Wednesday, April 17, 2019
Saving money on taxes, with Uncle Sam's blessing
I've had a hectically busy couple of weeks, finalizing taxes and associated book-keeping. It all worked out in the end, and has been very worthwhile. I thought those of my readers who are independent writers, as I am, or who operate small businesses, might find some of our "lessons learned" interesting.
Miss D. and I set up a limited liability company (LLC) last year, to handle my book publishing activities. It meant a lot more work, keeping the company books to corporate standards, setting up dedicated bank accounts, and so on. However, it allowed us to separate our business income and expenditure from all our other sources of revenue, and account for them in detail. Compared to previous years, I'd say it meant three times more work - but also three to four times greater savings on our tax bill. Being able to track everything within a corporate entity was worth the trouble; and being able to take advantage of corporate deductions for depreciation, etc. was very useful. We saved a bundle on taxes!
It's also meant that we have greater flexibility on our personal income taxes. Until last year, we'd simply used our standard income tax deduction (which was $12,000 in 2017) to cover business expenses (which aren't very high for a small business such as ours). This year, by separating the income and expense streams, not only did we account for business expenses much more rigorously, we were also able to reserve the whole of our standard tax deduction (which doubled to $24,000 in 2018) to reduce our income tax liability, over and above deductions for business expenses. Effectively, we had a combined tax deduction three times greater than the previous year, which saved a great deal of money in itself.
Finally, we've opted to have our LLC taxed as a C corporation - in other words, the money that flows into the LLC doesn't "pass through" to us, but is taxed in the company's hands. (We're going to build up a business reserve in the company account before worrying about paying ourselves anything from it.) The corporate tax rate is currently 21% - far less than the maximum personal tax rate of 37%. Of course, we're not wealthy, and don't even come close to that upper tax bracket; but those whose individual earnings exceed $37,701 (or, as a couple, $77,401) currently have to pay 22%, and the rate goes up from there. If you're in any higher tax bracket, the corporate tax rate can save you money.
All in all, it was worth all the time, trouble and expense of setting up the company, and the added work of keeping the books to the required standard. It's saved us thousands of dollars. Even if you're earning as little as $25,000 a year from your small business, consider setting up a corporate vehicle for it (or even a "trading as" classification, with a separate business bank account). It can be very worthwhile.
Peter
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6 comments:
You used your standard deduction to cover business expenses? But business expenses are reported on Schedule C along with business income. Or on Schedule E if reporting income as royalties. Those expenses are all deductible from your taxes independent of individual itemized or standard deductions.
From this it sounds like you've been paying too much tax independent of your LLC.
Don't forget that as a writer all your research expenses are deductible against earnings.
Any trip you take, from SF cons to those expeditions to historical sites in the Southwest are at least in part a business expense.
@Thomas W. - If you aren't set up as a business entity, it's a lot more difficult to claim certain expenses as business-related. For example, if you buy a car for business purposes, but register it in your name, you can't apply depreciation, etc. in the same way that a company can. That alone saved us thousands over this past year.
Also, bear in mind that a small business like ours doesn't spend a huge amount on business expenses; so it was usually the case that the standard deduction was larger than our costs, and thus worth taking rather than detail each expense.
I finally convinced my daughter to switch from a schedule C to an S-corp. I told her it'd save her about $500 a month, particularly since I do her payroll and taxes for free. She was a very happy camper when she compared 2018 to 2017.
@Peter - I'm sure there are things you can deduct as a corporation which are harder as an individual, though in the past a small, personal LLC giving somebody a company car would probably be a red flag for an audit to see if was really used for business purposes.
But my main confusion is why you were not deducting business expenses on Schedule C or Schedule E even while taking the standard deduction. The standard deduction is instead of itemizing on Schedule A, which is primarily for mortgage interest, taxes, and charitable contributions. Business expenses for any form of business (sole proprietorship, partnership, or whatever) are independent of the standard deduction and should be claimed in addition to the standard deduction.
So, spending 21% on taxes now and then 22% later is an improvement? I can see it working if you take the money as you make it, as personnel expenses count as an expense on the corporate account. But saving for later, when you may or may not have money flowing into the corporate account, seems like a gamble.
Then again, I always end up buying high and selling low, so what do I know. I promise to let you know the next time I do something with my IRAs, so you can do the opposite.
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