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Year End Tax Planning For Small Businesses

Plan MazeThe following is a guest post by Kim Fourman.

Taxes may not be foremost on your mind right now, but they are important to think about before the year is over. It would be wise to know what kind of changes are coming and how that can affect you. For those in business, including the self-employed, here are two big changes coming for this year’s tax return.

Section 179

So what is Section 179 anyway? Well, first you need to understand depreciation. If you buy an asset (say, a computer), you are generally not allowed to expense (“expensing” means writing off or deducting) the entire amount in the year that you purchased it. Instead you are supposed to spread out the expense over several years.

So, suppose the computer you purchased cost $1,000. Instead of expensing $1,000 in the year you purchased it, you slowly depreciate the computer by $200 a year for 5 years.  The idea is that the cost of the computer should be spread out over its useful life.

Section 179 is an exception to the usual depreciation rules. Section 179 says (with a few more of its own exceptions) that you can expense the entire cost of the equipment in the year that you purchase it.  Since 2010, business owners have been able to expense up to $500,000 worth of equipment a year using Section 179.

As the law is currently written as of the publication of this post, the total Section 179 allowable depreciation drops from $500,000 in 2013 all the way down to $25,000 in 2014. Many experts think that Congress will extend the $500,000 limit, but as of December 16, 2013, they have not done so.

Many business owners are purchasing equipment in these latter days of 2013 to take advantage of the higher limit. Section 179 comes with a few rules and limitations (i.e. you can’t take Section 179 for an amount higher than your net income, and there are limitations on vehicles), so please make sure you consult a tax professional.

Home Office Deduction

This change will affect your 2013 tax return. As of 2012, if you were eligible to take the home office deduction, you were required to use what the IRS calls the “regular option”. This means that you calculate the square footage of your office and then divide it by the total square footage of your home. This gives you a percentage of your home that you can deduct for your home office. You can then multiply this percentage by all of your home expenses – utilities, rent, insurance, etc. as well as the normally deductible interest and taxes.

This sometimes gets to be a bit of a pain to keep up with because of a few often-overlooked calculations. When you use this option, you are supposed to allocate the interest and taxes for your home between your Schedule C and Schedule A. Even trickier, you are supposed to depreciate the percentage of your home allocable to the home office AND then recapture that depreciation when you sell your home. This depreciation is supposed to be added back in to the basis of your home even if you didn’t take the depreciation deduction in past years. The IRS kind of sticks it to you there.

However, starting in 2013, the IRS is offering a simpler option.  The rules if you are eligible are the same, but once you figure the square footage of your home office (not to exceed 300 sq ft), you are almost done. You are allowed $5 per square foot for your home office, and all other home-related itemized deductions (such as interest and taxes) are deductible in full on your Schedule A – no more allocation between schedules. You don’t have to keep up with your utility bills and all that sort of stuff. Also, you don’t have to fuss with depreciation of your home. It really makes things quite a bit simpler for those that want to take this deduction.

What other tax issues are you considering at the end of the year? Do you currently use the home office deduction?

Kim is a licensed CPA, working at Loggins, Kern & McCombs, CPAs. If you have a tax question that you would like to submit, please click here. Whatever advice you receive, please remember to consult with your own tax professional as issues vary depending on your situation.

Image courtesy of FreeDigitalPhotos.net

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  2. Holly Johnson says

    We are taking the home office deduction for the majority of the year before we sold our house. I am fortunate that my husband does our taxes and knows all of the new rules and changes.

  3. I don’t use the home office deduction and I don’t qualify for it since I do not use my home office primarily for my small biz. I probably could justify it if I worked from home full-time, though. This is the first year I am reporting income for Young Adult Money and it definitely has been a bit time-consuming making sure I have everything in order so that I file the most accurate income possible.

    • Home office works if it is “exclusive” — meaning that it is your ONLY office, and that it is ONLY used for your business (like, a desk in a bedroom wouldn’t work). Make sure that you remember deductions like mileage — like if you drive to a conference or to go speak or something like that. It is 56.5 cents per mile, and it can add up.

  4. That point on the home office deduction is a pretty interesting one. I hadn’t heard of the simpler version. Definitely makes things a lot easier. Quick question for you. If I work at home and require internet for that work, can I deduct the internet bill in full? We obviously use it for personal time as well, but regardless I would have to pay the bill for my business. Thanks for the input!

  5. Interesting. I will be curious to know if the simple option is utlized amoung tax payers this year. I am not self employed but if I was, I would be tempted to use it just for the sake of simplicity!

    • Hi Liz — many people don’t use the home office deduction now because it is difficult to keep up with properly, but also because they feel it is an audit risk. A couple of years ago, the IRS lost a case where they challenged a taxpayer that used the home office deduction — since then, they have backed off of targeting the home office. I think that this simplified option is also a way to make it easier for people, so I expect it to be used much more often.

  6. John S @ Frugal Rules says

    Great things to look out for Kim! I always did our own taxes, but once our business took off we hired a tax professional as there just became too many moving pieces for me to confidently handle. I was not aware of the changes to the home office deduction. That said, will there be any change to what we can deduct due to the changes, or will the only change be the schedule we report it on?

    • Hey, John…glad you liked the article, thanks! The schedule you report it on remains the same, but the method that you use to calculate the amount will change. The amounts that you can deduct will be different depending on which method you use (regular or simplified), but you can choose which method you want to use.
      When I mentioned the schedules, what I meant is that you didn’t have to fuss with splitting your interest and taxes between schedule A (itemized deductions) and schedule C (the business). You can use the simplified option and deduct home office on schedule C, and then deduct your interest and taxes in full on schedule A, just like the rest of us non-business owners.

  7. This is great info, thanks Kim! I’m exploring the option of becoming a self-employed IT consultant in the next year or so, and this is exactly the kind of information I need to be soaking up.

    • Great — I’m glad it was good and useful info for you. I work with small business owners every day, and I love it. They have a unique passion for what they do, and I love helping them. In fact, in about 30 minutes, I’m about to go teach a QuickBooks class to a group of small business people!

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