PROFESSIONAL SERVICES: Tax planning tips for the self-employed sole proprietor

The self employed individual has the advantage of quickly implementing business strategies without the bureaucracy of the corporate office.

On the other side of the coin, he or she needs to act as both the chief financial officer and the chief executive officer. Before year end, the self employed individual needs to consider strategies to save on business income taxes.

The attempt to simplify accounting procedures can leave you exposed to the IRS’s denial of your business deductions.

For instance, many taxpayers enjoy the simplicity of the per diem rates to substantiate meals and lodging expenses; however, the self employed individual can only use this method to substantiate meals and incidental expenses, not lodging expenses. Your tax expert can provide you with a list that details how much can be deducted despite the absence of an actual receipt.

Mileage deduction

Another way to simplify tax accounting is by using the standard mileage deduction on your business auto. The rate is 32.5 cents per mile for the year 2000.

The standard mileage deduction can be used even when the basis of the vehicle has been reduced to zero. The standard mileage allowance cannot be used if you have two or more vehicles used in the business at the same time. If you do not qualify to use the standard mileage allowance, the actual expense method must be used. To hold up under IRS scrutiny, these expenses must be substantiated. When applying the actual expenses method, you can deduct the business portion of the gas, oil, maintenance, insurance, etc.

You have a choice of depreciation methods: the straight line method, the 150% declining balance method, or the 200% declining balance method of depreciation. If your have used the standard mileage rate in prior years, you must use the straight line method. Your choice of methods may be subject to depreciation limits.

Several popular vehicles have gross vehicle weights of more than 6,000 pounds. Vehicles over this weight are not subject to the annual depreciation limitations.

This will dramatically increase your depreciation deductions. In 1999, these vehicles included: American Motors General Hummer; Chevrolet Suburban and Tahoe: Ford Expedition; GMC Suburban and Yukon; Land Rover Discovery: Lexus LX450; Range Rover; and Toyota Land Cruiser.


Do you have several business ventures? If you do, then you need to consider the combined effect of both the selected depreciation method and the option to expense $20,000 of assets purchased in the current year. Your choice must be carefully made. When your business ventures require a significant annual purchase of depreciable assets, the MACRS depreciation combined with section 179 deductions may become suspended, increase the alternative minimum tax, or create a personal net operating loss. The effect of depreciation deductions need to be carefully assessed in the aggregate on your tax return.

As a self employed entrepreneur you are likely to have more than one business venture. This inevitably raises the issue of passive and active income types. Your level of participation in each activity is important to classify income as active. Your tax professional can help you to group activities in a manner that is most advantageous to satisfy the active participation requirements. Business ventures with losses, that are deemed to be passive, are subject to deduction limitations.

Home office

Beginning in 1999, the rules were eased on requirements that had prevented most self employed individuals from taking a home office deduction. Congress enacted legislation to extend the deduction to those who use the home office as the sole place for administrative or management activities. The home office will qualify your home for depreciation deductions, which reduce both the basis and the excludable gain on the home office portion of the house.

Give your child a job

Self employed individuals have the opportunity to shift income to a lower tax bracket, provide retirement account funding, and help to develop their child’s business skills. Even if the child is subject to the “kiddie” tax rates, reducing your adjusted gross income can reduce the effect of deduction phase-outs on your tax return. The wages paid to your child are considered to be earned income. Having earned income alleviates restrictions on your child’s standard deduction, retirement and college saving plan contributions, Hope and Lifetime Learning credits. Additionally, employing your child can put them a step ahead of their peers by giving them the opportunity to develop business skills.

Retirement plans

Before you file your tax return, strongly consider contributing to a retirement plan. Congressional activity in this area has provided many options for you to simultaneously fund your retirement and reduce your current tax liability.

If you are self employed with no employees, or just family members as employees, then you really need to consider the SEP. It’s too easy. You don’t even need to have it set up or contribute to it until the due date of your tax return (including extensions). Better yet, the SEP has no annual reporting requirement. Most retirement plan specialists don’t recommend this plan because it does not provide flexibility. However, this plain vanilla plan may be perfect for you because of its simplicity.

All qualified retirement plans have non-discriminatory requirements and testing. You can get a ball park idea of which plan serves you best by browsing the IRS publication 560. It is titled Retirement Plans for Small Business (SEP, SIMPLE, and Keogh Plans). This publication can be found on line among the tax forms and publications link at the IRS Web site: .

Don’t forget to consider other strategies to save on income taxes such as accelerating or deferring both income and deductions, and choosing a tax-smart inventory method. Finally, stay focused on your entrepreneurial endeavors, and don’t be afraid to delegate a few tasks to the tax experts.

Tim Cairns, CPA, is a senior accountant in the tax department of the Traverse City office of Rehmann Robson P.C.