PEMBROKE, Mass. — Most dry cleaners wonder if they are paying too much in taxes. Few are willing to study the tax codes or the changes that come out every year, so most rely on accountants. But what happens if your accountant is too conservative or uninformed? Here are answers to some common questions that should provide food for thought for the current tax season:
Q: What is this talk about a home office deduction?
The home office deduction has been around for 35 years, but the recent expansion in the interpretation has made it an attractive write-off for small-business people. In previous years, the home office had to be your principal place of business. Now the IRS allows a home office deduction for a business owner who conducts substantial administrative activities at home, even if he/she has an office at a separate work location. In other words, the dry cleaner who works out of a business location, but uses a room at home to do paperwork, can now deduct those proportionate costs of that room, if he/she complies with the following:
Must use that room exclusively and regularly for work.
Must do the majority of paperwork in the home office.
The deduction allows the owner to deduct all direct and proportionate expenses associated with the home office space. If 20% of house space is devoted to the home office, then the owner can deduct 20% of the mortgage, repair bills, upkeep, insurance, utilities, and depreciation on the property. These days, with an average house costing $300,000, it would not be hard to come up with a substantial home expense.
If it costs $25,000 to maintain your home (including depreciation), and you use 15% of the space for a home office, then you will wind up with a $3,750 home office deduction. Your business profits will be reduced by $3,750, and your company will save a minimum of $1,350 in taxes.
Furthermore, if you have a home office and store material or equipment in a garage or basement, you can include that space in your deduction even if the space isn’t used exclusively and regularly for your business. You can also deduct all mileage from home office to workplace, at 55 cents per mile. Make four trips a day at 5 miles a trip five days a week, and that’s 5,200 miles, or a $2,860 deduction. Those are added features of the expanded ruling.
Q: What if I’ve never taken a home office deduction before?
With the changing business environment, many small-business people who have never taken the home office deduction now do so. It is no longer the red flag it used to be. Consult with your accountant. Change a guest bedroom into a home office. Rearrange your daily schedule to do all paperwork at home. Make sure you can justify the home-office usage.
Q: What are the tax implications of filing as a Schedule C proprietorship, Subchapter S, or a C corporation?
A Schedule C—sole proprietor taxes everything that is left from expenses as income. A Subchapter S corporation allows all profit, loss and credits to flow through to the shareholders. A C corporation is taxed at a different rate (less than $50,000 profit at 15%, $50,000 to $75,000 at 25%, $75,000 to $100,000 at 34%, more than $100,000 at 39%), after your salary is deducted as an expense. Otherwise, they all follow a revenue minus expenses equals profit formula. So it is strictly a numbers cruncher calculation—where will you pay the least taxes? Generally, unless you’re earning in excess of $75,000 profit, the tax differences will be minimal.
Both the C corporation and the Subchapter S offer more protection against liability. That’s the main reason owners choose to incorporate. The disadvantage is extra paperwork and cost. One alternative is to remain a Schedule C sole proprietorship and purchase liability insurance.
Q: Should I take full use of my Section 179?
Section 179 allows the dry cleaner to deduct in full up to $250,000 of capital purchases for a tax year. Otherwise, the cost of the equipment would be depreciated over five to 10 years.
If you’ve spent $100,000 to upgrade equipment and your profits are higher than they usually are, you might expense the full $100,000 as a Section 179 expense. If you expect the next several years to earn substantial profits, you might depreciate over time. It is a guess of what future profits will be compared to this year’s results.
Q: What effect is there if I have to pay my own health insurance?
A: If you are incorporated, your full health insurance is deducted from revenue. If a proprietorship or partnership, you can deduct 100% of the cost of health insurance from income on your 1040.
One way a sole proprietor (Schedule C filer) can receive the full write-off benefit now is to employ his spouse, pay her a small salary ($50 a week), and grant her health insurance as a benefit. Because she is entitled to family coverage (Code 213), her health insurance includes you and the children.
Check back Thursday for the conclusion!
Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an attorney or tax adviser for advice regarding your particular situation.