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The Benefits of Being Self-Employed

Long time, no post. Sorry about that. I have been super busy. One of the things I have been working on is my own business. I still work full-time for my employer, so squeezing in time for my own business is difficult (and it cuts into my blogging time). However, I think that anyone concerned about their personal finances should look into the benefits of owning their own business. As this is something I always contemplate, I figure I would share some of the ideas I have thought of myself, and some that I have stumbled upon elsewhere.




One of the very first benefits to running your own business is the tax write offs that you receive. Annd these benefits have improved over the last few years, particularly if you run your business from your home. For example, if you have a home office, you can deduct utilities, mortgage interest, and even depricate the portion of your home (over 27.5 years). The deprication portion used to always be something to tread lightly on, because it would mean you would have to pay capital gains tax on that deprication when you sold your home. However, in recent years, the capital gains taxes on home sales have nearly been eliminated for the average American. So, you can write off a portion of your mortgage interest and property taxes (you will want to weigh this against your ability to itemize your taxes), a portion of standard utilities (water and sewage, electricity, gas, and maybe your telephone), and all of your utilities and expenses that can be considered for business use (Internet access, business phone lines, cellular phone service).


Beyond that, you can write off mileage that you accumulate on your personal vehicle. You have an option here, though. You could actually take all the expenses associated with using your personal vehicle and write those off. This would include the price of fuel, a portion of your auto insurance, maintenance, car washes (if you need to impress your clients), etc. Or, you could lease your vehicle and claim its entire use as for your company.


So, those are some of the basic things you can do to offset your tax liability by having your very own business. A lot of people do these things, and it serves them very well. Performing these things could actually allow you the lifestyle of someone make nearly $100,000/year for the taxes of someone who makes $40,000/year, or less. That is a very compelling difference. Further, you can do this even if you keep your full-time employment elsewhere. However, what if you really begin doing well in your business and you take it on as your full-time employment, and you want to do even more?


One of the things I have been looking into is setting my children up for success. Part of that success includes paying for their education. But, I would also like to teach them the value of money, how to save for their future, and how to run their own business, as well. Well, when you children reach the magical age of eight, and you run your own business, you can hire them to work in your business. I have written about this before in Saving for Retirement: The Younger the Better. Essentially, you can hire your children to work in your business, and you do not have to pay many of the employer related taxes that you would have to pay for normal employees. These include the FICA match, FUTA, etc. Further, your children do not have to pay FICA, and up to the standard deduction, they do not have to pay income taxes. So, for up to the standard deduction, everything that you pay your children is entirely tax-free to you and your child, and you can deduct it as a business expense, which lowers your AGI, possibly putting you in a lower tax bracket, again. What can be done with this great tax free money? You can put it into Coverdell ESAs and Roth IRAs. The real great thing with these is that you use after tax money to fund these accounts, and the earnings are tax free. Since your child did not pay any taxes, up to the standard deduction, this is tax free money for life! The annual limit for each of these, for each child, would be $2000 for the Coverdell ESA and $4000 (in 2006) for the Roth IRA. Your child will be the first kid on the block with a retirement account! The money in a Coverdell ESA can be used to pay for education expenses, but must be spent by the age of 30. The principle in a Roth IRA can be withdrawn, without penalty, after five years, and can be used for anything. Beyond that, the earning can be withdrawn, without penalty, for education expenses. That means you have $6000 a year to work with for each child. This can be a primary way for them to fund their education. Further, they can use the principle from the Roth IRA to pay for a home (or at least a nice down payment), and anything else can get them a substantial head-start on saving for retirement. I have three children, so this can add up to a very large sum each year. If I could do this for each child, this year, then I could lower my AGI by $18,000 this year alone. However, my oldest child will be turning eight next month, so we will just be getting started, and I could yet benefit from $18,000 lower without not being able to meet the cost of my family's lifestyle (which is pretty low).


I was reading IRA Contribution Workaround on Five Cent Nickel, and he came up with a very creative way to get around the $4,000/year limit of IRA contributions. I see it from a slightly different perspective, and I commented on it in his post. Whenever you contribute to a 401(k) or a Traditional/Roth IRA, you are paying some taxes on it. You may not realize it, but your funds run through FICA taxes before they get the benefit of avoiding income taxes. Employers like the idea of giving a match on 401(k) because it is a nice benefit they can give you that costs them less, dollar for dollar. Why? You do not pay FICA on this money, which means they do not match it. So, Five Cent Nickel suggests using a SEP-IRA to get around the $4,000 limit. I say, use the SEP-IRA, and forget the Traditional/Roth IRA, unless you meet the SEP-IRA limit. Why? Because you can contribute to it as an employer, and the employee part of you does not have to contribute. This means that 100% of it avoids the FICA and the FICA match! Later on, you can roll it over into a Traditional/Roth IRA. And with all the tax savings you get already, you could stand to take the hit on rolling it into a Roth IRA. So, you can begin saving for your retirement with even greater advantages than before, and this again lowers your AGI.


I am not a tax professional, so you would need to verify the specifics to your own satisfaction, which may mean consulting a tax professional. However, these concepts can allow you to keep more of the money you earn. Taxes are the number one expense we incur here in America. That is something that I find outrageous. We fought for our independence with unfair taxation as a stimulus, and we are still taxes an outrageous amount. However, do not forget that you will still be paying a considerable amount of taxes anyway. There are property taxes, sales tax, embedded fuel tax, vehicle registration tax, and some user fees. As Americans, we should pay as little in taxes as we can legally pay. We should be responsible for ourselves, and we should help others. If we get to keep more of our own money, that gives us greater flexibility in doing all of those things. Why would you want to let the government do it for you? Just stop by your license branch and see what a bang up job they are doing there.



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Anonymous Apex Says:

March 16, 2006 11:03 AM 

As a point of information, I am not sure what source you are using to make the statement about deducting personal vehicles for business use but this is inaccurate.

You can deduct vehicles (personal or otherwise) and they associated expenses only to the extent that they are actually used explicitly for the business. If you have a business that is vehicle dependent then it becomes easier to deduct most or all of the vehicle. But if you have a business that requires almost no vehicle use then you will find it very difficult to survive an audit where you deduct more than just a minimal amount of vehicle usage and that will probably need to be backed up with some kind of proof or pass some reasonable use test.

The IRS is not going to let you get away with deducting personal items for business use regardless of what they are. I know some people claim they do this and they may, but its illegal and will not survive an audit if you get one. The result will be back taxes, back interest, and a penalty. Ignorance will probably get you out of any fraud charges unless they can prove outright intent to defraud.

So keep in mind that to deduct something you can only deduct that portion of it that is used expressly for your business.

Blogger Dus10 D Says:

March 16, 2006 11:46 AM 

Apex:

As a point of clarification, I never meant that you could deduct your entire vehicle. I assumed that within the context of the artcile, running your own business, that users would understand that I was talking about the usage of the vehicle for business purposes. This is fully within your rights, and you can deduct whatever is applicable. Any mileage you incur in the process of doing business can be written off. Also, you could opt-out of mileage, and deduct the exact cost of using your personal vehicle for business purposes. It is all outlined in IRS
Publication 334
.

While I appreciate the call for clarification, you could have done so without trying to outright discredit everything... because that is inaccurate. Further, I did state that anyone wanting to gain further knowledge about the specifics should do so, and may want to consult with a tax professional. Further research would certainly indicate that proper documentation is necessary as evidence to prove the nature of the expenses.

There are plenty of personal expenses that can become business expenses. Virtually anything can become a business expense, as long as it is within the context of your business. I am not implying that anyone should break the law, and I did qualify that by stating that you should pay as little taxes as legally possible. Further, I did not claim anywhere that you should deduct everything; I qualified that by stating a "portion" of this, and a "portion" of that. That "portion" implies the portion used for business purposes, given the context of the post.

Anonymous Apex Says:

March 16, 2006 3:59 PM 

You wrote the following about vehicle deductions:

"Beyond that, you can write off mileage that you accumulate on your personal vehicle. You have an option here, though. You could actually take all the expenses associated with using your personal vehicle and write those off. This would include the price of fuel, a portion of your auto insurance, maintenance, car washes (if you need to impress your clients), etc. Or, you could lease your vehicle and claim its entire use as for your company."

Your response shows that you are correctly informed on the rules. However to me what was written above makes one think you can deduct the entire vehicle including personal use.

one key statement is:

"You could actually take all the expenses associated with using your personal vehicle and write those off."

You use the word all and don't say all business expenses. The itemized list you give after that sentence only uses the word portion for the auto insurance. The rest of it does not give an indication that its only business expenses.

The paragraph closes with this statement:

"Or, you could lease your vehicle and claim its entire use as for your company."

You use the word entire and don't say only if the vehicle is used entirely for business purposes. The paragraph actually never mentions that only business expenses are deductable for auto expenses. You may have intended that to be implied but I don't think it is implied and it doesn't read that way. The reason I say I don't think it is implied is because I know multiple people who attempt to deduct personal vehicle expenses for business. So I was just trying to make sure anyone reading this knows that is not legal. I am not accussing you of suggesting it is legal. I was merely commenting to clear it up for anyone reading the article because I believe the way it was worded it was not clear that it is illegal.

Do you think your article makes it clear that you can only deduct business vehicle expenses?

In your comment you said you wished I had not tried to "outright discredit everything." I only tried to point out that you can't deduct personal vehicle expenses. I stated that all business expenses were deductible. What valid deductions do you feel I attempted to discredit?

I truly did mean it only as a point of clarification. If you would prefer not to have comments clarifying your posts just say the word and I will refrain.

Blogger Dus10 D Says:

March 16, 2006 4:27 PM 

Thank you for that comment. Clarification is a great thing. And, as you stated, some people try to go overboard and claim things that are acutally personal expenses, which is illegal. So, yes, it should be noted that this applies to actual business expenses.

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