Knowing income tax law is not enough. In order to offer value to taxpayers, tax law knowledge must be combined with effective tax planning strategies in order to yield maximum benefit. What would you do if you owned a landscaping business with the upcoming facts and circumstances? I will tell what I would do.
While having a quiet night out at a local restaurant, listening to music from a local band, I am approached by a friend that has just started a landscaping business. He is married and has one young daughter, age twelve. He will have gross receipts of $48,000 and will receive a 1099 for his efforts. His first question to me is how he should go about making quarterly estimated tax payments to cover both income tax expense and social security tax (SE tax). My response to him was; “hold on there young fellow. Let’s have a discussion of the facts and circumstances before we begin”.
As the band played beautiful music and a soft summer breeze cooled the restaurant patrons, I asked our young entrepreneur if he would need to buy a new truck for his business venture. His response was not only yes, but he informed me that he has already picked out the very one and knows the cost to be $35,000. In this case, he can deduct the entire cost of this new truck in year one under internal revenue code section 179. This allows for the write-off of new property placed in service of up to $125,000 in year one. Because this guy is financing the truck over four or five years, this becomes a great benefit to get such a large write-off without having to spend a bunch of cash. Projected income from all business activities are now reduced to $13,000.
During our ongoing discussion, my friend tells me of his desire to provide for his daughters college education. The 529 was mentioned but I had a better idea. What if we put your daughter on the payroll of your business for $5,000 (near the standard deduction for all individual taxpayers)? This will further reduce your exposure to income tax and self-employment tax. His daughter will not have to pay income tax because her standard deduction will reduce her tax exposure to zero. In addition, there will be no exposure to social security tax on his daughter’s wages because she is a minor and works for her dad’s unincorporated business. Projected net income is now reduced to $8,000. If our hero forms a partnership with his wife, she is a passive owner as she will not participate in the day to day operations of the business and his exposure to SE tax will be cut in half (assuming a 50/50 partnership interest). Roughly, the total tax exposure for 2007 will be $1,400 which includes the SE tax. This is before any other tax deductions the couple might have. Regardless, there will be no need for estimated income tax payments in year one.
For the future, year two offers hope that a retirement plan be formed to shelter some income as the truck deduction was used in the current year. There will also be the opportunity to claim a home office deduction as my friend takes over the entire operation and moves it into his home. Believe it or not, this conversation lasted about twenty minutes. My dessert had arrived and it was time to deal with the matters at hand. I was even invited to sing a couple of numbers with the band. I always do say, never trust an accountant that can’t sing and dance.