Saving On 2006 Taxes

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With the end of the year drawing ever nearer, there are several things that small-business owners can do to minimize their tax burdens for 2006. Keith Hall, CPA and tax adviser for the National Association of the Self-Employed's TaxTalk service, spoke recently with Smart Answers columnist Karen E. Klein about the seven steps entrepreneurs should take now.



What's step one?



Fund your retirement plan. What you can do is lower your taxable income by putting as much money as you can into retirement savings accounts such as IRA, SIMPLE, SEP, Keogh, and the new individual 401[k]s.



What if you don't have a retirement account through your company?



It's very easy and inexpensive to set up a prototype plan with your financial institution. The individual 401[k] makes this option more feasible for the self-employed, who can defer some of their earnings via contributions to the plan and then receive a match from the business.



You recommend accelerating expenses. How is that done?



The key for accelerating expenses is not to spend money just to generate a tax deduction, but to evaluate expenditures that you will expect to have within the next several months. Bonuses to key employees, office supplies, a new computer, can all be things that you expect to spend money on in the near future. If so, consider spending that money before yearend so that you get the tax deduction now rather than later. If you're planning a major capital expenditure during the first half of next year, buy it now if you can, in order to get the deduction this year. Under IRS tax code section 179, you may be able to deduct up to $108,000 of capital purchases in 2006.



Along with accelerating expenses, you also recommend deferring income. Are you talking about yearend income?



Defer income where you can, but only if it makes good business sense. That means scheduling your invoicing and shipping so that income that might have been received in 2006 would be received in 2007.



What's the use of that? Won't you just have to pay taxes on it in 2007 anyway? Why delay?



You will still have to pay taxes on the income in 2007, but those payments will be later rather than sooner. In the meantime, those tax payments will be in your savings account earning interest instead of already in the hands of the IRS.



What else can small-business owners and self-employed people do?



They can look for hidden deductions that they're not already taking advantage of. The home-office deduction enables a deduction for a portion of mortgage interest and real estate taxes from self-employment tax, which results in up to a 15.3% tax savings. Also, it enables the deduction of direct and indirect expenses on maintaining a home office. If you use a portion of your home regularly and exclusively for your business, then you can deduct a portion of those expenses. Anyone who is self-employed and works out of their home should try to find a way to qualify.



Another deduction that's not often recognized is the ability to hire your children and take a deduction for compensation you pay them for services they provide to the business. Your dependents under age 18 can have up to $5,200 in compensation this year without paying FICA, unemployment, or Medicare taxes. Find something in your business that your children can do -- maybe over the holidays -- and pay them for it. You can basically get up to a $5,000 business deduction for money you're probably giving your kids anyway. And maybe, the kids will learn a few things about the business.



What about traditional deductions like medical expenses?



Health insurance premiums are deductible for most small-business owners, but the deduction is included on page one of their tax return instead of on the business part of their tax return. If your spouse works in the business as a bona fide employee, you should consider establishing a Section 105 Health Reimbursement Arrangement [HRA].



With an HRA Plan, you can deduct and reimburse your employee for health-insurance premiums, as well as other medical expenses that may not be fully deductible. If your spouse is an employee, you will be able to reimburse their medical costs and in effect be turning personal money into a business deduction, and that's the best kind of deduction of all. The National Association for the Self-Employed [www.nase.org] can help with the details on these plans.



There are always particular tax credits that expire at the end of the calendar year. How can entrepreneurs learn about them and make use of them?



Check your eligibility for tax credits such as welfare-to-work, research and development, and work opportunity tax credits. Deductions for charitable contribution of certain computers and the enhanced deduction are still in effect until the end of the year. The best place to get more detail on specific tax-law changes is straight from the horse's mouth. The IRS [www.irs.gov] has a very good Web site with downloadable forms and publications to help with almost any question.