Tax-related stressors can be easily and quickly dismissed by planning early. Below are some answers to common tax questions.
What deductions can a self-employed individual take?
To be deductible, a business expense must be both ordinary and necessary.
An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business.
An expense does not have to be indispensable to be considered necessary.
What investments can be made to help defer taxes?
The interest gained from state and local bonds is usually exempt from federal income taxes. These investments pay back at a lower interest rate than commercial bonds of similar quality.
Treasury Bonds are similarly exempt from state and local income tax, and can be a wise investment for those who are in high tax brackets and live in high-income-tax states.
What can be done if there is a large capital gain this year?
It may be advisable to hold onto the investment until next year to put the gain on next year's taxes. You may also want to sell off any investments that you have that are losing value at the moment to claim your losses.
What retirement plans are available to aid in the deferral of taxes?
You and your employees have the ability to invest some of the money that you would have paid in taxes and add it to your retirement fund.
You can defer a portion of your earnings and contribute them directly to your retirement account. As a self-employed individual you may want to look into a Keogh, or SIMPLE or Sep IRA.
If you are a business owner that offers a matching funds plan for employees, suggest that they save at least the same amount that you contribute to the plan.
In what other ways can annual income be deferred?
If you own your business you can postpone sending certain invoices to ensure that you will receive payment in the following tax year. This can help greatly if some of this income would push you into a higher tax bracket. You may also want to accelerate payments to benefit your taxes in the current year.
What documents should be kept tax purposes?
Hold onto your receipts and any other records that you may have of your income and expenses for at least four years.
How should these documents be separated and organized?
It is advantageous to categorize your expenses, separating business from personal expenses and income.
Here are some suggested categories:
What type of record-keeping system is best?
It depends on whether you are a business owner or employee. If you are an employee of a company, your system can be as simple as storing your records in separate folders.
Business owners may want to consider hiring a bookkeeper or accountant. Check the Financial Guide for Business on this website.
How long should documents be kept?
It is recommended that you keep these documents four years. Check the Retention Guide on this site for additional details.
How long should old tax returns be held on to?
During an audit the IRS will usually ask for the last few years of tax returns. It is recommended to keep these tax returns forever. Keeping your tax returns from one year to the next also helps you see what you claimed in previous years.
What other records should be kept?
Keep receipts for purchased goods that you plan to sell at a later date. This will help you correctly calculate your gain or loss on them.
You may also want to hold onto:
Are there available tax breaks for a child's education?
There are several ways to get tax credits toward your child’s education. However, you can only receive one type of relief for one item. Consult with your accountant or financial professional to determine which would be the most advantageous.
What is the education tax credit?
You must make a choice between two types of tax education credit.
What is a Coverdell (Section 530)?
A Coverdell (Section 530) is an education IRA. It differs from a traditional IRA in the following ways:
What is the best way to use the Coverdell (Section 530)?
You can open one Coverdell account per student in your family. However, other family members or family friends can also open a Coverdell IRA for your child’s educational purposes. There is no limit to the number of people that can open an account like this for a child.
The great thing about this is that the account can be transferred to another family member at any time. If the original child decides against going to college or is granted a scholarship, another family member can still utilize the money that has been saved.
What is a qualified tuition program?
A qualified tuition program—Section 529—is a college savings account. Money in the account is invested to cover the costs of future education. These investments grow tax-free and the distributions may also be tax-free.
What differentiates the Coverdell Section 530 and Section 529?
There are several differences between the two types of accounts.
Can money be taken from a traditional or Roth IRA to fund a child's education?
Yes. Distributions can be taken from IRAs for qualifying education expenses without incurring the 10% additional tax penalty. However, you may owe income tax on at least part of the amount that has been taken out. The amount of the distribution that is more than the education expense itself does not qualify for the 10% tax exception.
Is student loan interest tax deductible?
In certain instances, student loan interest may be deductible, but the deduction is also subject to income phase-outs.
Here are some guidelines:
What tax deductions can be used for college education?
There is a limited deduction allowed for higher education and related expenses. Business expense deductions are allowed, without a dollar limit, for education related to the taxpayer's business.
Mark S. Freedman, CPA Inc.
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Northridge CA 91324
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