This section includes frequently encountered topics relating to small businesses. It discusses business deductions, how to avoid underpayment penalties, 1099s and much more.

Health Savings Accounts Offer Tax Breaks

A Health Savings Account (HSA) is a trust account into which tax-deductible contributions can be made by qualified taxpayers who have high deductible medical insurance plans. Income earned on the HSA balance is tax-free. The funds from these accounts are then used to pay “qualified medical expenses” not covered by the medical insurance for an “eligible individual.” If these funds are not used, they roll over year to year. Once the taxpayer turns 65, the funds can be used like a retirement plan (taxable when withdrawn, but not subject to a withdrawal penalty) or saved for future medical expenses. Since the contribution is an above-the-line deduction, a taxpayer need not itemize to take advantage of this tax break. The rules discussed here are applicable to federal tax returns and may not apply to your particular state.
  • Eligible Individual – For HSA purposes, the law defines an eligible individual as one who is covered by a “high deductible plan” and, while covered by that plan, is not also covered by another plan that does not have a high deductible. For purposes of determining if a plan does or does not have a high deductible, the law allows certain types of coverage, such as workers’ compensation, insurance for a specific condition, dental care, vision, long-term care and certain others, to be disregarded.

  • High Deductible Plans – For 2016 and 2017, high deductible plans are defined as those with the following deductible amounts:

    o Self-only coverage with an annual deductible of $1,300 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $6,550; or

    o Family coverage with an annual deductible of $2,600 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $13,100.

  • Qualified Medical Expenses – Qualified medical expenses that can be paid from these accounts are generally defined as those that would be allowable as a medical deduction on your tax return.

  • Contribution Limits – The eligibility and contribution amounts for these accounts are determined monthly. Therefore, during any month in which you qualify, you would be entitled to contribute up to one-twelfth of the annual limits. For 2017, the annual limits (note these values are adjusted annually for inflation) are:

    o $3,400 (up from 3,350in 2016) for single coverage plans;  
    o $6,750 (as in 2016) for family coverage plans; and
    o $1,000 additional for individuals age 55 or older.

    Individuals entitled to benefits under Medicare and those claimed as a dependent on another person’s tax return cannot make contributions. Contributions can be made as late as the due date of the tax return without extensions; contributions in excess of the allowable amounts are subject to an annual 6% excise penalty. If your employer makes the contributions for you through a payroll deduction plan, the contributed amounts are not subject to normal payroll withholdings such as FICA and taxes.

    Example: John, a single taxpayer, age 58, begins a high deductible health plan with an annual deductible of $5,000 starting in March of 2017. We need to determine his maximum annual contribution limit, which is $4,400 ($3,400 plus $1,000 for being over 55). Next, we divide the annual limit by 12 to determine the monthly limit; in John’s case, it is $366.67 ($4,400/12). Since John was in a high deductible health plan for 10 months during 2017, his maximum contribution limit for 2017 would be $3,666.70  $366.67 x 10). If John were in the 25% tax bracket, he would realize a tax savings of $916.

  • Non-Qualified Distributions - Distributions from an HSA are permitted at any time, and if used exclusively to pay for qualified medical expenses of the account beneficiary, his or her spouse, or dependents, are excludable from gross income. Amounts not used to pay for qualified medical expenses are includible in the account beneficiary’s gross income and are subject to a 20% penalty tax. However, the penalty does not apply if the distribution is made on account of the beneficiary’s:

    o Death;
    o Disability; or
    o Attaining age 65.

  • Qualified Medical Expenses – are unreimbursed expenses paid by the account beneficiary, his or her spouse, or dependents for medical care, generally the same definition used for itemized-deduction medical expenses. The qualified medical expenses must be incurred only after the HSA has been established. Medical expenses paid or reimbursed by HSA distributions cannot also be claimed as a medical expense for itemized deduction purposes.  
If you have questions related to Health Savings Accounts or how an HSA might suit your particular medical or retirement plans, please give this office a call.

Tax Credits for Small Employers Offering Health Coverage

The Patient Protection and Affordable Care Act provides a tax credit for an eligible small employer (ESE) for nonelective contributions to purchase health insurance for its employees. The term "nonelective contribution" means an employer contribution other than an employer contribution pursuant to a salary reduction arrangement.

Qualified small employers, generally those with no more than 25 full-time employees with an average annual full-time equivalent wage of no more than$51,800 (for 2016; adjusted annually for inflation) will be eligible for a tax credit of up to 50% (35% for tax-exempt 501(c) organizations) for up two years, of the cost of non-elective contributions to purchase health insurance purchased through a state or federal marketplace (SHOP) for its employees.  (Note, however, that the phase-out of the credit operates in such a way that an employer with exactly 25 full-time equivalent employees or with average annual wages exactly equal to $51,800 for 2016 is not eligible for the credit. The maximum credit is available to employers with no more than 10 full-time equivalent employees with annual full-time equivalent wages from the employer of less than $25,000.)

The credit percentage that can be claimed varies with the number of employees and average wages. 

Calculating the credit amount - The credit is equal to the lesser of the following two amounts multiplied by the applicable tax credit percentage and subject to the phase-outs discussed later:

(1) The amount of contributions the eligible small employer made on behalf of the employees during the tax year for the qualifying health coverage.

(2) The amount of contributions that the employer would have made during the tax year if each employee had enrolled in a plan with a premium equal to the average premium for the small group market in the rating area in which the employee enrolls for coverage, also referred to as the small business benchmark premium. Contributions under this method are determined by multiplying the benchmark premium by the number of employees enrolled in coverage and then multiplied by the uniform percentage that applies for calculating the level of coverage selected by the employer. 

To figure the reduction of credit when the limits are exceeded, the number of the employer’s full-time equivalent employees and average annual full-time equivalent wages (AAEW) for the year must be determined.

Figuring the number of full-time equivalent employees - An employer's full-time equivalent employees (FTEs) for 2016 is determined by dividing the total hours the employer pays wages during the year (but not more than 2,080 hours per employee) by 2,080. The result, if not a whole number, is then rounded down to the next lowest whole number if any (unless the result is less than one, in which case, the employer rounds up to one FTE).

Calculating average annual wages (AAEW) - Average annual equivalent wages is determined by dividing the employer’s total FICA wages (without regard to the wage base limitation) for the tax year by the number of the employer's full-time equivalent employees for the year (rounded down to the nearest $1,000 if need be).

Credit reduction - If the number of full-time equivalent employees exceeds 10 or if AAEW exceed $25,000, the amount of the credit is reduced (but not below zero).  Both reductions can apply at the same time!

Example – Joe owns a small wood working business and has 12 employees, not counting himself or family members.  The total FICA wages (without regard for wage base limitations) for the year were $297,500 and total hours worked by his employees during the year were 24,400.  None of his employees worked more than 2,080 hours during the year.   Joe made non-elective contributions to purchase health insurance for his employees in the amount of $49,800 for the year. He has not claimed the small business health insurance credit in any other year.  Joe’s credit is determined as follows (the $25,900 amount used in the AAEW reduction formula is for 2016; this amount is adjusted annually for inflation):
  • Small Business Benchmark Premium (estimated for this example. In actual practice the benchmark premiums are included in the instructions for Form 8941) = 12 x 5,345 = $64,140
  • Smaller of actual premium paid or Benchmark premium = $49,800
  • Tentative credit = $49,800 x 0.50 = $24,900
  • Full-time equivalent employees (FTEs) = 24,400/2080= 11.7 rounded down = 11
  • Average annual full-time equivalent wages (AAEW) = $297,500/11 = $27,045 rounded down = $27,000 
  • FTE Reduction = ((11-10)/15) x $24,900 = $1,660
  • AAEW Reduction = ((27,000-25,900)/25,900) x $24,900 = $1,058
  • Joe’s health insurance tax credit = $24,900 - $1,660 - $1,058= $22,182

Other Issues:

  • The credit reduces the employer's deduction for employee health insurance.  
  • Special rules apply if the employer benefits from state tax credits or a premium subsidy paid by the state for providing health insurance for its employees.
  • Aggregation rules apply in determining the employer. 
  • Self-employed individuals, including partners and sole proprietors, 2% shareholders of an S Corporation, and 5% owners of the employer are not treated as employees for purposes of this credit. 
  • There's a special rule to prevent sole proprietorships from receiving the credit for the owner and their family members.  
  • The credit is a general business credit that can offset the taxpayer’s income tax, and if the amount of the credit is greater than the tax, the excess can be carried back one year and forward for 20 years. However, because an unused credit amount cannot be carried back to a year before the effective date of the credit, any unused credit amounts for taxable years beginning in 2010 can only be carried forward.
  • The credit is available to offset tax liability under the alternative minimum tax.  
Please call this office if you have questions related to Tax Credits for Small Employers Offering Health Coverage.

When 1099s Must Be Filed

If you use independent contractors to perform services for your trade or business and you pay them $600 or more for the year, you are required to issue them a Form 1099 at the end of the year to avoid facing significant penalties and the loss of the deduction for their labor and expenses. It is not uncommon to use the services of a repairman early in the year, pay him less than $600, then use his services again later and have the total for the year exceed the $600 limit. As a result, you may have overlooked getting the information needed to file the 1099s for the year (service providers name, address and tax ID number). Therefore, it is good practice to always have individuals who are not incorporated complete and sign the IRS Form W-9 the first time you use their services. Having a properly completed and signed Form W-9 for all independent contractors and service providers eliminates any oversights and protects you against IRS penalties and conflicts.

IRS Form W-9, Request for Taxpayer Identification Number and Certification, is provided by the government as a means for you to obtain the data required to file the 1099s from your vendors. It also provides you with verification that you complied with the law should the vendor provide you with incorrect information. We highly recommend that you have a potential vendor complete the Form W-9 prior to engaging in business with them. The form, available from this site, can either be printed out or filled onscreen and then printed out. The W-9 is for your use only and is not submitted to the IRS.

In order to avoid a penalty, copies of the 1099-MISCs must be sent to the recipient and filed with the IRS by January 31.  Other types of 1099s need to be the recipients by January 31 and filed with the IRS by February 28 (February 29 in a leap year). They must be submitted electronically or on optically scannable forms (OCR forms). This firm prepares 1099s in OCR format for submission to the IRS with the 1096 submittal form. This service provides recipient copies and file copies for your records. Copies to recipients must be sent by the last day of January to avoid a penalty. Use the worksheet to provide us with the information we need to prepare your 1099s. Note: If the due date falls on a Saturday, Sunday or legal holiday, the due date is the next business day.

The penalties for failure to file the required information returns are $260 for each informational return, up to a maximum of $3,193,000 ($1,064,000 for small businesses).  The amounts shown are for 2016 filings and are annually adjusted for inflation.

What Happens When I Default on a Business Loan?

What does it mean to default on a loan?

A loan default is the failure to meet the financial obligations indicated in the loan agreement that is signed by you and your lender. Often, a loan default translates into the business owner's inability to pay their debts on time. Due to the differences in each loan agreement, default penalties vary. However, the effects of defaulting on the loan fall into two general categories- immediate repercussions and future implications for both you and your business.
What are the immediate effects to my business if I default on a loan?

Drop in business and/or personal credit score. Missing your payments and defaulting on your loans negatively impacts your business credit score. Your personal credit score may be affected, depending on the type of business structure that you have in place. 

Increased interest rates. Your business interest rates (and possibly your personal interest rates) may increase if your credit score dips. Depending on your loan agreement, a higher interest rate could affect the loans that you currently have, as well as future loans you plan to seek.

Foreclosure or seizing of property and collateral. Foreclosure may be the most severe repercussion due to a loan default, allowing lenders to recuperate losses from loan defaults. In this situation, your lender will have the full right to take control and ownership of your property and collateral that you have included in your contract. They normally will sell your property privately or by a public auction, depending on the profit margin.

What steps should I take next?

Negotiate terms with your lender. If you default, you can try renegotiating the terms of your loan contract with your lender. While lenders may not always be willing to renegotiate, if you are successful you can minimize the damage to your business's financial health. Ways to reduce the negative impacts of the loan default include:

 Changing the terms of payment, e.g., paying less per installment but for a longer period of time
• Paying less over more time with a higher interest rate
• Asking your lender to forgive a portion of your late payment and agree to pay on time in the future

Consider government debt relief options. The federal government’s Small Business Administration (SBA) can help facilitate business loans with a third party lender, guarantee a bond, or help a business find venture capital. During severe financial crises, the government often creates specific programs for a limited time to help faltering small businesses.

Cut costs. Minimize your expenses. Though this may not be an ideal situation, you can consider laying off part of your staff and downsizing your business, among others. If you are paying rent for your place of business, consider moving to smaller quarters or to a locale where rents are less expensive, if doing so won’t harm your business’ sales or  a move won’t be too costly.

Sell business assets. Liquidating business assets or converting your assets into cash may temporarily help you pay off your loans until you can afford to pay your bills on time again.

Consult a lawyer. Consulting a lawyer about your options may also help you through the process. 

What does this mean for the future of my business?

Difficulty finding new loans. After you default on one loan, it will make it much more difficult to find a new loan. If loans are the chief means of financing your business, then you will be running into some difficult hurdles. You may want to start looking into other methods of funding your business.

Bankruptcy. If your business cannot repay its loans, you may need to file for bankruptcy.
What Can I Do to Avoid a Loan Default?

Of course, the best way to avoid defaulting is to pinpoint the pitfalls of bad loans and avoid them at all costs. To avoid loan defaults, business owners should remember the following best practices:

• Have a concrete payment plan before you decide to borrow.
• Do not offer collateral and property in your contract that you cannot afford to lose.
• Read the fine print and thoroughly understand the terms of the contract.

Looking for Business Tax Deductions? Look No Further Than Your Business Vehicle!

The options for deducting the business use of a vehicle are both numerous and generous. In fact, there are so many options that some can easily be overlooked. Note: When a vehicle is used both for personal and business use, the expenses must be prorated based on miles driven for each purpose.

Listed below are some of the current options:
  • Lease or Purchase – Your first option deals with the manner in which you acquire the vehicle. Whether you decide to lease the vehicle or purchase it, you may choose to deduct the business use of the vehicle using either the actual expense method or the standard cents-per-mile method. Note: If you choose the actual expense method the first year, then the standard cents-per-mile method cannot be used in any future year for that vehicle.

  • Trade-In or Sell Old Vehicle – If you are replacing an existing vehicle, you have the option either to trade in the old vehicle or to sell it. Without considering other economic factors, if the sale of the old vehicle would result in a gain, then you may wish to consider trading it in and avoid the need of reporting the gain and instead reduce the cost basis of the replacement vehicle. On the other hand, if the sale will result in a loss, then it would probably be better to sell the vehicle and take the loss on your return.

  • Cents-Per-Mile Method – This method requires the least amount of bookkeeping. You need only record the business miles and total miles driven on the vehicle each year, and the business deduction is the business miles multiplied by the rate for the year. Note: This method cannot be used to compute the deductible expenses of five or more autos owned or leased by a taxpayer and used simultaneously, such as in fleet operations.

  • Actual Expense Method – As the name implies, this method involves deducting the actual expenses of operating the vehicle. This requires keeping track of the operating costs, including fuel, oil, maintenance, repairs and insurance. In addition, either the annual lease expense or, depending on the class of vehicle, an allowance for wear and tear on the vehicle is added to the annual expenses. A record of the business and total miles must also be maintained to determine the business portion of the expenses.

  • Class of Vehicle – The class of vehicle affects the limitations that are applied to the allowances for wear and tear available for a particular vehicle.

    A. Vehicles With No Limitations: The following vehicles qualify for the Sec 179 deduction, regular depreciation and for years when permitted by law, first-year bonus depreciation. Depending on the methods selected, virtually any amount of the cost of this type of vehicle can be deducted in the year of purchase.

    - Heavy Vehicle – A vehicle exceeding 6,000 pounds gross unladen weight such as many of today’s sport-utility vehicles.

    - Qualifying Nonpersonal Use Vehicle
    – A vehicle that has been specially modified with the result that it is not likely to be used more than a de minimis amount for personal purposes.

    - Exempt Vehicles – A vehicle used directly in a taxpayer’s trade or business of transporting persons or property for compensation or hire, such as an ambulance, hearse, taxi, clean fuel vehicles, bus or commuter highway vehicles.

    B. Those With Limitations: The following vehicles are limited by the luxury auto rules:

    - Luxury Vehicle – Generally, a vehicle costing more than an annually inflation-adjusted threshold ($15,900 to $17,700 for 2016) and not falling into one of the other previous categories. This threshold and the annual limits are not determined until part way through the year.

    - Special Trucks & Vans – Defined as passenger autos that are built on a truck chassis, including minivans and sport-utility vehicles (SUVs). These vehicles are subject to the annual luxury vehicle limitations, but are allowed an additional amount (usually $200 or $300, depending on the year purchased) added on to those limitations.

    C. Vehicles with Other Limitations: In addition to those described above, there are certain other seldom encountered vehicles, such as electric vehicles and certified clean fuel vehicles, with other special allowances.

  • Interest and Taxes – In addition to the other deductions discussed above, the business portion of personal property taxes, license and interest on the debt to purchase the vehicle are also deductible when the vehicle expenses are being deducted on a business schedule.
NOTE: Limitation for Employees -  An employee who uses a personal vehicle for business and who qualifies to claim unreimbursed vehicle-related costs must include those expenses as part of the miscellaneous itemized deductions category on Schedule A, and that entire category of expenses is deductible only to the extent the total exceeds 2% of the taxpayer’s adjusted gross income. However, employees are allowed to claim all of the personal property tax portion of their vehicle registration fees as a Schedule A tax expense rather than as part of their employee business expenses.

Self-Employed Education Twists

Self-employed taxpayers should consider their options carefully when it comes to applying tax benefits for their own education tuition and expenses. Tax law provides multiple ways to benefit from the educational expenses and one may provide more benefit to you than another based on your particular set of circumstances. In addition, your tuition may qualify for one tax benefit while other education expenses qualify for another.

  • As a Business Expense – Generally, if the education qualifies, it is better to take the cost as a business expense since as a business expense it will offset both income taxes and self-employment tax. The expenses can include tuition, books, supplies, and allowable travel for the education. To qualify as a business expense, the education must either be to maintain or improve your skills or be required in your business. You may, however, not wish to use the education’s costs as a business expense when doing so limits your net profit and consequently limits your retirement plan contribution. Another situation when you may not want to claim the education costs as a business expense is when your Schedule C only has a very small profit or shows a loss for the year.
  • As an Adjustment to Income – If the education expense is tuition at an institution of higher education and you are under the AGI phase-out limit for this deduction, you have the option to deduct up to $4,000 as an adjustment to overall income for the year. You can take this above-the-line education deduction whether or not the education maintains or improves your skills required in your business. Other expenses related to this education such as books, supplies, and travel can still be deducted on your Schedule C as long as the education maintains or improves your skills required in your business. The deduction is a maximum of $4,000 if AGI does not exceed $65,000 ($130,000 for married couples filing jointly) or a maximum of $2,000 if AGI doesn’t exceed $80,000 ($160,000 for married joint filers). This provision is scheduled to expire at the end of 2016, unless extended by Congress.
  • As a Tax Credit – As with the adjustment to income above, if the education expense is tuition at an institution of higher education, you might qualify for the lifetime learning credit. It may be more beneficial than the business expense or AGI adjustment for the tuition portion of the expenses, especially if you are in a lower tax bracket or the business profits are low. The lifetime learning credit allows you a credit of 20% of the cost of your tuition (up to $10,000 of costs annually) as a tax credit. It, too, has an AGI phase-out limitation. For 2016, the credit for single taxpayers phases out between $55,000 and $65,000 and $111,000 to $131,000 for joint filers. The phase-out ranges are inflation adjusted each year. Please call this office for the phase-out ranges for years other than 2013. If you meet the full-time student requirement, you may qualify for the more beneficial American Opportunity credits.
If you have any questions regarding these various options, please call our office.

Employing a Family Member

A way to reduce the overall family tax bill is by employing family members to work in your business by shifting income to them and providing them with employment benefits.
  • Employing your Spouse. Reasonable wages paid to your spouse entitles you to a business deduction. Although the wages are subject to both income and FICA taxes, your spouse may qualify for Social Security benefits to which he or she might not otherwise be entitled. In addition, your spouse may also be entitled to receive coverage under the qualified retirement and health plans of your business, allowing you to obtain business deductions for contributions to your spouse’s retirement nest egg and health insurance premium payments made on behalf of your employed spouse. While maintaining the same family medical care coverage, you increase your business deductions by providing your spouse with family health insurance coverage as an employee.

  • Employing your child. By employing your child, the income tax advantages include obtaining a business deduction for a reasonable salary paid to that child, thus reducing your self-employment income and tax by shifting income to the child. Since the salary paid to your child is considered earned income, it is not subject to the “Kiddie Tax” rules that apply to children under the age of 19, as well as some older children. The maximum standard deduction available to your child in 2016 is $6,300 (same as 2015) if he or she has at least that amount of earned income. Therefore, the standard deduction eliminates all tax on this income if you pay your child $6,300 (2016) in compensation. If your business is unincorporated, wages paid to your child under age 18 are not subject to social security taxes. Not only are there significant income tax advantages to employing your child, but you may provide him or her with fringe benefits such as group-term life insurance and qualified pension plan contributions.

Your child may also make deductible contributions to an IRA of the lesser of earned income or the annual limitation. These contributions can offset earned and unearned income. As example, in 2016 your child could receive $11,800 gross income ($6,300 earned and $5,500 unearned) by combining the IRA deduction ($5,500) with the standard deduction ($6,300) and pay no tax. You should consider giving him or her part or all of the money needed to fund the IRA (as part of your $14,000/$28,000 annual exclusion for gifts) if your child does not want to use his or her earned income to fund an IRA contribution.

Please keep in mind that when you employ a family member in your business, the wages should be reasonable for the work performed and that the services performed are necessary to the business.

Health Insurance for the Self-Employed

Becoming self-employed often means leaving the comfort of employer-provided affordable and easily obtainable health insurance. The following tips may save you some of the frustration you may encounter as a self-employed individual in the market for health insurance.

Do your homework - Research the company and policy thoroughly before buying insurance and you may save hundreds of dollars yearly. Here are some guidelines to consider....
  • Become familiar with the different policies available. Being ignorant will not help you in your decision-making. You have a wide range of resources such as the Web to determine the pros and cons of each policy. You may even qualify for subsidized insurance through a state or federal insurance marketplace. 
  • If you have employees - see if a SHOP group policy obtained through a state or federal marketplace meets your needs. 
  • Determine the companies which offer the type of policy that best fits your needs. After you have decided on the type of insurance you need, research the agents and local companies that offer the policies you are looking for. 
  • Obtain in writing what the policy will pay for and what it won't. The description of the plan needs to include the total out-of-pocket expenses you will be liable for and the coinsurance limit. In addition, request a detailed explanation on reimbursement of office visits, prescriptions and emergency room visits. It might also be helpful to find out the hospitals and medical groups included in the plan’s coverage area and the reimbursement percentage of each one. 
Make annual or semi-annual payments of premiums. Ask your agent about service fees and discounts. If you pay annually or semi-annually, the service fee may be waived, and you may receive a discount.

A higher deductible should be taken into consideration. You may want to consider changing to a higher deductible if your family is healthy and has been for a number of years. A higher deductible could significantly reduce your premium. Plans with deductibles over $1,300 for a self-only plan or $2,600 for a family plan that limits out-of-pocket expenses to $6,550 for a self-only plan or $13,100 for a family plan may qualify you to have a health savings account to which you can make an above-the-line tax deductible contribution of up to $3,350 or $6,750 for a family plan (a higher contribution is possible if you are age 55 or older). These amounts are for 2016 and are adjusted for inflation. Check with this office for amounts for other years.

Participate in an independent group plan. To help lower the overall cost of insurance premiums, most self-employed people join associations to enroll in a group health plan. If an existing group health plan is not available, consider starting one within the trade association with which you are affiliated.

Tax Deduction Considerations - A self-employed individual may deduct, in computing adjusted gross income, amounts paid during the tax year for insurance that constitutes medical care for the taxpayer, spouse, dependents and any child of the taxpayer who hasn't attained age 27 as of the end of the tax year if certain requirements are satisfied. A “child” includes the taxpayer’s child, stepchild, legally adopted individual, an individual lawfully placed with the employee for legal adoption, and an eligible foster child. There are no other qualifications other than being the taxpayer’s child; thus income or marital status has no bearing.

If the self-employed person considers these issues in the initial process, finding an affordable and convenient health insurance should be effortless. Contact this office for further assistance.

Which is Better - Keogh or SEP?

Retirement plans available to a self-employed individual vary from the very fundamental to the complex variety; with the latter requiring the services of professional pension plan administrators. Among the plans available are the Keogh, SEP, and Defined Benefit and Simple IRA plans. Because of their complexity and normally high administration costs, the Defined Benefit and Simple IRA plans are not discussed in this article. However, older individuals should take note of the larger retirement contributions available with Defined Benefit plans that could justify the higher administration costs.

Keogh Plans: The overall annual contribution limit to a Keogh plan is 25% of the net profits less the retirement contribution made to the plan itself. After doing the appropriate math, we find 25% of the net profits less the retirement contribution actually equates to 20% of the net profit. The total contribution for the year is also limited to the annual contribution limit.  For 2017, that limit is $54,000 (up from $53,000 in 2016) and the maximum compensation upon which the contribution is based is limited to $270,000 (up from $265,000 in 2016.

Self-Employed Individual Keogh Limit - The contribution limit is 25% of the net profits from self-employment less the amount of the contribution itself and the self-employment (SE) tax deduction.  This will result in a contribution amount somewhat less than 20% of the net profits before deducting the contribution itself and the SE tax deduction. The contribution is also limited to the same maximum contribution amount and compensation limits as applicable to an employee.

Keogh plans must be established before the end of the year for which a contribution is made. However, the contribution for any year can be delayed until later, but not later than the due date of the taxpayer's individual return including extension. Reporting requirements for one-participant Keogh plans require that Form(s) 5500-EZ be filed for the year the assets of all related plans exceed $250,000 and in the final year of the plan.  All other plans must file Form(s) 5500 annually. For calendar year taxpayers, the due date for this report is July 31.

SEP Plans: Unlike the Keogh plan, a SEP plan can be established after the close of the tax year. However, it must be established and funded by the due date of the taxpayer's return plus extensions. SEP plans are also referred to as SEP IRAs since they utilize IRA accounts as the depository for the plan contribution. Even though the funds are being deposited into an IRA account, the SEP contribution has the same contribution limits as the Keogh plan. An additional advantage of a SEP plan is that there are no annual reporting requirements like those that apply to the Keogh plans.

Employees: If a self-employed individual has employees, it may be necessary to include the employees in the plan. Most plans require coverage once an employee attains age 21. With a Keogh plan, you don't have to cover employees until they have completed at least one year of service (two years in some cases). A SEP is a little different, since you only need to cover employees who have worked for you during three of the past five years. Once this test is met, most part-time workers will have to be covered under a SEP.

Luxury Car Rules May Limit Vehicle Write-Offs

Unfortunately, if you deduct actual expenses for business use of your car, you probably find your write-offs for depreciation restricted due to so-called luxury car limitations. And most cars (including trucks or vans) fit the IRS definition of a "luxury vehicle," regardless of their cost. If a vehicle is four-wheeled, used mostly on public roads, and has an unloaded gross weight of no more than 6,000 pounds, the car is considered a "luxury vehicle." 

To see how this works, let's hypothetically say you and an associate each bought a car. Your car costs $50,000 while your associate's costs $32,000. You both use your vehicles 75% for business. Cars are in the 5-year life depreciation category and the first-year depreciation for 5-year life items is 20%.  However, your depreciation deduction for the year (including any choice to expense part of the car's cost) will be subject to the first-year "luxury vehicle" limitation, which is $3,160 for 2016.  However, there is a special 50% bonus depreciation allowance for boosts the “luxury auto limitation” by $8,000 to a total of $11,160 for 2016. The limit is $400 more for trucks and vans purchased in 2016.

Your Car
Associates Car
1. Vehicle Cost
2. 50% Bonus Depreciation
3. Balance
4. 20% First year Depreciation (20% of line 3)
5. Depreciation Before Limit
6. Luxury Auto Limit
7. Allowable Deduction (lesser of 5 or 6)


As you can see, both you and your associate’s depreciation for the first year is the same amount because of the luxury auto limits. Your associate will be able to deduct the same amount as you, even though his car had a much lower cost than yours.

Thus, your first-year depreciation (you used the vehicle 75% for business) will be $8,370 (11,160 x .75)

This may seem unfair, but there is an alternative that can help. Certain sports utility vehicles (a Suburban for example) exceed 6,000 pounds unloaded gross weight and have special rules.

CAUTION: Since bonus depreciation is being phased out, the bonus depreciation applicable to luxury vehicles is also being phased out after 2017.  Thus the luxury auto rates shall be increased by the following bonus depreciation rates:

2015 through 2017 - $8,000
2018 - $6,400
2019 - $4,800

For more information on how to maximize your business vehicle deductions, please give this office a call.

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