This year, taxes on small-business owners are under particular scrutiny. They're getting so much attention because Congress is currently debating a jobs bill with multibillion-dollar tax credits for small businesses. Last week, the Senate passed a bill with a payroll tax holiday for business owners and their employees and an extension of a tax deduction on capital expenditures. The payroll tax holiday—dubbed the Hire Now Tax Cut—allows an employer to forgo payroll tax on any unemployed person hired by the firm this year.
[See our list of the Best Mutual Funds for 2010.]
While this bill offers a tax incentive for 2010, when it comes to taxes, 2009 is currently the more important year for small-business owners. The 2010 jobs bill does not affect the returns taxpayers are filing this April. Instead, small-business owners will be trying to cash in on several tax breaks stemming from last year's stimulus bill that can reduce the amount they owe on their 2009 income.
The majority of small businesses, which have few or no employees, may have trouble finding tax breaks that apply to them. "If you comb through the stimulus package and see what's practical for small businesses, there's just not a lot there, especially for the really small folks," says Kevin Reeth, CEO of Outright.com, a website that offers financial management tools for small businesses and the self-employed. For example, one stimulus provision offered a special tax refund to small businesses that had carried operating losses in recent years. But calculating if a business is eligible for this provision—which expired in September for corporations and October for individuals—often requires the help of an accountant. Many of the smallest businesses might find that it's not worth spending those extra resources for the credit. "How much of a difference will it make, and will they burn through that money paying for a professional?" asks Reeth.
But there is also good news for small-business owners this tax season. Some of the tax breaks that may seem out of reach or overly complicated are actually worth the effort. And there are some new tax breaks this year that appeal to many business owners—not just the most successful.
Overlooked Tax Breaks
• When self-employed people ask him for tax advice, Reeth finds confusion over the home office tax deduction to be the most common misconception that causes entrepreneurs to miss out on tax benefits. This item in the tax code allows an individual to deduct any expenses incurred from running a business out of the home. For example, if you have a room in your home where you do all your work, you can write off a percentage of your rent or mortgage interest based on the proportion of your home that the office occupies. Reeth finds, however, that "it's shocking how few home-based businesses claim it because they are afraid they will get audited." Audits do occur, but Reeth says that businesses that could easily avoid IRS suspicion are often overly sensitive to this threat. They miss out on big savings as a result. For example, many eBay or Amazon-based businesses might use one room in a home to store all the items sold online. Simply measuring the square footage of the space devoted to inventory is one way to figure out how much to write off. If that room is filled to the brim with inventory and not used for other purposes, the chances of problems with the tax man are minimal.
• Another misunderstood tax-code item concerns businesses that do independent contract work. The owners of these business must report the income earned from clients on their 1099 forms. But many do not realize, says Reeth, that the total amount that was billed to the client is not always the amount that should go on the 1099. "Say you invoice a client for $11,000, and $1,000 is for supplies they are reimbursing you for," he says. In that case, $10,000 is the actual earned income, because reimbursements do not have to be reported. But many business owners forget and increase their tax liability as a result. "People just get busy at this time of year, so they're just not paying attention and gloss over it," says Reeth.
New Tax Breaks
• Last year's stimulus bill created the Making Work Pay tax credit, which is worth up to $400 for working individuals who earn between $75,000 and $95,000, and $800 for working married couples who earn between $150,000 and $190,000. The tax credit is aimed at employees, but many business owners will get to cash in as well. That's because for about 20 million businesses in the country, the owner is the sole employee, so he or she might be eligible for the credit. "What's cool about that is it's a credit and not a deduction, you can write it off straight off your tax liability," says Reeth.
• Small businesses that provide health insurance for their employees know about the Consolidated Omnibus Budget Reconciliation Act, which allows former employees to continue coverage for a period of time after they leave a business. Individuals who receive health benefits under COBRA have to pay 35 percent of the cost of premiums, while the former employer pays for the remaining 65 percent. But a stimulus provision offers a tax credit that reduces a business's employment taxes by whatever it is paying for the 65 percent.