Home office is not one that saves you millions of dollars in taxes. However, it is one that routinely adds up to six, ten, or even twelve thousand dollars in deductions per year. When you consider the compounding effect over time, it can have a positive impact on reducing your tax burden over time.
Your home office has to be a separate room, it has to be in your home or dwelling. It can't be your dining room table where you work after feeding the kids dinner and getting them to bed. It can't be a mixed-use room such as an office/guest bedroom. It needs to be a separate area that is exclusively used for business. If it meets these requirements, then you may qualify for a home office.
The way the business use percentage is calculated is by taking the square footage of the separate area and dividing it by the total square footage of the entire home. This will give you a percentage, which is typically between 8% and 12%. Sometimes it may be a little more, sometimes a little less. Once you qualify for a home office, this percentage is used to determine your deduction.
If you're renting the property, you can deduct that percentage of your rent.
If you own the property, you can deduct that percentage of mortgage interest, real estate taxes, utilities, such as the electric bill, internet, phone, and anything similar.
Equipment and furniture, such as microphone and paintings, that you need to furnish and equip the home office can also be deductible.
Additionally, improvements to the overall structure can be deductible. For example, if you put a new roof on the entire property but qualify for a home office deduction, you might be able to deduct a percentage of the entire cost.
Things like a new AC system, new flooring, or building a home studio for podcasts and videos are also deductible if you qualify for the home office deduction. We recommend that you keep track of all of these expenses.
Traditionally, clients have been hesitant to take the home office deduction, but in the post-COVID world we live in, home offices are becoming more common, with some households having multiple offices or studios.
Your children can actually work for you. They have to perform some sort of service, and you have to pay them in line with the going market rates. This is not just a way to give your kids some extra cash. They need to provide a legitimate service to your business, and you need to pay them fairly.
Depending on the labor laws of the state you live in, there are a couple of things to consider. It has to be considered normal and necessary, and they need to be properly set up, and this needs to be defensible. So what does that mean?
For example, I have two sons, they are three and five. If I were to claim that my five-year-old son was helping with tax returns and doing client-facing activities, and paying him an exorbitant salary every year, that's not going to make sense. It's not going to be defensible.
However, when they do get a little bit older, around 8, 10, maybe 12 years old, if they're managing your social media, designing and updating your websites, or putting together mailers and sending those out to clients, those are jobs that you would have to hire someone else to fulfill.
Instead of hiring somebody else, you can hire your own children and have them on the payroll as long as they're providing a service for your company and you're paying them in line with going market rates. So you can pay them up to $13,850 in 2023.
That money is a deduction from your business, and then it's tax-free to them as your children. So this is a great way to get a deduction from your business income and then transfer wealth to your children.
A really good strategy here is that you could use your children’s money to invest in a Roth IRA. Since your child now is considered to have earned income, they could invest this money into a Roth IRA every year.
This really has a compounding effect. Now it's growing post-tax with the current stock markets or whatever investments that the Roth IRA is holding onto. People do this for 6, 8, 10 years and then use those funds to fully fund college savings plans or gift to the child to buy their first investment property or start a business.
Very similar to that Roth IRA compounding over time, this is for the business owner themselves in qualified retirement plans.
This is by far the easiest and most simple plan to set up and get going. You could probably set it up with whoever you have your current business bank account with. A lot of times, you can do these online without even having to go into the bank or anything like that.
In 2022, you could put up to $6,000 into an individual IRA, and that money is tax-deductible for you. In 2023, it is going up to $6,500. With individual IRAs, you actually have the extended tax deadline to make those contributions to them and count them for the previous year.
This is one of the more entry-level qualified retirement plans that are available to business owners as your business grows and becomes a little more successful.
SEP stands for Simplified Employee Pension, and it's an individual retirement account that you can put in 2022 limits. The limits were $60,000 in 2022 and $66,000 in 2023, so you can put up to $66,000 into these plans. That money is a deduction from your business income for you and is now growing in a tax-deferred vehicle.
With these IRAs, if you go through mainstream institutions like Merrill Lynch or one of the big bank institution types, a majority of the time they're going to have you invest those funds in mainstream securities, basically in the stock market.
However, there are alternative investments that you can do. Depending on the institution that you choose as your intermediary, you can invest them in things like real estate or cryptocurrency.
With the SEP IRA, once your business reaches a pretty successful amount, you're going to need several hundred thousand dollars per year in income to truly max this out and make the investment make sense. But you're getting to the point where you're getting a deduction from your business income and putting money away for retirement.
For example, I'm putting $60,000 into this individual retirement account, and I'm in a 30% tax bracket, so I'm actually saving $18,000 on taxes. I would never use the term 'free money,' and it's not common that the IRS is going to give you a tax deduction for saving your own money, but that's what you're doing.
You're transferring the money from one place to another, saving $18,000 in taxes, and now this money is in a tax-deferred account that you can invest in basically whatever you decide at that point.
When it comes to tax deductions, the Solo 401(k) is probably the best option.
Solo 401(k) has the same limits as a SEP IRA, with $61,000 being the limit in 2022. In 2023, it's going up to $66,000. However, here you can actually add your spouse, if your spouse works in your business with you, then you can both contribute to this $66,000 number in 2023. The money is a deduction from your business income, and is now in this tax-deferred vehicle for you too.
Augusta Rule came from the Augusta National Golf Course, the big fancy Masters golf tournament that they hold every year. The residents of Augusta, Georgia who had all these big fancy houses around the golf course, wanted to rent those out because people were willing to pay a pretty penny to stay in these nice houses and have a great view of the course throughout the whole tournament.
They actually lobbied Congress and got the IRS to approve them being able to rent out their homes for up to 14 days per year without having to pay taxes on the rental income. And so it says Internal Revenue Code Section 280 A.
There are a lot of different ways you can rent your home. We're talking about 20-30,000 dollars, you could bring in as tax-free income. So, there are really two main strategies that we see: you can rent out your home, or you can rent out a portion of your home.
You can rent your house for upcoming events for up to 14 days per year, and the income derived from that activity is tax-free to you as a homeowner or as a business owner.
Think about the lines of events, marketing activities, or meetings where you're going to need to rent a space, such as a hotel meeting space or a private room at a restaurant. Instead of hosting this event at a hotel or a restaurant or anywhere else, you can host the events in your home.
However, there has to be a specific business activity. You have to charge in line with going market rates. And instead of paying an outside source to host the event, you can host it in your home.
When your business gets into seven figures or multiple seven figures, good bookkeeping is incredibly important for a number of reasons. The biggest one is to make sure your numbers are accurate and you're getting all of the deductions that you're entitled to.
Having a separate bank account is key. Co-mingling items in your personal account and having to go back and clean things up at the end of the year is not something that you need to be doing. You must use a separate account, have all of the income flowing into there, and have all of the expenses coming out of there.
QuickBooks Online is the preferred software that we use, but there are a ton of other ones out there: Hurdler, FreshBooks, etc. Use some sort of bookkeeping software so that you can categorize and reconcile.
With this software, you are reporting the right amount of income and the right amount of expenses at the end of the year. Then, you want to know what's coming in and what's going out on a regular basis. Eventually, you want to get to the point where every month you've got an accurate P&L where you can tell exactly how much money came in and exactly how much money came out so you can start to make better decisions on how to run your business.
One of the best ways to do bookkeeping is to customize the chart of accounts.
When you're doing that, you're going to be able to break down the revenues and expenses by type. A step further is that you can tie the expenses to those lines of revenue, and that is called true cost accounting. That way, you can see which lines of revenue are the most profitable for you.
As boring as it is to talk about good bookkeeping, it is essential to what we do from a tax planning perspective. It's just as essential from an overall running-your-business perspective too.
The tax code is written for business owners, not employees. The reason is that two-thirds of new jobs in the US are created by small businesses. Up to 40% of economic activity is attributed to small businesses.
So, the tax code is specifically written to benefit business owners for pumping money back into the economy, for creating new jobs, for spending money on infrastructure, and investing in their businesses.When you utilize the tax code to its fullest potential, it's how you get the fullest benefit.
The IRS (Internal Revenue Service) is a debt collection agency. They are the most powerful debt collection agency in the world. Their job is to collect money. Your job is to minimize the amount that you pay them. So, understanding the tax code is key, as well as understanding what the IRS is.
We get the question a lot, "what's the difference between tax preparation and tax planning?" That tax preparation is what we did for the last year. Tax planning is what we do for this year and for moving forward.