NEW $94,200 BASE FOR SELF-EMPLOYMENT CREATES

NEED FOR BETTER PLANNING

In 1935, the self-employment tax topped out at $60.  Those 1935 lawmakers must be twirling in their graves with the new rules for 2006:

• A $14,413 self-employment tax that comes from the 15.3% rate at the new $94,200 base.
• A 2.9% tax that applies to all self-employment income in excess of the base amount.

You know the expression “Don’t let the camel’s nose get under the tent.”  It applies here.  Look at what has happened to self-employment taxes since they first came into being in 1935, assuming you earn at the base amount:

• $60 in 1935
• $60 in 1949
• $3,175 in 1980
• $7,849 in 1990
• $14,413 in 2006

To put the rates in perspective, say you earn $94,200 in 2006.  On the last dollar you earned—dollar number $94,200—how much federal tax did you pay?  The answer:

• 40.3 cents if married (15.3% self-employment tax plus 25% federal income tax).
• 43.3 cents if single (15.3% self-employment tax plus 28% federal income tax).

Wow!  That’s a lot.  Then if you live in a state with an income tax, add the state income tax on top of that.

Say you currently earn $94,200 and you do some tax planning that lets you find $10,000 in new deductions.  This little bit of planning, which involves activities you already do and will continue to do, puts money in your pocket:

• $4,030 in after-tax cash if you are married.
• $4,330 in after-tax cash if you are single.

In most cases, the return on your planning is not a one-time event.  Once your plan is in place, you will reap the benefits year after year.  Thus, good tax planning is like an annuity.

Here is a short checklist of some tax-planning ideas.  Review these ideas so you can identify new business deductions for your tax return.  You want business deductions, because business deductions reduce both your income and self-employment taxes.

• Eliminate the word “friend” from your vocabulary.  From now on, these people are sources of business, so start talking business and asking for referrals over meals or beverages, when playing golf or going to the movies.
• Hire your children (deductions for you, nontaxable or low-tax income for the children; also, wages paid by parents to children are exempt from payroll taxes).
• Use the gift-leaseback strategy on fully depreciated assets, thus turning a useless asset into a tax benefit.
• Learn how to combine business and personal trips so that the personal side of your trip becomes part of your business deduction under the travel rules (for example, traveling by cruise ship to a convention on St. Thomas).
• Properly classify business-expansion expenses as deductions rather than nondeductible capital costs.
• Properly identify deductible start-up expenses ($5,000 up front and the balance amortized) rather than letting them fall by the wayside (a common oversight).
• Properly classify entertainment that qualifies for the 100% deduction rather than the 50% deduction.
• Know the entertainment facility rules so your vacation home can become a tax deduction.
• Know when you can deduct commission rebates.
• Identify the vehicle deduction method that gives you the largest deductions (choosing between the IRS mileage method and the actual expense method).
• Properly identify your maximum business miles so you deduct the largest percentage of your vehicles.
• Use a 1031 exchange to defer and defer and defer taxes (perhaps until death, when, say the assets are marked up to fair market value and the income taxes are forgiven).
• Qualify your office in your home as an administrative office.
• Use allocation methods that make your home-office deductions larger.
• Install a section 105 medical plan to move your deductions to Schedule C for maximum benefits.
• Use the tax-law-allowed discrimination with health insurance to give health insurance to select employees (thus saving gross premiums on those you do not cover).
• If you are single, operate as a C corporation to obtain medical deductions.
• Operate as a C corporation to save Social Security benefits.  (If earnings are too high, you have to give back Social Security benefits; the C corporation can help solve this problem.)

This is not a complete list, but it should give you some ideas that will get you started on your savings.  Keep in mind that putting tax-planning ideas into practice is like benefiting from an annuity: You get the benefits every year you are in business.

Information provided by Tax Reduction Letter, February 2006, Volume 15, Number 2