small business owners

Financial Planning Tax

A SIMPLE Retirement Plan for the Self-Employed

Of all the retirement plans available to small business owners, the SIMPLE IRA plan (Savings Incentive Match PLan for Employees) is the easiest to set up and the least expensive to manage.

These plans are intended to encourage small business employers to offer retirement coverage to their employees. SIMPLE IRA plans work well for small business owners who don’t want to spend a lot of time and pay high administration fees associated with more complex retirement plans.

SIMPLE IRA plans really shine for self-employed business owners. Here’s why…

Self-employed business owners are able to contribute both as employee and employer, with both contributions made from self-employment earnings.

SIMPLE IRA plans calculate contributions in two steps:

1. Employee out-of-salary contribution
The limit on this “elective deferral” is $12,000 in 2013, after which it can rise further with the cost of living.

Catch-up. Owner-employees age 50 or older can make an additional $2,500 deductible “catch-up” contribution (for a total of $14,500) as an employee in 2013.

2. Employer “matching” contribution
The employer match equals a maximum of 3% of employee’s earnings.

Example: A 52-year-old owner-employee with self-employment earnings of $40,000 could contribute and deduct $12,000 as employee, and an additional $2,500 employee catch-up contribution, plus $1,200 (3% of $40,000) employer match, for a total of $15,700.

SIMPLE IRA plans are an excellent choice for home-based businesses and ideal for full-time employees or homemakers who make a modest income from a sideline business.

If living expenses are covered by your day job (or your spouse’s job), you would be free to put all of your sideline earnings, up to the ceiling, into SIMPLE retirement investments.

A Truly Simple Plan

A SIMPLE IRA plan is easier to set up and operate than most other plans. Contributions go into an IRA you set up. Those familiar with IRA rules – in investment options, spousal rights, creditors’ rights – don’t have a lot new to learn.

Requirements for reporting to the IRS and other agencies are negligible. Your plan’s custodian, typically an investment institution, has the reporting duties. And the process for figuring the deductible contribution is a bit easier than with other plans.

What’s Not So Good About SIMPLE Plans

Once self-employment earnings become significant however, other retirement plans may be more advantageous than a SIMPLE retirement plan.

Example: If you are under 50 with $50,000 of self-employment earnings in 2013, you could contribute $12,000 as employee to your SIMPLE plus an additional 3% of $50,000 as an employer contribution, for a total of $13,500. In contrast, a 401(k) plan would allow a $30,000 contribution.

With $100,000 of earnings, it would be a total of $15,000 with a SIMPLE and $42,500 with a 401(k).

Because investments are through an IRA, you’re not in direct control. You must work through a financial or other institution acting as trustee or custodian, and you will generally have fewer investment options than if you were your own trustee, as you would be in a 401(k).

It won’t work to set up the SIMPLE plan after a year ends and still get a deduction that year, as is allowed with Simplified Employee Pension Plans, or SEPs. Generally, to make a SIMPLE plan effective for a year, it must be set up by October 1 of that year. A later date is allowed where the business is started after October 1; here the SIMPLE IRA must be set up as soon thereafter as administratively feasible.

If the SIMPLE IRA plan is set up for a sideline business and you’re already vested in a 401(k) in another business or as an employee the total amount you can put into the SIMPLE IRA plan and the 401(k) combined (in 2013) can’t be more than $17,500 or $23,000 if catch-up contributions are made to the 401(k) by someone age 50 or over.

So someone under age 50 who puts $9,000 in her 401(k) can’t put more than $8,500 in her SIMPLE 2013. The same limit applies if you have a SIMPLE IRA plan while also contributing as an employee to a 403(b) annuity (typically for government employees and teachers in public and private schools).

How to Get Started with a SIMPLE IRA Plan

You can set up a SIMPLE account on your own, but most people turn to financial institutions. SIMPLE IRA Plans are offered by the same financial institutions that offer any other IRAs and 401k plans.

You can expect the institution to give you a plan document and an adoption agreement. In the adoption agreement you will choose an “effective date” – the beginning date for payments out of salary or business earnings. That date can’t be later than October 1 of the year you adopt the plan, except for a business formed after October 1.

Another key document is the Salary Reduction Agreement, which briefly describes how money goes into your SIMPLE. You need such an agreement even if you pay yourself business profits rather than salary.

Printed guidance on operating the SIMPLE may also be provided. You will also be establishing a SIMPLE IRA account for yourself as participant.

401k, SEPs, and SIMPLES Compared

 

401k SEP SIMPLE
Plan type: Can be defined benefit or defined contribution (profit sharing or money purchase) Defined contribution only Defined contribution only
Number you can own: Owner may have two or more plans of different types, including an SEP, currently or in the past Owner may have SEP and 401k Generally, SIMPLE is the only current plan
Due dates: Plan must be in existence by the end of the year for which contributions are made Plan can be set up later – if by the due date (with extensions) of the return for the year contributions are made Plan generally must be in existence by October 1 of the year for which contributions are made
Dollar contribution ceiling (for 2013): $51,000 for defined contribution plan; no specific ceiling for defined benefit plan $51,000 $24,000
Percentage limit on contributions: 50% of earnings for defined contribution plans (100% of earnings after contribution). Elective deferrals in 401(k) not subject to this limit. No percentage limit for defined benefit plan. Lesser of $51,000 of 25% of eligible employee’s compensation ($255,000 in 2013). Elective deferrals in SEPs formed before 1997 not subject to this limit. 100% of earnings, up to $12,000 (for 2013) for contributions as employee; 3% of earnings, up to $12,000, for contributions as employer
Deduction ceiling: For defined contribution, lesser of $51,000 or 20% of earnings (25% of earnings after contribution). 401(k) elective deferrals not subject to this limit. For defined benefit, net earnings. Lesser of $51,000 or 25% of eligible employee’s compensation. Elective deferrals in SEPs formed before 1997 not subject to this limit. Same as percentage ceiling on SIMPLE contribution
Catch-up contribution age 50 or over: Up to $5,500 in 2013 for 401(k)s Same for SEPs formed before 1997 Half the limit for 401k and SEPs (up to $2,750 in 2013)
Prior years’ service can count in computing contribution No No
Investments: Wide investment opportunities. Owner may directly control investments. Somewhat narrower range of investments. Less direct control of investments. Same as SEP
Withdrawals: Some limits on withdrawal before retirement age No withdrawal limits No withdrawal limits
Permitted withdrawals before age 59 1/2 may still face 10% penalty Same as 401k rule Same as 401k rule except penalty is 25% in SIMPLE’s first two years
Spouse’s rights: Federal law grants spouse certain rights in owner’s plan No federal spousal rights No federal spousal rights
Rollover allowed to another plan (Keogh or corporate), SEP or IRA, but not a SIMPLE. Same as 401k rule Rollover after 2 years to another SIMPLE and to plans allowed under 401k rule
Some reporting duties are imposed, depending on plan type and amount of plan assets Few reporting duties Negligible reporting duties

Please contact us if you are a business owner interested in exploring retirement plan options, including SIMPLE IRA plans.

Tax

Tax Planning for Small Business Owners

Tax planning is the process of looking at various tax options in order to determine when, whether, and how to conduct business and personal transactions to reduce or eliminate tax liability.

Many small business owners ignore tax planning. They don’t even think about their taxes until it’s time to meet with their accountants, but tax planning is an ongoing process and good tax advice is a valuable commodity. It is to your benefit to review your income and expenses monthly and meet with your CPA or tax advisor quarterly to analyze how you can take full advantage of the provisions, credits and deductions that are legally available to you.

Although tax avoidance planning is legal, tax evasion – the reduction of tax through deceit, subterfuge, or concealment – is not. Frequently what sets tax evasion apart from tax avoidance is the IRS’s finding that there was fraudulent intent on the part of the business owner. The following are four of the areas most commonly focused on by IRS examiners as pointing to possible fraud:

  1. Failure to report substantial amounts of income such as a shareholder’s failure to report dividends or a store owner’s failure to report a portion of the daily business receipts.
  2. Claims for fictitious or improper deductions on a return such as a sales representative’s substantial overstatement of travel expenses or a taxpayer’s claim of a large deduction for charitable contributions when no verification exists.
  3. Accounting irregularities such as a business’s failure to keep adequate records or a discrepancy between amounts reported on a corporation’s return and amounts reported on its financial statements.
  4. Improper allocation of income to a related taxpayer who is in a lower tax bracket such as where a corporation makes distributions to the controlling shareholder’s children.

Tax Planning Strategies

Countless tax planning strategies are available to small business owners. Some are aimed at the owner’s individual tax situation, and some at the business itself, but regardless of how simple or how complex a tax strategy is, it will be based on structuring the strategy to accomplish one or more of these often overlapping goals:

  • Reducing the amount of taxable income
  • Lowering your tax rate
  • Controlling the time when the tax must be paid
  • Claiming any available tax credits
  • Controlling the effects of the Alternative Minimum Tax
  • Avoiding the most common tax planning mistakes

In order to plan effectively, you’ll need to estimate your personal and business income for the next few years. This is necessary because many tax planning strategies will save tax dollars at one income level, but will create a larger tax bill at other income levels. You will want to avoid having the “right” tax plan made “wrong” by erroneous income projections. Once you know what your approximate income will be, you can then take the next step: estimating your tax bracket.

The effort to come up with crystal-ball estimates may be difficult and by its very nature will be inexact. On the other hand, you should already be projecting your sales revenues, income, and cash flow for general business planning purposes. The better your estimates, the better the odds that your tax planning efforts will succeed.

Maximizing Business Entertainment Expenses

Entertainment expenses are legitimate deductions that can lower your tax bill and save you money–provided you follow certain guidelines.

In order to qualify as a deduction, business must be discussed before, during, or after the meal and the surroundings must be conducive to a business discussion. For instance, a small, quiet restaurant would be an ideal location for a business dinner. A nightclub would not. Be careful of locations that include ongoing floor shows or other distracting events that inhibit business discussions. Prime distractions are theater locations, ski trips, golf courses, sports events, and hunting trips.

The IRS allows up to a 50 percent deduction on entertainment expenses, but you must keep good records and the business meal must be arranged with the purpose of conducting specific business. Don’t hesitate to call us if you need assistance with recordkeeping requirements.

Important Business Automobile Deductions

If you use your car for business such as visiting clients or going to business meetings away from your regular workplace you may be able to take certain deductions for the cost of operating and maintaining your vehicle. You can deduct car expenses by taking either the standard mileage rate or using actual expenses.

The mileage reimbursement rates for 2013 are as follows: 56.5 cents a mile for business, 24 cents for moving and medical miles and 14 cents per charitable mile.

If you own two cars, another way to increase deductions is to include both cars in your deductions. This deduction works because business miles driven is determined by business use. To figure business use, divide the business miles driven by the total miles driven. This strategy can result in significant deductions.

Whichever method you decide to use to take the deduction, always be sure to keep accurate records such as a mileage log and receipts. If you need assistance figuring out which method is best for your business, please contact us.

Increase Your Bottom Line When You Work At Home

The home office deduction is quite possibly one of the most difficult deductions ever to come around the block. Yet, there are so many tax advantages it becomes worth the navigational trouble. Here are a few common tips for home office deductions that can make tax season significantly less traumatic for those of you with a home office.

Try prominently displaying your home phone number and address on business cards, have business guests sign a guest log book when they visit your office, deduct long-distance phone charges, keep a time and work activity log, retain receipts and paid invoices. Keeping these receipts makes it so much easier to determine percentages of deductions later on in the year.

Section 179 expensing allows you to immediately deduct, rather than depreciate over time, up to $500,000, with a cap of $2,000,000, worth of qualified business property that you purchase during 2013. The key word is “purchase”. Equipment can be new or used and includes certain software. All home office depreciable equipment meets the qualification. Also, if you purchase more than $500,000 in equipment, you can expense the first $500,000 and then depreciate the rest. In addition, a “Bonus Depreciation” of 50 percent is allowed on qualified assets (new equipment only–no used equipment and no software) placed in service during 2013.

Some deductions can be taken whether or not you qualify for the home office deduction itself. If you’d like to meet with us to learn more about home office deductions, please give us a call.

Business Financial Planning Retirement Tax

A SIMPLE Retirement Plan for the Self-Employed

Of all the retirement plans available to small business owners, the SIMPLE plan is the easiest to set up and the least expensive to manage.

These plans are intended to encourage small business employers to offer retirement coverage to their employees. SIMPLE plans work well for small business owners who don’t want to spend a lot of time and pay high administration fees associated with more complex retirement plans.

SIMPLE plans really shine for self-employed business owners. Here’s why…

Self-employed business owners are able to contribute both as employee and employer, with both contributions made from self-employment earnings.

SIMPLE plans calculate contributions in two steps:

1. Employee out-of-salary contribution
The limit on this “elective deferral” is $11,500 in 2012, after which it can rise further with the cost of living.

Catch-up. Owner-employees age 50 or over can make an additional $2,500 deductible “catch-up” contribution (for a total of $14,000) as an employee in 2012.

2. Employer “matching” contribution
The employer match equals a maximum of 3% of employee’s earnings.

Example: A 52-year-old owner-employee with self-employment earnings of $40,000 could contribute and deduct $11,500 as employee, and an additional $2,500 employee catch-up contribution, plus $1,200 (3% of $40,000) employer match, for a total of $15,200.

SIMPLE plans are an excellent choice for home-based businesses and ideal for full-time employees or homemakers who make a modest income from a sideline business.

If living expenses are covered by your day job (or your spouse’s job), you would be free to put all of your sideline earnings, up to the ceiling, into SIMPLE retirement investments.

A Truly Simple Plan

A SIMPLE plan is easier to set up and operate than most other plans. Contributions go into an IRA you set up. Those familiar with IRA rules – in investment options, spousal rights, creditors’ rights – don’t have a lot new to learn.

Requirements for reporting to the IRS and other agencies are negligible. Your plan’s custodian, typically an investment institution, has the reporting duties. And the process for figuring the deductible contribution is a bit easier than with other plans.

What’s Not So Good About SIMPLE Plans

Once self-employment earnings become significant however, other retirement plans may be more advantageous than a SIMPLE retirement plan.

Example: If you are under 50 with $50,000 of self-employment earnings in 2012, you could contribute $11,500 as employee to your SIMPLE plus an additional 3% of $50,000 as an employer contribution, for a total of $13,000. In contrast, a 401(k) plan would allow a $29,500 contribution.

With $100,000 of earnings, it would be a total of $14,500 with a SIMPLE and $42,000 with a 401(k).

Because investments are through an IRA, you’re not in direct control. You must work through a financial or other institution acting as trustee or custodian, and you will generally have fewer investment options than if you were your own trustee, as you would be in a 401(k).

It won’t work to set up the SIMPLE plan after a year ends and still get a deduction that year, as is allowed with Simplified Employee Pension Plans, or SEPs. Generally, to make a SIMPLE plan effective for a year, it must be set up by October 1 of that year. A later date is allowed where the business is started after October 1; here the SIMPLE must be set up as soon thereafter as administratively feasible.

If the SIMPLE plan is set up for a sideline business and you’re already vested in a 401(k) in another business or as an employee the total amount you can put into the SIMPLE plan and the 401(k) combined (in 2012) can’t be more than $17,000 or $22,500 if catch-up contributions are made to the 401(k) by someone age 50 or over.

So someone under age 50 who puts $9,000 in her 401(k) can’t put more than $8,000 in her SIMPLE 2012. The same limit applies if you have a SIMPLE plan while also contributing as an employee to a 403(b) annuity (typically for government employees and teachers in public and private schools).

How to Get Started with a SIMPLE Plan

You can set up a SIMPLE account on your own, but most people turn to financial institutions. SIMPLE Plans are offered by the same financial institutions that offer IRAs and 401k master plans.

You can expect the institution to give you a plan document and an adoption agreement. In the adoption agreement you will choose an “effective date” – the beginning date for payments out of salary or business earnings. That date can’t be later than October 1 of the year you adopt the plan, except for a business formed after October 1.

Another key document is the Salary Reduction Agreement, which briefly describes how money goes into your SIMPLE. You need such an agreement even if you pay yourself business profits rather than salary.

Printed guidance on operating the SIMPLE may also be provided. You will also be establishing a SIMPLE IRA account for yourself as participant.

401k, SEPs, and SIMPLES Compared

 

401k SEP SIMPLE
Plan type: Can be defined benefit or defined contribution (profit sharing or money purchase) Defined contribution only Defined contribution only
Number you can own: Owner may have two or more plans of different types, including an SEP, currently or in the past Owner may have SEP and 401k Generally, SIMPLE is the only current plan
Due dates: Plan must be in existence by the end of the year for which contributions are made Plan can be set up later – if by the due date (with extensions) of the return for the year contributions are made Plan generally must be in existence by October 1 of the year for which contributions are made
Dollar contribution ceiling (for 2012): $50,000 for defined contribution plan; no specific ceiling for defined benefit plan $50,000 $23,000
Percentage limit on contributions: 50% of earnings for defined contribution plans (100% of earnings after contribution). Elective deferrals in 401(k) not subject to this limit. No percentage limit for defined benefit plan. Lesser of $50,000 of 25% of eligible employee’s compensation ($250,000 in 2012). Elective deferrals in SEPs formed before 1997 not subject to this limit. 100% of earnings, up to $11,500 (for 2012) for contributions as employee; 3% of earnings, up to $11,500, for contributions as employer
Deduction ceiling: For defined contribution, lesser of $50,000 or 20% of earnings (25% of earnings after contribution). 401(k) elective deferrals not subject to this limit. For defined benefit, net earnings. Lesser of $50,000 or 25% of eligible employee’s compensation. Elective deferrals in SEPs formed before 1997 not subject to this limit. Same as percentage ceiling on SIMPLE contribution
Catch-up contribution age 50 or over: Up to $5,500 in 2012 for 401(k)s Same for SEPs formed before 1997 Half the limit for 401k and SEPs (up to $2,500 in 2012)
Prior years’ service can count in computing contribution No No
Investments: Wide investment opportunities. Owner may directly control investments. Somewhat narrower range of investments. Less direct control of investments. Same as SEP
Withdrawals: Some limits on withdrawal before retirement age No withdrawal limits No withdrawal limits
Permitted withdrawals before age 59 1/2 may still face 10% penalty Same as 401k rule Same as 401k rule except penalty is 25% in SIMPLE’s first two years
Spouse’s rights: Federal law grants spouse certain rights in owner’s plan No federal spousal rights No federal spousal rights
Rollover allowed to another plan (Keogh or corporate), SEP or IRA, but not a SIMPLE. Same as 401k rule Rollover after 2 years to another SIMPLE and to plans allowed under 401k rule
Some reporting duties are imposed, depending on plan type and amount of plan assets Few reporting duties Negligible reporting duties

Please contact us if you are a business owner interested in exploring retirement plan options, including SIMPLE plans.

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