Ten must-take deductionsTeacher: Roz Retkwa
Deduction junction, what's your function? For a free agent, taking the right deductions can mean huge tax savings — potentially, thousands of dollars in savings.
Therefore, every free agent should be intimately familiar with deductions, how to take them and how to maximize them.
What are deductions?
Broadly defined, deductions are eligible expenses that can be deducted — subtracted, whole or in part — from your taxable income. The benefit is obvious: The less taxable income you have, the less taxes you pay.
The IRS defines what's eligible and what's not. Generally, any expense that is "ordinary and necessary," is for a "reasonable" amount and contributes to your business qualifies for a deduction. IRS publications (such as Publication 587: Business Use of Your Home, available on the IRS website) and your accountant can help you determine what expenses you can deduct and how much.
How do I take deductions?
When you file your taxes, you must also submit itemized list of expenses that you are deducting from your taxable income. You do not submit receipts or personal records, but it's critical that you keep them in case you get called for an audit.
On Schedule C (Profit and Loss from Business), you calculate your self-employment income (minus your total deductions) and list each of your deductible business expenses. Some specific deductions require that you submit additional forms, such as Form 2106 for business mileage. Some deductions, such as major purchases and repairs, must be spread out over several years.
On Schedule A (Itemized Deductions), you can take additional personal deductions, such as part of your mortgage interest, the 60 percent self-employed health insurance deduction, retirement account contributions and alimony.
However, you must be careful with Schedule A. You can only deduct miscellaneous itemized deductions to the extent they exceed two percent of your adjusted gross income. (So, you may have to push to maximize your deductions here.) Plus, a Schedule A deduction won't reduce your self-employment tax, while a Schedule C deduction will. Taking away Schedule C deductions to pad those in Schedule A is just one tax mistake to avoid.
How can I make deductions easier?
There's no getting around it: Deductions require work and careful attention at tax time and throughout the year. Here are a few tips for making deductions easier:
The top 10 deductions
Just about every free agent should take the following 10 deductions. In addition, you should consider expenses for expenses for license fees, advertising and promotion and dry cleaning and laundry while on a business trip.
1. The home office percentage. For this, you'll need Form 8829 — "Expenses for Business Use of the Home." For 1999, you can write off a home office even if you work off-site, but maintain an office for management purposes.
At the top of the form, you'll be asked to report the total area of your home and the area used for business, measured in square feet. Business area divided by total area gives you a percentage (e.g., 30 percent).
You can then take that percentage of your rent or your mortgage interest and real estate taxes as a deduction against your Schedule C income from self-employment. That will reduce both your income taxes and the 15.3 percent self-employment tax for Social Security and Medicare.
If you're a homeowner, the balance of your mortgage interest and real estate taxes can still be deducted on your 1040 form (Schedule A), if you itemize. If you rent, don't drive yourself crazy looking for the line that says "rent" — there isn't one. Rent is entered on line 20 of Form 8829 under "other expenses."
2. Utilities, maintenance, repairs, etc. You can use the same percentage from your home office deduction to take deductions on the expenses that are basic to maintaining the space you use for business. That includes electricity, repairs and maintenance (including painting and cleaning, if you use a cleaning service) and even decorating and landscaping, if clients visit.
"If it's a decoration for the home office as well as the home, you can take a quarter of a bush," says Evan Snapper, a senior manager at Ernst & Young.
3. Home office expenses. Not all of your home office deductions are limited by that percentage. If you buy an air conditioner or a chair that's used exclusively for your home office, you can take that as a 100 percent write-off.
Also, if any repair or maintenance is for your home office only, then the expenses are fully deductible. Deductions for capital improvements, however, must be spread over a number of years (see Depreciation, below).
4. Telephone expenses. If you maintain a separate phone line (or cell phone or fax line) for business purposes, that's a complete write-off. But if you have just one line, you can deduct only a percentage of your monthly usage but not the charges that are basic to maintaining phone service in your home. Unreimbursed long-distance calls are a complete write-off.
Phone expenses (including out-of-pocket expenses for calls made from public pay phones and your Internet connection) go into the category of "other expenses" on Schedule C.
5. Depreciation. If you buy a major piece of equipment or furniture, like a computer system or a desk, you can expense it all in one year, or you can depreciate it over time — usually, three to five years.
If you expense it all in one year, you can't write off more than $19,000 in 1999, says Bob Bernstein, a CPA in Old Greenwich, Conn. (In 2000, that will rise to $20,000.) And, you can't deduct more than your net profit, he cautions.
If you own the home in which you have a home office, you can take depreciation on your home office, though it "gets a little complicated," says Bernstein. You have to find out what the land is worth because your basis is the cost of the house minus the value of the land. You can then take the percentage of the house that's being used as a home office and depreciate it over 39 years, he says.
6. Common business expenses. These fall under the IRS' definition of "ordinary and necessary" and include dues for professional organizations, postage, furniture and equipment.
Schedule C has separate lines for supplies; legal and professional services; travel and meals and entertainment. With trips or meals that cost $75 or less (including local transportation on buses or the subway), you don't need receipts, but any accountant will tell you that it's a good idea to maintain a diary just in case you're audited.
7. Education and professional counseling. Any classes, seminars, conferences — even private career counseling sessions — that are business-related are fully deductible.
Also, don't overlook publications that are directly related to your business or may be "related to a piece of equipment used in a trade or business," says Snapper. He has a Palm computer and takes a deduction for a PC magazine subscription that "keeps me up-to-date on any new applications." If you use the Internet for business purposes, "any magazines related to the Internet are deductible," he says.
8. Health insurance. For 1999, you can write off 60 percent of the health insurance premiums for yourself, your spouse and your children. The 1040 has a separate line for your "self-employed health insurance deduction," and you can take that deduction even if you don't itemize.
But your health insurance write-off can't be greater than your net profit. You can indeed take a partial write-off to the point of "zeroing out" — that is, reducing your profits to a zero. But you can't use your health insurance premiums to go beyond that and create a net loss.
Also, the IRS also won't let you deduct premiums for any month in which you were covered by a plan subsidized by your spouse's employer, even if your spouse pays a premium to have you included. For the time you are covered in such a way "you are totally ineligible for that 60 percent," notes Douglas Stives, a CPA with Wiss & Company in Red Bank, NJ.
9. Travel and mileage. You can't deduct a car that's used only to commute to your office. Other than that, though, there are two methods for writing off the use of a car.
The simpler method is to take the per-mile allowance, which includes gas, oil, repairs, and depreciation. The one additional cost you can take is tolls. For 1999, the rate is 32.5 cents per mile through March 31. From April 1st onward, it's 31 cents.
The other method is to depreciate the car and all of its related expenses over five years, Snapper says. However, you can't buy a Rolls or a Mercedes and write off the entire cost, even over time. Going by the IRS' 5-year depreciation schedule, the maximum deduction is a little more than $15,000 for a car used in business.
Some other tidbits to note: If you tack on a couple of days' vacation to a business trip, you can only deduct expenses for the business part of the trip. Snapper also says to be careful when trying to deduct any part of a cruise — expenses are subject to some tough tests.
10. Professional services. If one of your clients stiffs you, you can't write off the amount of the billing.
You can, however, write off any expenses you incurred in doing the job. You can also write off the cost of legal fees and a collection service.
And, yes, you can pay your accountant to deal with most of these issues — and deduct the expense.
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