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Sole Proprietor Tax Tips: Treat Yourself Like an Employee

Special to the Las Vegas Business Press: Many entrepreneurs start new business ventures while still balancing a full-time day job along with managing extensive start-up responsibilities. They often pay their mortgage out of their side business’ earnings along with daily living expenses or supplies. To a sole proprietor, co-mingling their business and household budget might seem inevitable. If this is you, take a step back and treat yourself like an employee.

Successful entrepreneurs look at their company from the perspective of a business owner with employees, including themselves. For instance, employees are required to submit an expense report to make certain they are properly reimbursed by the company. A business requires backup and a paper trail for any items purchased for the company. A sole proprietor should require the same for themselves and doing so can reduce unforeseen issues with business risks, taxes and substantiation.

Co-Mingling: Break the Habit!

The first step in breaking the habit of co-mingling funds is to set up separate personal and business bank accounts. A separate business account will help properly document business transactions. It’s more efficient and can protect your personal bank account from additional inquiries from the IRS during audits. In addition, if the bookkeeping software ever fails, the statements from the dedicated business bank account could serve as back up for business expenses and deposits, without the risk of reconstructing personal activities from business transactions.

The IRS does not typically audit the entire tax return, but hot items such as auto, travel and entertainment are often scrutinized. Small businesses have a higher probability of being audited by the IRS because of various points of tax doctrine and lack of sophistication on the tax returns. These good habits for reporting could save unnecessary pain during an audit, should questions arise.

Track Expenses & Deductions

An important step for a sole proprietor is to create and track invoices for business expenses. Technically, only deductions directly related to business expenses require documentation. For example, if you are taking your car registration, mortgage payments and mileage as a business deduction, one must document the substantiation of business versus personal amounts that could be deductible.

Automobile usage is one area where entrepreneurs often mingle personal and business expenses. If you were to treat yourself like an employee, an employee would be required to submit an odometer reading and receipts to document vehicle usage. Would an employer actually reimburse an employee if they provided no substantiation? Absolutely not! The same standard policy should be followed for a sole-proprietor’s start-up business. Decide whether the actual cost or standard mileage methods are better for the allowed deductions. Either way, proper substantiation of business usage is a vital business practice to require.

A huge risk for sole proprietors is substantiation of directly related business expenses and planning for tax payment requirements, especially the unexpected self-employment tax (Social Security and Medicare). Accompanying important decisions can be inadvertently ignored for required estimated tax payments, medical insurance and possible retirement plan options.

Remember businesses always receive a dollar for dollar deduction. Employees who do not receive reimbursements for employee expenses are only allowed a miscellaneous itemized deduction, which is limited to the excess of two percent of adjusted gross income. Therefore, maximize all options for direct business expenses rather than the un-reimbursable approach from your employment.

Add Extra Protection

In order to protect deductions and limit excess taxes, it may be advantageous to create a business entity. A sole proprietor with personal items mixed together with business may receive minor differences for tax breaks and incentives, but they are also eligible for little liability protection from litigation. A sole proprietor with possible risk should consider an appropriate business entity by applying the same principles for substantiation and documentation.

Moving from a sole proprietor to a protected entity such as an LLC or an S-corp is the next step for additional separation and security. This provides a protective fence around the business owner from creditors and lawsuits. Both LLC’s and S-Corporations, if properly administered, can provide entity protection for the owners.

As a business grows, a sole proprietor should adjust and restructure to fit the revenue, expense and risk of the business. Seek professional advice from experts who can help you proper business owner decisions. Consult with an experienced CPA that can recommend proper business entity and tax structures and suggest the most advantageous tax strategies along the way.

Scott Taylor, CPAis a Tax Principal at Piercy Bowler Taylor & Kern, a large local accounting firm. Scott has never seen a three-pointer he didn’t want to take, and he is very sure his five children did not inherit their musical abilities from him. He can be reached at staylor@ptbk.com.

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PATH Extended Bonus Depreciation - But Should You Take It?

Bonus depreciation allows businesses to recover the costs of depreciable property more quickly by claiming additional first-year depreciation for qualified assets. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) extended 50% bonus depreciation through 2017.

The break had expired December 31, 2014, for most assets. So the PATH Act may give you a tax-saving opportunity for 2015 you wouldn’t otherwise have had. Many businesses will benefit from claiming this break on their 2015 returns. But you might save more tax in the long run if you forgo it.

What assets are eligible?

For 2015, new tangible property with a recovery period of 20 years or less (such as office furniture and equipment) qualifies for bonus depreciation. So does off-the-shelf computer software, water utility property and qualified leasehold-improvement property.

Acquiring the property in 2015 isn’t enough, however. You must also have placed the property in service in 2015.

Should you or shouldn’t you?

If you’re eligible for bonus depreciation and you expect to be in the same or a lower tax bracket in future years, taking bonus depreciation (to the extent you’ve exhausted any Section 179 expensing available to you) is likely a good tax strategy. It will defer tax, which generally is beneficial.

But if your business is growing and you expect to be in a higher tax bracket in the near future, you may be better off forgoing bonus depreciation. Why? Even though you’ll pay more tax for 2015, you’ll preserve larger depreciation deductions on the property for future years, when they may be more powerful — deductions save more tax when you’re in a higher bracket.

We can help

If you’re unsure whether you should take bonus depreciation on your 2015 return — or you have questions about other depreciation-related breaks, such as Sec. 179 expensing — contact us.

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