Deduction

Article Dean Dorton

In addition to income tax, you must pay Social Security and Medicare taxes on earned income, such as salary and self-employment income. The 12.4% Social Security tax applies only up to the Social Security wage base of $118,500 for 2016. All earned income is subject to the 2.9% Medicare tax.

The taxes are split equally between the employee and the employer. But if you’re self-employed, you pay both the employee and employer portions of these taxes on your self-employment income.

Additional 0.9% Medicare tax

Another employment tax that higher-income taxpayers must be aware of is the additional 0.9% Medicare tax. It applies to FICA wages and net self-employment income exceeding $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately).

If your wages or self-employment income varies significantly from year to year or you’re close to the threshold for triggering the additional Medicare tax, income timing strategies may help you avoid or minimize it. For example, as a self-employed taxpayer, you may have flexibility on when you purchase new equipment or invoice customers. If your self-employment income is from a part-time activity and you’re also an employee elsewhere, perhaps you can time with your employer when you receive a bonus.

Something else to consider in this situation is the withholding rules. Employers must withhold the additional Medicare tax beginning in the pay period when wages exceed $200,000 for the calendar year — without regard to an employee’s filing status or income from other sources. So your employer might not withhold the tax even though you are liable for it due to your self-employment income.

If you do owe the tax but your employer isn’t withholding it, consider filing a W-4 form to request additional income tax withholding, which can be used to cover the shortfall and avoid interest and penalties. Or you can make estimated tax payments.

Deductions for the self-employed

For the self-employed, the employer portion of employment taxes (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. (No portion of the additional Medicare tax is deductible, because there’s no employer portion of that tax.)

As a self-employed taxpayer, you may benefit from other above-the-line deductions as well. You can deduct 100% of health insurance costs for yourself, your spouse and your dependents, up to your net self-employment income. You also can deduct contributions to a retirement plan and, if you’re eligible, an HSA for yourself. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income (AGI) and modified AGI (MAGI), which are the triggers for certain additional taxes and the phaseouts of many tax breaks.

For more information on the ins and outs of employment taxes and tax breaks for the self-employed, please contact us.

Article Dean Dorton

If you have incomplete or missing records and get audited by the IRS, your business will likely lose out on valuable deductions. Here are two recent U.S. Tax Court cases that help illustrate the rules for documenting deductions.

Case 1: Insufficient records
In the first case, the court found that a taxpayer with a consulting business provided no proof to substantiate more than $52,000 in advertising expenses and $12,000 in travel expenses for the two years in question.

The business owner said the travel expenses were incurred ”caring for his business.“ That isn’t enough. ”The taxpayer bears the burden of proving that claimed business expenses were actually incurred and were ordinary and necessary,“ the court stated. In addition, businesses must keep and produce ”records sufficient to enable the IRS to determine the correct tax liability.“ (TC Memo 2016-158)

Case 2: Documents destroyed
In another case, a taxpayer was denied many of the deductions claimed for his company. He traveled frequently for the business, which developed machine parts. In addition to travel, meals and entertainment, he also claimed printing and consulting deductions.

The taxpayer recorded expenses in a spiral notebook and day planner and kept his records in a leased storage unit. While on a business trip to China, his documents were destroyed after the city where the storage unit was located acquired it by eminent domain.

There’s a way for taxpayers to claim expenses if substantiating documents are lost through circumstances beyond their control (for example, in a fire or flood). However, the court noted that a taxpayer still has to “undertake a ‘reasonable reconstruction,’ which includes substantiation through secondary evidence.”

The court allowed 40% of the taxpayer’s travel, meals and entertainment expenses, but denied the remainder as well as the consulting and printing expenses. The reason? The taxpayer didn’t reconstruct those expenses through third-party sources or testimony from individuals whom he’d paid. (TC Memo 2016-135)

Be prepared
Keep detailed, accurate records to protect your business deductions. Record details about expenses as soon as possible after they’re incurred (for example, the date, place, business purpose, etc.). Keep more than just proof of payment. Also keep other documents, such as receipts, credit card slips and invoices. If you’re unsure of what you need, check with us.

Article Dean Dorton

Many expenses that may qualify as miscellaneous itemized deductions are deductible only to the extent they exceed, in aggregate, 2% of your adjusted gross income (AGI). Bunching these expenses into a single year may allow you to exceed this “floor.” So now is a good time to add up your potential deductions to date to see if bunching is a smart strategy for you this year.

Should you bunch into 2016?

If your miscellaneous itemized deductions are getting close to — or they already exceed — the 2% floor, consider incurring and paying additional expenses by Dec. 31, such as:

  • Deductible investment expenses, including advisory fees, custodial fees and publications
  • Professional fees, such as tax planning and preparation, accounting, and certain legal fees
  • Unreimbursed employee business expenses, including vehicle costs, travel, and allowable meals and entertainment.

But beware …

These expenses aren’t deductible for alternative minimum tax (AMT) purposes. So don’t bunch them into 2016 if you might be subject to the AMT this year.

Also, if your AGI exceeds the applicable threshold, certain deductions — including miscellaneous itemized deductions — are reduced by 3% of the AGI amount that exceeds the threshold (not to exceed 80% of otherwise allowable deductions). For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (married filing jointly) and $155,650 (married filing separately).

If you’d like more information on miscellaneous itemized deductions, the AMT or the itemized deduction limit, let us know.

Article Dean Dorton

Today it’s becoming more common to work from home. But just because you have a home office space doesn’t mean you can deduct expenses associated with it.

Eligibility Requirements

If you’re an employee, your use of your home office must be for your employer’s convenience, not just your own. If you’re self-employed, generally your home office must be your principal place of business, though there are exceptions.

Whether you’re an employee or self-employed, the space must be used regularly (not just occasionally) and exclusively for business purposes. If, for example, your home office is also a guest bedroom or your children do their homework there, you can’t deduct the expenses associated with that space.

A Valuable Break

If you are eligible, the home office deduction can be a valuable tax break. You may be able to deduct a portion of your mortgage interest, property taxes, insurance, utilities, and certain other expenses, as well as the depreciation allocable to the office space.

Or you can take the simpler “safe harbor” deduction in lieu of calculating, allocating, and substantiating actual expenses. The safe harbor deduction is capped at $1,500 per year, based on $5 per square foot up to a maximum of 300 square feet.

More Considerations

For employees, home office expenses are a miscellaneous itemized deduction. This means you’ll enjoy a tax benefit only if these expenses, plus your other miscellaneous itemized expenses, exceed 2% of your adjusted gross income (AGI).

If, however, you’re self-employed, you can deduct eligible home office expenses against your self-employment income.

Finally, be aware that we’ve covered only a few of the rules and limits here. If you think you may be eligible for the home office deduction, contact us for more information.

Article Dean Dorton

The Energy Policy Act of 2005 was enacted to provide immediate tax savings opportunities for energy efficient improvements. For commercial buildings, the Energy Policy Act of 2005 allows for a tax deduction of up to $1.80 per square foot for energy-efficient features of the building’s construction or retrofit under IRC §179D. Commercial buildings also include multi-family residential buildings with more than three stories. For instances where a non-taxpaying entity, such as the government or a municipality owns the building, the Energy Policy Act of 2005 allows for the primary designer, typically the architects and engineers, to claim the deductions. If the market downturn is a factor in current year profitability, this may still be beneficial due to the ability for certain small businesses to carry back net operating losses up to five years, thus, creating immediate cash benefits.

To claim a tax deduction under the Energy Policy Act of 2005, there are three different areas that qualify for a tax deduction of up to $.60 per square foot for each area:

  • Interior lighting systems
  • HVAC
  • Building envelope, e.g. the perimeter of the building including the roof, walls, windows, doors and floor/foundation

The deductions apply to buildings or systems placed in service or remodeled during calendar years 2006-2016. To qualify for those deductions, a project – whether an entire building or one of the three subsystems – must cut energy use compared to the limits specified in ASHRAE 90.1-2001.

Of the three areas available for these tax incentives, the one that is drawing the most attention is interior lighting systems. With substantial improvements in recent lighting product efficiency, most products currently available meet the requirements of the Energy Policy Act of 2005. The incentive for lighting systems can also be taken advantage of without energy modeling, which is required by the two other areas. Owners of commercial buildings have the opportunity to take advantage of the combination of savings from the energy efficient lighting and the savings from the tax incentives available. To demonstrate the economic benefit of a commercial building that qualifies for the maximum deduction for lighting systems, a 100,000 square foot building will generate an immediate federal tax deduction of $60,000 and in most states an additional $60,000 state deduction.

In order to qualify for these deductions for commercial buildings, a certification must be obtained by an engineer or contractor that is properly licensed as a professional engineer or contractor in the jurisdiction in which the building is located. Dean Dorton has the resources available to provide you with this certification and walk you through the cost/benefit analysis of taking advantage of these tax incentives.