Business Matters

By Michael D. Raymond

The Taxman Cometh

Yes, it’s true that the income tax season is fast approaching. Benjamin Franklin said nothing is certain but death and taxes, but at least death doesn't get worse every year. Many of my clients complain about the complexity of our revenue laws and the almost-impossible challenges they present. They also complain about the amounts they must pay. I don’t think Congress is listening.  I once met a dance studio owner who said, "I don’t mind paying taxes." but I suspect this teacher is in the minority.

When Congress changed the tax codes with the Tax Reform Act of 1986, it eliminated many of the deductions that had enabled people to avoid paying some income taxes. Near the end of each year (November or December) is the time to take one last look and try to determine how to reduce taxes for the following year, but many of us put it off until we are preparing our returns near the deadline of April 15.  According to the government itself, it’s even patriotic to try to pay less:

"Over and over again Courts have said there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich and poor, and all do right, for nobody owes any public duty to pay more than the law demands. Taxes are enforced exactions, not voluntary contribution.”

—Honorable Learned Hand, US Appeals Court Justice

Once you develop that mind set, your motivation to save taxes gets even stronger, so get your records together. Remember, you pay tax on adjusted gross income (AGI)—that’s gross income less your proper deductions, so be sure to report both accurately.

Gross income includes, but is not limited to, wages and self-employment (1099) income; dividends and interest; commissions, bonuses, and tips; rents and royalties; alimony (received); prizes and awards; some scholarships and fellowships; some Social Security benefits; income distributions from trusts and estates; unemployment compensation; and gains from gambling and lotteries.

There are a number of above-the-line deductions that may reduce AGI, subject in many cases to limitations such as a dollar amount or income ceiling. These include contributions to qualified retirement plans; job-related moving expenses; interest paid on student loans; alimony; classroom supplies purchased by teachers; self-employment taxes; and deductible IRA contributions that top out at $3,000 in 2004—$3,500 for taxpayers who reach the age of 50 by the end of the year.

I also suggest, if you have not done so already, that you consult with your financial advisor or CPA about starting up a tax-deductible/tax-deferred pension plan this year. Did you know, according to a survey by the Employee Benefit Research Institute, that of all workers in America, more than one-quarter have saved less than $10,000 for retirement? A better approach might be to allocate a certain amount for pension savings every month and pay your self first as though it were an expense.

Another way to reduce future income tax liability is to invest in securities that are exempt from taxation. Have you ever considered general obligation municipal bonds? Better yet, GO bonds—which finance government activities—are never taxed even under the AMT (Alternative Minimum Tax). Again, with a little planning and some help from a qualified tax professional, you may be able to lower your 2005 income taxes. You just have to plan ahead.

Wearing Two Hats

Many newly self-employed teachers are surprised to find out that in addition to their federal income taxes, they must also pay SECA taxes. The Self-Employment Contributions Act (SECA) tax is made up of your contributions to the Social Security and Medicare programs. Wage earners may be accustomed to having their FICA (Federal Insurance Contributions Act) withheld from their paychecks, and their employer making a matching contribution that is filed quarterly with the employer’s payroll tax returns. As a self-employer, you pay both the employee portion and the employer matching contribution as part of your federal income taxes. New self-employed persons discover their tax bills at the end of the year are much higher than expected because of their change in status.

If you are unincorporated, and if you earned at least $400 after expenses from your work as a sole-proprietor, the income is generally considered self-employment income. It makes no difference if you think of your dance business as full-time or part-time. The current tax rate is 15.3 percent, with 12.4 percent allocated toward Social Security and 2.9 percent to Medicare. For 2005, the wage base for withholding social security is $90,000. This means that only the first $90,000 of your net business earnings is subject to the social security tax (maximum $11,160). Unfortunately, there is no wage base limit for Medicare—2.9 percent of your entire net earnings will be subject to the Medicare tax. Clearly, the rules covering self-employment taxes are complex so those who are new to self-employment should consult an experienced tax preparer or a CPA for advice on meeting their tax obligations.

The information provided in this article is not specific investment advice, a guarantee of performance, or a recommendation. This material is not intended as individual tax advice. Investors should consult with an appropriate professional regarding their own personal situation.

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