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Savings for the Self-Employed

Tracy Byrnes

There are serious perks to having your own business. No boss, no corporate bureaucracy and no time-clock.

Of course, the flipside is that the pressure is on you to make the rent, you've probably used your life savings for the start-up costs and you could really use one of those juicy corporate expense accounts right about now.

Still, for most self-employed folks, yours truly included, the good outweighs the bad. But to keep your independence intact, you need to think about some year-end tax planning for your business.

The first step is to understand your company's financial situation, so get your books up to date. It'll be easier to make year-end decisions when you know your bottom line.

Then understand your accounting method. The cash method of accounting allows for deductions and income reported for the year they are paid or received. The accrual accounting method applies income and deductions in the year incurred. The tax tips will differ with each method.

For now, we'll assume you use a cash method of accounting. But in either case, be sure to meet with your tax adviser before the end of the year.

Black is Back!

If you made money in 2006, congratulations! But you'll probably want to beef up your 2006 expenses to offset the tax bill on that income.

Consider deferring any payments you're scheduled to receive to the first week of January. It'll just be less taxable income for you to worry about.

And then go shopping! For your business, that is, not your fabulous shoe collection. Try to increase your expenses as much as you can to offset the income you made.

Purchase items your business will need in the immediate future to maximize your deductions for this year. So if you have the cash, stock up on office supplies, like fax paper, printer cartridges, stationary, and other office items. Prepay any subscriptions and 2007 travel plans. And then pay some January bills, like your cell phone, rent, insurance and utilities in December.

Same goes for charitable donations. Get them in by year-end and make sure you get a receipt for the tax deduction.

And then take advantage of the IRS' Section 179 deduction. It basically allows small businesses to deduct the cost of equipment, machinery, furniture, software and other assets placed into service in the tax year those were bought. Otherwise, the tax rules say your business would have to depreciate the asset -- that basically means you would deduct a piece of the cost of the asset's years in service.

As a simple example, let's say you bought a piece of equipment for $2,000 in 2006 and depreciated it over five years. You would get a deduction for $400 a year for the next five years. But Section 179 says a small business can opt to take a deduction for the whole amount, the $2,000, in 2006.

For 2006, the maximum amount you can deduct under Section 179 is $108,000.

You can decide whether it's best for you to deduct the whole cost this year or depreciate it over a few years. Talk to your accountant.

And finally, if you have inventory or goods that have been damaged or have become obsolete, consider writing them off this year to offset all that money you made!

If You're in the Red

While wearing red is very fashionable these days, it doesn't look pretty on an income statement. But things happen, and to get the best tax advantage consider pushing expenses and purchases off to 2007. That means any of the purchases we mentioned above should wait until after the New Year. Hopefully, you'll have some income in 2007 and can write off those expenses against that newfound money.

On the flipside, think about offering some incentives to get your buyers to pay before year-end. Taking payments in December might not be such a bad thing since you won't have much of a tax bill to begin with.

Your Biz, Your Retirement

While we love our independence, saving for retirement is completely our responsibility. So be sure you have a qualified retirement plan set up before Dec. 31, and then make deductible contributions to it for 2006.

You have to set up a KEOGH plan or a Roth IRA by Dec. 31. (The deadline for SIMPLE -- Savings Incentive Match Plans for Employees -- IRAs was Oct. 1.) If your business consists of just you and your spouse, consider opening a self-employed 401(k) (that's what I have). The account has to be open by year-end, but you have until the day you file your 2006 return to make contributions for that year.

And Your Final Bonus

"If you're giving yourself a bonus, use your discretion," reminds Bob Scharin, editor of Warren, Gorham & Lamont/RIA's Practical Tax Strategies, a monthly journal written for tax professionals.

Many small-business owners decide to give employees bonuses at the end of the year. But be sure to time the expense with your income situation. It might be better to pay them out in 2007. And use those bonuses as performance incentives for next year -- especially if your company was wearing red for 2006.

So here's to being self-employed. While we have to take on many more aspects of the business ourselves, you just can't beat working at home in your fuzzy slippers!