self-employment tax rate of only 12.36%, not 15.3%. Remember, you’re paying the first 7.65% no matter who you work for, so the self-employment tax amounts to an extra 4.71% tax for someone in the 25% federal tax bracket, not an extra 7.65%. That’s a small price to pay for being your own boss, right?
Self-Employment Tax Deduction: The self-employment tax refers to the employer portion of Medicare and Social Security taxes that self-employed people must pay. Everyone who works must pay these taxes, which for 2010 are 7.65% for employees and 15.3% for the self-employed (7.65% x 2). In 2011, taxes for self-employed filers are being reduced to 13.3%. Many people view the self-employment tax as a discouragement to entrepreneurship, but the IRS does a couple of things to reduce the sting.First, you get to deduct half of your self-employment taxes from your net income. Essentially, the IRS treats the self-employment tax as a business expense and allows you to deduct it accordingly. Second, you only incur self-employment tax on your net business income, or what’s left over after you subtract your business expenses.Finally, you only pay self-employment tax on 92.35% of your net business income in 2010. Thus, someone in the 25% federal tax bracket ends up with an effective self-employment tax rate of only 12.36%, not 15.3%. Remember, you’re paying the first 7.65% no matter who you work for, so the self-employment tax amounts to an extra 4.71% tax for someone in the 25% federal tax bracket, not an extra 7.65%. That’s a small price to pay for being your own boss, right?
Home Office: The home office deduction is one of the more complex deductions. In short, any workspace that you use regularly and exclusively for your business, regardless of whether you rent or own, can be deducted as a home office expense. While you are basically on the honor system, you should be prepared to defend your deduction in the event of an audit. Make sure to prepare a specific map of your workspace, with the correct measurements, in case you are required to submit this information to receive your deduction. And don’t forget to include your restroom, as the government expects your home company to need facilities too. The expenses you can deduct for your home office include the business percentage of rent or mortgage, property axes, utilities, homeowners insurance and home maintenance that you pay during the year. For example, if your home office occupies 15% of your home, then 15% of your annual electricity bill becomes tax deductible.
Health Insurance Premiums: The tax code makes it difficult for most people to deduct the cost of their health insurance premiums. However, if you are self-employed, pay for your own health insurance premiums, and were not eligible to participate in a plan through your spouse’s employer, you can deduct all of your health, dental and long-term care insurance premiums. What’s more, you can also deduct premiums that you paid to provide coverage for your spouse and dependents. This is technically considered a personal deduction, not a business deduction, but it is only available to the self-employed.
Meals and Entertainment: To deduct meals and entertainment (meals being considered the most common business entertainment expense), you must conduct business with the person you are entertaining during the meal/event or immediately before or after it. Unlike other deductions, these expenses are only 50% deductible, not 100%. Examples of deductible expenses in this category include tickets to a sporting event, the cost of a meal (with beverages, tax and tip), or the cost of a game of golf. Make sure to keep meticulous records of what business activity you conducted, when, with whom, and how it directly relates to the entertainment expense; keep your receipts. This area is audit-prone because many people try to cheat the system here.
- Internet and Phone: Regardless of whether you claim the home office deduction, you can deduct your business phone, fax and internet expenses. The key here is to only deduct the expenses that are directly related to your business. If you have only one phone, you shouldn’t deduct its basic monthly charge, which you would likely incur whether you worked form home or not. You should only deduct costs that specifically relate to your business. If you have a second phone line that you use exclusively for business, however, you can deduct 100% of that cost. By the same token, you would only deduct your monthly internet expenses in proportion to how much of your time online is related to business – perhaps 25%.
- Interest on Business Loans and Business Credit Card Interest: It’s a no-brainer that interest on a typical business loan from a bank is a tax deductible business expense. However, normally, credit card interest is not tax deductible. If you make business purchases on your business credit card and incur interest, however, this credit card interest is tax deductible. That said, it’s always cheaper to spend only the money you already have and not incur any interest expenses at all.
- Car: When you use your car for local business trips, your vehicle expenses for those trips are tax deductible. Transportation expenses are considered an audit flag, however, so make sure you only take what you are entitled to and that you keep excellent records.You can either deduct the standard mileage rate (determined annually by the IRS) or deduct your actual expenses. The standard mileage rate is the easiest because it requires minimal record-keeping or calculations. Keep track of the business miles you drive and the dates you drove them. Then, multiply the total miles by the standard mileage rate (50 cents per mile in 2010). This amount is your deductible expense. To use the actual expense method, you must calculate the percentage of driving you did for business over the course of the year as well as the total cost of operating your car during the year, including gas, oil changes, repairs and car insurance.
- Publications: The cost of specialized magazines and books directly related to your business is tax deductible. For example, a daily newspaper would not be specific enough to be considered a business expense, but a subscription to the CPA Journal would be tax-deductible if you are a Certified Public Accountant (CPA). (And yes, some people are passionate about accounting.)
- Travel: Overnight travel outside your city limits for business purposes is tax deductible.To be considered a business trip, your trip should have a specific business purpose planned before you leave home, and you must actually engage in some business activity – such as finding new customers, meeting with clients, or learning new skills directly related to your business – while you are on the road.Taxpayers should be particularly careful to maintain complete and accurate records and receipts for their business travel expenses and the business activities they performed, as this deduction often draws attention from the IRS. Deductible travel expenses include the cost of transportation to and from your destination (such as plane fare), the cost of transportation at your destination (such as a car rental or subway tickets), lodging and meals. You are even allowed to travel luxuriously, taking first class flights or staying at four-star hotels, but remember, it’s you, not the IRS, who will be paying the bulk of your travel costs.100% of your travel expenses for business are deductible, except for meals and entertainment, which are limited to 50%. If your trip does not involve an overnight stay, you can still deduct the cost of transportation, but you cannot deduct the cost of meals as a travel expense. If your trip combines business with pleasure, however, things get a lot more complicated.
- Education: Any education expenses that you want to deduct must be related to your existing business – that is, not just any class is deductible, even a class meant to prepare you for a new line of work. If you are a real estate consultant, taking a course called “Real Estate Investment Analysis” to brush up on your skills would be tax deductible, but a class on film noir would not.
- Self-Employed Retirement Plans: Self-employed retirement plans – such as SEP-IRAs, SIMPLE IRAs, Keogh plans and solo 401(k)s – are particularly valuable for reducing your tax bill now and racking up tax-deferred retirement savings for later. In 2010, you could feasibly contribute 20% of your net self-employment income (based on a maximum net income of $245,000 in 2010) plus a $16,500 elective salary deferral to a solo 401(k) – that’s a total maximum contribution of $49,000!Those who don’t make quite as much can contribute to both a self-employed retirement plan and an IRA (as long as you are within the IRA’s income phase-out limits). And, if you still have a day job where your employer doesn’t offer any kind of retirement plan, starting your own profitable business will get you out of the only-$5,000-a-year rut (the maximum annual IRA contribution) and allow you to start saving more for retirement.
- Conclusion: Most small business deductions are a bit more complicated than can be explained in this brief overview, but this is a good introduction to the basics. Remember, any time you’re not sure whether an expense is a legitimate business expense, ask yourself, “Is this an ordinary and necessary expense in my line of work?” This is the same question the IRS will ask when examining your expenses if you get audited. If the answer is no, don’t take the deduction. If you’re not sure, seek professional help with your tax return from a CPA.
Wednesday, March 2, 2011
Five Unusual Business Tax Write-Offs You've Probably Been Missing
Entrepreneurs might find tax time a bit less taxing this year and next due to some new write-offs covering a range of common expenses for growing businesses.
Here's a quick look at five breaks aimed at certain businesses that you'll want to know about:
Here's a quick look at five breaks aimed at certain businesses that you'll want to know about:
1. New-job creators
A new-hires tax credit can give employers a break on their payroll tax if they hired new workers into new job slots between Feb. 3, and Dec. 31, 2010. These workers can't have replaced people who left. They have to add to your headcount. And they have to have been unemployed for 60 or more days prior to you hiring them.
A new-hires tax credit can give employers a break on their payroll tax if they hired new workers into new job slots between Feb. 3, and Dec. 31, 2010. These workers can't have replaced people who left. They have to add to your headcount. And they have to have been unemployed for 60 or more days prior to you hiring them.
If your business qualified for this deduction, which amounts to 6.2% of your payroll tax, you should have taken from your quarterly payroll tax estimates during 2010. But if you missed it, it's worth going back and amending those quarterly payments to account for the credit. What's more, an additional $1,000 general business tax credit may be available in 2011 if you keep these new employees for 52 weeks or longer. So if you qualified for the first credit, make sure you qualify for the second one as well,
2. Cell-phone users
Mobile phones used to be counted among items the Internal Revenue Service refers to as "listed property," such as laptops or cars that might be purchased for work or provided by an employer but that lend themselves to personal use. Users had to keep track of their business and personal use for these items and write off the former proportionally.
The IRS has removed cell phones from this onerous list, which means that if you provide employees with cell phones or use one for business yourself, "Your business can write it off directly," says Rice.
3. Large sport-utility vehicle buyers
This is a great break for entrepreneurs who need an SUV that's heavier than 6,000 pounds for their business, such as a Chevy Tahoe or Ford Explorer. If you bought or plan to buy a new one between Sept. 8, 2010, and Dec., 31, 2011, you may be able write off the full value in a single tax year, rather than having to depreciate it over a few years, as has been the case previously.
Mobile phones used to be counted among items the Internal Revenue Service refers to as "listed property," such as laptops or cars that might be purchased for work or provided by an employer but that lend themselves to personal use. Users had to keep track of their business and personal use for these items and write off the former proportionally.
The IRS has removed cell phones from this onerous list, which means that if you provide employees with cell phones or use one for business yourself, "Your business can write it off directly," says Rice.
3. Large sport-utility vehicle buyers
This is a great break for entrepreneurs who need an SUV that's heavier than 6,000 pounds for their business, such as a Chevy Tahoe or Ford Explorer. If you bought or plan to buy a new one between Sept. 8, 2010, and Dec., 31, 2011, you may be able write off the full value in a single tax year, rather than having to depreciate it over a few years, as has been the case previously.
"This is a loophole for a lot of taxpayers," says Rice.
If you really do need this kind of horsepower, this credit could go a long way toward defraying the cost of owning one of these gas guzzlers.
4. New-equipment buyers
In a bid to get business owners to open the till and spend a little, the IRS is offering "bonus depreciation," which is the temporary ability to write off more equipment in a bigger way.
4. New-equipment buyers
In a bid to get business owners to open the till and spend a little, the IRS is offering "bonus depreciation," which is the temporary ability to write off more equipment in a bigger way.
If a business bought or buys new equipment between Sept. 8, 2010, and Dec. 31, 2011, it may be able to write off 100% of the cost all at once. We're talking big items like computers, office furniture and manufacturing equipment. "This was enacted to help manufacturers and help to spark the economy," Rice says. For this reason, the items have to be purchased new, not used, and put into use during that same period.
Better still, the write-off has no limits on how much you spend and isn't capped by your taxable income, as is the case with the write-off rule this one temporarily supersedes, says Rice.
5. Employee health-insurance buyers
The small employer health-care credit lets very small businesses write off 35% of the premiums you pay for employees' health insurance. It sounds great, and it is, if you qualify, but there are limits, says Anderson.
5. Employee health-insurance buyers
The small employer health-care credit lets very small businesses write off 35% of the premiums you pay for employees' health insurance. It sounds great, and it is, if you qualify, but there are limits, says Anderson.
To qualify, a business must have fewer than the equivalent of 25 full-time workers. So, for example, you could have 50 part-time workers. The average annual salary across your employees can't top $50,000, and you must be covering more than half of your workers' health-care costs.
The credit will rise to 50% in 2014, but it will also phase out for employers who pay an average annual employee wage between $25,000 and $50,000. "It's meant to give a tax credit to business owners who provide health insurance to lower-wage workers," says Rice, "But it's too onerous to qualify for it. It isn't going to get a lot of play [in places where wages are high]."
Even so, with the number of new tax breaks this year, many entrepreneurs are likely to find at least one that could come in handy this spring.
Don't Let the IRS Reclassify Your Business as a Hobby
Artists, photographers, travel writers and horse breeders might seem to have fun businesses, but not where the Internal Revenue Service is concerned.
If you're a sole proprietor filing a Schedule C in industries that are generally seen as recreational such as quilting or jewelry making, and your business hasn't made a profit in at least three of the past five consecutive years, the IRS may audit your business and reclassify it as a hobby. (For horse breeders and trainers, the rule is at least two of the last seven years must be profitable.)
With tax time around the corner, a number of struggling businesses may fall into this predicament -- after the worst recession to hit the U.S. since the Great Depression laid siege to many small companies' finances.
If your business gets reclassified as a hobby, you may be forced to kiss some valuable tax deductions goodbye. For instance, you could lose your ability to write off business losses and expenses against other income from, say, a day job. What's more, since the IRS can go back three years in an audit, you may face a really big tax bill as well as the inability to write off losses from your “hobby” in the current tax year and into the future.
A lot of owners assume this reclassification is automatic -- that having more than three years of losses in five consecutive years or three consecutive years of losses will blow you out of the water no matter what. Fortunately, they're wrong. It's not automatic. Instead, if you are selected for an audit, the IRS will typically give you a chance to prove your profit motive and whether your fun business is a legitimate enterprise.
Here are nine tips for helping persuade auditors that you're serious about running and building a business -- and not just playing at it:
If you're a sole proprietor filing a Schedule C in industries that are generally seen as recreational such as quilting or jewelry making, and your business hasn't made a profit in at least three of the past five consecutive years, the IRS may audit your business and reclassify it as a hobby. (For horse breeders and trainers, the rule is at least two of the last seven years must be profitable.)
With tax time around the corner, a number of struggling businesses may fall into this predicament -- after the worst recession to hit the U.S. since the Great Depression laid siege to many small companies' finances.
If your business gets reclassified as a hobby, you may be forced to kiss some valuable tax deductions goodbye. For instance, you could lose your ability to write off business losses and expenses against other income from, say, a day job. What's more, since the IRS can go back three years in an audit, you may face a really big tax bill as well as the inability to write off losses from your “hobby” in the current tax year and into the future.
A lot of owners assume this reclassification is automatic -- that having more than three years of losses in five consecutive years or three consecutive years of losses will blow you out of the water no matter what. Fortunately, they're wrong. It's not automatic. Instead, if you are selected for an audit, the IRS will typically give you a chance to prove your profit motive and whether your fun business is a legitimate enterprise.
Here are nine tips for helping persuade auditors that you're serious about running and building a business -- and not just playing at it:
- Keep a set of books -- preferably on accounting software or on a spreadsheet. Generate profit-and-loss statements and comparative profit-and-loss statements to measure the growth of your business against prior years. Chart future projections, and write a plan for turning the business into a profitable enterprise. Keep all your notes and financial statements to present during an audit.
- Be in compliance with local, state and federal requirements by obtaining all required licenses, insurance and permits. Maintain a file of all certificates and licensing information to present during an audit.
- Keep a mileage log or at least an appointment book to substantiate any automobile deductions. Follow the rules for deducting commonly flagged expenses like travel, meals and entertainment.
- Improve your skills. Attend classes, trade shows and conventions. Keep all registration forms and fliers to prove your attendance and the nature of the event.
- Open a separate business bank account. Deposit all sales revenue into this account and pay all business expenses from this account. If you don't have enough sales revenues to cover the expenses, don't start paying business bills from another account. Instead, transfer funds from your personal accounts to cover the bills.
- Advertise. Keep copies of every advertisement you place. During an audit, these records will go a long way toward proving that you're serious about the business.
- Network. Get out there among your peers and exchange ideas. You can do this by joining a local chamber of commerce and other professional organizations.
- Do some thinking. Be ready to explain to the IRS why your business is a serious enterprise. Perhaps you're nearing retirement and are looking to turn a part-time venture into a full-fledged business? And why exactly aren't you showing a profit? The recent recession is a good reason many businesses aren't moving forward. And there is nothing wrong with admitting that you're having trouble getting the hang of being a good businessperson. After all, entrepreneurial skills are often acquired.
- Stand your ground. If you're being audited, and you find yourself on the losing end of the argument, stop the audit. Tell the auditor that you need to discuss the matter with a tax professional before you continue. The auditor must honor your request and give you adequate time before resuming the audit.
Insurance related Tax Deductions You May Be Missing
When it comes to filing taxes, getting the best returns is not about skill - it's about what you know. Unfortunately, many taxpayers miss out on deductions and credits simply because they just aren't aware of them. Several of the most overlooked deductions pertain to health and medical expenses and insurance premiums. Are you paying more tax than you need to? Read on for some deductions you may be missing.
Tips for Individual Filers
Disability Insurance Disability insurance is probably the most common type of premium that is overlooked as a tax deduction. If you deduct the premium, any benefits paid from the policy will be considered taxable income. By contrast, policy benefits will not be taxable if you do not deduct the premium, and some taxpayers use this arrangement so that they can receive tax-free benefits if they become disabled.
Health Savings Accounts Another insurance–related tax perk that people without access to traditional group health coverage should be aware of is health savings accounts, which combine a tax-advantaged savings element with a high-deductible health insurance policy. All HSA contributions, up to the maximum permitted by law, are tax-deductible, even for those who do not itemize, and earnings accumulate tax-free. All proceeds withdrawn from the account are tax-free, provided they are used to pay for qualified medical expenses.
Timing Medical Expenses Because medical expenses are only deductible if they exceed 7.5% of adjusted gross income, few taxpayers accumulate enough unreimbursed bills in one year to qualify for the deduction. If you have substantial medical bills pending, you can boost your deduction by scheduling other medical procedures or expenses in the same year.
For example, someone with annual adjusted gross income of $40,000 would be able to deduct any medical expenses not covered by health insurance in excess of $3,000. The deduction might include $17,000 of a $20,000 operation not covered by insurance, plus any other unreimbursed expenses incurred in the same year, such as routine medical checkups, dental procedures, chiropractic treatments and even contact lenses and prescription drugs.
However, if you get a check the following year from your insurance company, you will have to declare the amount of the deduction that was reimbursed as income the following year. For example, if you deducted $17,000 for a surgery this year and your insurance company sent you a check for the surgery the next year, this would have to be declared as income in the year the check arrives. If there's a chance you may get medical expenses covered by your insurance company in the future, do not declare this deduction until you know whether the insurance company will reimburse you. You can always submit an amended return for the year you would have received the deduction if your insurance claim is denied.
Receipt of Unemployment or Workers’ Compensation Insurance Benefits It is important to discern unemployment benefits from a state unemployment agency from workers' compensation, which is awarded to workers who cannot perform their duties as a result of injury. Unemployment benefits are always taxable, as they are considered a replacement of regular earned income, and should be reported on IRS Form 1040. Workers' compensation is never declarable as income.
Deductions for Businesses and Self-Employed Taxpayers Self-employed taxpayers and other business entities can deduct business-related insurance premiums of any kind, including health, disability and dental insurance premiums as well as legal and liability coverage. Vehicle insurance can also be deducted, if the taxpayer is elected to report actual expenses and is not taking the standard mileage rate.
Life Insurance Life insurance premiums are deductible as a business-related expense, and the death benefit is generally tax-free for individual policy owners. Although death benefits for business-related beneficiaries are often tax-free as well, there are certain situations in which the death benefit for corporate-owned life insurance can be taxable. However, employers offering group-term life coverage to employees can deduct the first $50,000 of premiums that they pay, and amounts up to this limit are not counted as income to the employees. Life insurance premiums can also often be deducted for most types of non-qualified plans, such as deferred compensation or executive bonuses. Usually, the premiums are considered compensation for key executives under the rules of these plans. However, in some cases the deduction cannot be taken until the employee constructively receives the benefit.
Other Qualifying Plans Nonqualified plans aren’t the only type of retirement savings vehicle that can be funded with tax-deductible premiums. 412(I) plans are qualified, defined benefit plans that can provide substantial deductions for small business owners looking to catch up on their retirement savings and receive a guaranteed income stream. These plans are funded solely with insurance products such as cash value life insurance or fixed annuity contracts, and the plan owner can often deduct hundreds of thousands of dollars in contributions to these plans each year.
Finally, participants in standard qualified plans, such as 401(k) plans, can purchase a limited amount of either term or permanent coverage subject to specific restrictions. But the coverage must be considered “incidental” according to IRS regulations. In any type of qualified defined-contribution plan, the cost of whole life premiums for each participant must be less than 50% of the employer’s contribution amount, plus forfeitures.
For term and universal coverage, the limit is 25%. This is the only instance where individuals can purchase life insurance on a tax-deductible-basis (assuming the plan is a traditional plan and not a Roth plan.) Life insurance death benefits paid out of qualified plans also retain their tax-free status, and this insurance can be used to pay the taxes on the plan proceeds that must be distributed when the participant dies.
The Bottom Line This article only mentions a few of the more commonly overlooked deductions and tax benefits related to insurance for which business and individual taxpayers are eligible. Other deductions relating to compensation, production, depreciation of buildings and equipment are listed on the IRS website in various downloadable instruction manuals. For more information, visit http://www.irs.gov/ or consult your tax advisor.
Tips for Individual Filers
Disability Insurance Disability insurance is probably the most common type of premium that is overlooked as a tax deduction. If you deduct the premium, any benefits paid from the policy will be considered taxable income. By contrast, policy benefits will not be taxable if you do not deduct the premium, and some taxpayers use this arrangement so that they can receive tax-free benefits if they become disabled.
Health Savings Accounts Another insurance–related tax perk that people without access to traditional group health coverage should be aware of is health savings accounts, which combine a tax-advantaged savings element with a high-deductible health insurance policy. All HSA contributions, up to the maximum permitted by law, are tax-deductible, even for those who do not itemize, and earnings accumulate tax-free. All proceeds withdrawn from the account are tax-free, provided they are used to pay for qualified medical expenses.
Timing Medical Expenses Because medical expenses are only deductible if they exceed 7.5% of adjusted gross income, few taxpayers accumulate enough unreimbursed bills in one year to qualify for the deduction. If you have substantial medical bills pending, you can boost your deduction by scheduling other medical procedures or expenses in the same year.
For example, someone with annual adjusted gross income of $40,000 would be able to deduct any medical expenses not covered by health insurance in excess of $3,000. The deduction might include $17,000 of a $20,000 operation not covered by insurance, plus any other unreimbursed expenses incurred in the same year, such as routine medical checkups, dental procedures, chiropractic treatments and even contact lenses and prescription drugs.
However, if you get a check the following year from your insurance company, you will have to declare the amount of the deduction that was reimbursed as income the following year. For example, if you deducted $17,000 for a surgery this year and your insurance company sent you a check for the surgery the next year, this would have to be declared as income in the year the check arrives. If there's a chance you may get medical expenses covered by your insurance company in the future, do not declare this deduction until you know whether the insurance company will reimburse you. You can always submit an amended return for the year you would have received the deduction if your insurance claim is denied.
Receipt of Unemployment or Workers’ Compensation Insurance Benefits It is important to discern unemployment benefits from a state unemployment agency from workers' compensation, which is awarded to workers who cannot perform their duties as a result of injury. Unemployment benefits are always taxable, as they are considered a replacement of regular earned income, and should be reported on IRS Form 1040. Workers' compensation is never declarable as income.
Deductions for Businesses and Self-Employed Taxpayers Self-employed taxpayers and other business entities can deduct business-related insurance premiums of any kind, including health, disability and dental insurance premiums as well as legal and liability coverage. Vehicle insurance can also be deducted, if the taxpayer is elected to report actual expenses and is not taking the standard mileage rate.
Life Insurance Life insurance premiums are deductible as a business-related expense, and the death benefit is generally tax-free for individual policy owners. Although death benefits for business-related beneficiaries are often tax-free as well, there are certain situations in which the death benefit for corporate-owned life insurance can be taxable. However, employers offering group-term life coverage to employees can deduct the first $50,000 of premiums that they pay, and amounts up to this limit are not counted as income to the employees. Life insurance premiums can also often be deducted for most types of non-qualified plans, such as deferred compensation or executive bonuses. Usually, the premiums are considered compensation for key executives under the rules of these plans. However, in some cases the deduction cannot be taken until the employee constructively receives the benefit.
Other Qualifying Plans Nonqualified plans aren’t the only type of retirement savings vehicle that can be funded with tax-deductible premiums. 412(I) plans are qualified, defined benefit plans that can provide substantial deductions for small business owners looking to catch up on their retirement savings and receive a guaranteed income stream. These plans are funded solely with insurance products such as cash value life insurance or fixed annuity contracts, and the plan owner can often deduct hundreds of thousands of dollars in contributions to these plans each year.
Finally, participants in standard qualified plans, such as 401(k) plans, can purchase a limited amount of either term or permanent coverage subject to specific restrictions. But the coverage must be considered “incidental” according to IRS regulations. In any type of qualified defined-contribution plan, the cost of whole life premiums for each participant must be less than 50% of the employer’s contribution amount, plus forfeitures.
For term and universal coverage, the limit is 25%. This is the only instance where individuals can purchase life insurance on a tax-deductible-basis (assuming the plan is a traditional plan and not a Roth plan.) Life insurance death benefits paid out of qualified plans also retain their tax-free status, and this insurance can be used to pay the taxes on the plan proceeds that must be distributed when the participant dies.
The Bottom Line This article only mentions a few of the more commonly overlooked deductions and tax benefits related to insurance for which business and individual taxpayers are eligible. Other deductions relating to compensation, production, depreciation of buildings and equipment are listed on the IRS website in various downloadable instruction manuals. For more information, visit http://www.irs.gov/ or consult your tax advisor.
Beware of identity thieves when dealing with IRS
Ah, springtime. Baseball players headed south, birds are heading north, and Uncle Sam has come a knocking for his annual bite of your income.
Federal tax returns are not due this year until April 18 — a three-day extension on the normal due date.
That doesn't mean you have to procrastinate. For those of you filing early, remember that identity thieves are lurking — and nothing makes a scam artist salivate like tax season.
Why? Because tax returns contain all the information identity thieves need to make your life an unholy mess, including the golden ticket that can unlock all your deepest financial secrets: your Social Security number.
What does this mean for you, the responsible tax filer?
Be careful.
You should pay particular attention to where you drop your return in the mail.
Never leave the envelope out for the mailman to pick up. Always drop it in a secured mailbox, preferably one from which the mail will be retrieved soon. Ideally, you should send your return from the nearest post office.
If you're filing online, make sure you're using a secure computer with a solid firewall and updated anti-virus and anti-malware programs.
“Certainly don't do it from a Wi-Fi spot,” Rice said.
Because a Wi-Fi connection is not secure, other wireless computer users can install software that will allow them to view your information.
If you're using a tax preparation service, like H&R Block or Jackson Hewitt, watch how they handle your personal information. When discussing your taxes, make sure you are in a private, secure environment where no third party can hear.
If you are due a refund, make sure you have a mailbox that locks. If it doesn't, consider having your mail sent to a post office box, and retrieve your mail immediately. If you're traveling out of town, have a friend or relative pick up your mail so it doesn't sit around overnight.
Remember, the Internal Revenue Service never contacts individuals by e-mail. If you receive an e-mail purporting to be from the IRS, ignore it — it is a scam artist trying to get your identifying information.
The same goes for telephone calls. Never, ever give a caller personal financial information over the phone. If someone claims they're with the IRS and asks for a bank account number or your Social Security number, hang up. Call the IRS yourself and ask if it wants to talk to you.
If you fear your identity has been stolen, you should call the IRS Identity Protection Specialized Unit at 800-908-4490.
Why is it important to report a potential theft? If your Social Security number is stolen, the thief can use it to get a job. The thief's employer would then report income to the IRS using your number, which could make it appear as though you have not reported all of your earnings.
Even if you have no problems filing your returns, you're not done protecting your identification. Keep all your paperwork, including W-2 forms, receipts, and other documents, in a secure location in your house.
Experts advise keeping the tax return and supporting documents for seven years. Why so long? The IRS has three years from your tax-filing date to audit, and six years to challenge a claim.
Once the documents have outlived their usefulness, shred them.
“If you're using a shredder, make sure you use one that has a cross-cut or a diamond cut, not just a simple strip-cut shredder,” Rice said. “Someone who is resourceful could potentially paste those strips together. It's worth it to spend a few extra dollars on a different shredder.”
Keep in mind:
The IRS no longer sends taxpayers blank tax forms, so if you need a form you must download it from the agency's website at http://www.irs.gov/, or call 800-829-1040.
Federal tax returns are not due this year until April 18 — a three-day extension on the normal due date.
That doesn't mean you have to procrastinate. For those of you filing early, remember that identity thieves are lurking — and nothing makes a scam artist salivate like tax season.
Why? Because tax returns contain all the information identity thieves need to make your life an unholy mess, including the golden ticket that can unlock all your deepest financial secrets: your Social Security number.
What does this mean for you, the responsible tax filer?
Be careful.
You should pay particular attention to where you drop your return in the mail.
Never leave the envelope out for the mailman to pick up. Always drop it in a secured mailbox, preferably one from which the mail will be retrieved soon. Ideally, you should send your return from the nearest post office.
If you're filing online, make sure you're using a secure computer with a solid firewall and updated anti-virus and anti-malware programs.
“Certainly don't do it from a Wi-Fi spot,” Rice said.
Because a Wi-Fi connection is not secure, other wireless computer users can install software that will allow them to view your information.
If you're using a tax preparation service, like H&R Block or Jackson Hewitt, watch how they handle your personal information. When discussing your taxes, make sure you are in a private, secure environment where no third party can hear.
If you are due a refund, make sure you have a mailbox that locks. If it doesn't, consider having your mail sent to a post office box, and retrieve your mail immediately. If you're traveling out of town, have a friend or relative pick up your mail so it doesn't sit around overnight.
Remember, the Internal Revenue Service never contacts individuals by e-mail. If you receive an e-mail purporting to be from the IRS, ignore it — it is a scam artist trying to get your identifying information.
The same goes for telephone calls. Never, ever give a caller personal financial information over the phone. If someone claims they're with the IRS and asks for a bank account number or your Social Security number, hang up. Call the IRS yourself and ask if it wants to talk to you.
If you fear your identity has been stolen, you should call the IRS Identity Protection Specialized Unit at 800-908-4490.
Why is it important to report a potential theft? If your Social Security number is stolen, the thief can use it to get a job. The thief's employer would then report income to the IRS using your number, which could make it appear as though you have not reported all of your earnings.
Even if you have no problems filing your returns, you're not done protecting your identification. Keep all your paperwork, including W-2 forms, receipts, and other documents, in a secure location in your house.
Experts advise keeping the tax return and supporting documents for seven years. Why so long? The IRS has three years from your tax-filing date to audit, and six years to challenge a claim.
Once the documents have outlived their usefulness, shred them.
“If you're using a shredder, make sure you use one that has a cross-cut or a diamond cut, not just a simple strip-cut shredder,” Rice said. “Someone who is resourceful could potentially paste those strips together. It's worth it to spend a few extra dollars on a different shredder.”
Keep in mind:
The IRS no longer sends taxpayers blank tax forms, so if you need a form you must download it from the agency's website at http://www.irs.gov/, or call 800-829-1040.
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