Question

what are the tax planning steps a self-employed person can take in order to defer or minimize the tax liabilities ( I mean tax avoidance) and what is the advantage the self-employed will receive of tax deferring? (ACCA TAX-UK F6)

Answer 1

1. Estimate your business income

It’s absolutely essential that you find out where you stand tax-wise – before you start taking other tax planning steps.

You don’t want to make expenditures, for example, in a year when you don’t need the deduction.

If you expect to be in a higher tax bracket this year or next, you’ll want to take as many deductions as possible in the year you are subject to the highest tax rate.

Unless you estimate your business income, tax planning is guesswork at best.

2. Time your income

You can’t postpone income simply by not cashing checks that come to you, or by telling customers not to pay you until after the end of the year.

Income is generally taxable when it is available to you.

However, you can time billing near the end of the year to your advantage. You certainly can sell assets at a gain before or after the end of the year, depending on your tax situation.

3. Time your expenditures

There’s always a surge in business equipment sales at the end of the year – and it’s not entirely because computers and printers are a popular holiday gift.

On the other hand, if you’re on the cash basis, paying some bills can help lower your bill this year.

Don’t bother buying inventory or supplies that will be part of inventory before the end of the year, unless you need them. You generally don’t deduct the cost of inventory until you sell the product.

4. Make the most of medical insurance deductions

You can deduct health insurance premiums for yourself, your spouse, and your dependents as an adjustment to income.

This includes premiums for long-term care insurance. The policy does not need to be in the business name – it’s deductible even if it’s in your name.

5. Keep the form of your company simple

Unless you need to form a partnership or a corporation for some reason, stick with a Schedule C, Sole Proprietorship. It’s the simplest way to file, and there’s nothing you have to disband if you move on to something else.

If you’re looking for legal protection, get liability insurance (and consult your lawyer).

6. Automate your record-keeping

Small business record-keeping doesn’t have to be as hard as it used to be. In fact, shoeboxes (or grocery bags) full of crumpled receipts should be a thing of the past.

Use personal finance software that’s synchronized to your bank accounts.

Automatic record-keeping not only saves you time, but it’s less prone to mistakes, too.

7. Understand itemized deductions vs. business deductions

By taking a business deduction instead of an itemized deduction, you reduce your adjusted gross income and your self-employment tax.

Whenever possible, deduct an expense or a portion of an expense as a business expense.

8. Pay your kids

You can deduct the amounts you pay your kids to work in your business, and the kids generally pay less tax than you would.

The first $5,950 the child earns is sheltered by the standard deduction, and any amount above that is taxed at the child’s rate, which is generally much lower than yours.

9. Take a home office deduction

If you have a qualified home office, you can deduct some of your otherwise nondeductible expenses, such as a portion of your home insurance, utilities, and rent.

To make this process easier, the IRS has devised the Simplified Home Office Deduction. This allows taxpayers to take advantage of small business tax perks without the stress of lengthy calculations and record-keeping.

10. Avoid the hobby trap

If the IRS deems your business to be a hobby, you’ll have to report any income, but you’ll only be able to deduct expenses up to the amount of your income.

That’s no deal if you’re seriously trying to earn a profit – especially if you may clear a handsome taxable profit in future years!

It helps to clear a profit in three out of five consecutive years, but you may still convince the IRS you are a for-profit business if you operate in a businesslike manner and keep good records.

On the other hand, if you make a little income every year from something that really is a hobby, such as breeding dogs or carving lawn ornaments, you may want to keep it that way.

Hobby income is not subject to self-employment tax, which otherwise would be 15.3% of your net income from the operation.

11. Turn charitable contributions into business expenses

Under normal circumstances, you can’t deduct charitable contributions on your Schedule C. However, if you give money to charities in exchange for advertising, it’s a business expense.

That will give you a greater tax benefit than an itemized deduction.

12. Increase your self-employed retirement contributions

Contributions to IRAs are still limited, but you can contribute significantly more by opening a SEP, SIMPLE, or profit-sharing plan, instead.

2 ) ADVANTAGES OF TAX DEFERRING

An account is tax-deferred if there is no tax due on income earned in the account. The ability to defer taxes on the returns of an investment benefits individuals in two different ways. The primary benefit comes in the form of tax-free growth. As an alternative to paying tax on the current returns of an investment, taxes are paid only at a future date, allowing the investment to grow without current tax implications. The secondary benefit of tax-deferred investments is that they often occur during working years when earnings and taxes are most often higher than earnings and taxes during retirement.

The use of a tax-deferred investment account is most often a wise decision when you are in a higher tax bracket now compared to the income tax bracket you anticipate to be taxed at in the future when you will be taking withdrawals.