Becoming a parent is both gratifying and challenging in its own right and being a small business owner or self-employed can be rewarding yet difficult, as well. In this article, we will look to tax benefits for small business owners, who also happen to be parents, to help bring them some financial assistance. We will share various tax breaks available and how small business owners with children can do some tax planning to fully utilize these tax breaks.
By Mike D’Avolio
For small business owners, there are a few things to keep in mind:
New 20% deduction
Under new law, there is a 20% deduction on business income for small business owners who report their operations on Form 1040, such as sole proprietors who use Schedule C (as well as income from partnerships, S corporations and limited liability companies). This is a big windfall for small business owners as $20,000 of $100,000 of business income would go untaxed! There are some calculations and limitations surrounding this deduction, including a phase-out of the deduction for high-income earners (over $160,700 for single filers, $321,400 for joint filers, $160,725 for married filing separate filers).
Home office deduction
Running a business out of a home can turn certain nondeductible housing expenses into valid business deductions. If a home office qualifies, a portion of otherwise nondeductible expenses, such as utilities, insurance, home repairs and depreciation, can become deductible business expenses. A qualified home office can also turn nondeductible commuting expenses into deductible business mileage.
To take a business deduction for a home office, a taxpayer must use part of his or her home under one of the following situations.
- An area in the home is exclusively and regularly used as the principal place of business. For example, taxpayer meets or deals with patients, clients, or customers in the normal course of a trade or business.
- Storage of inventory or product samples.
- The home is used as a day care facility.
The government encourages people to open a new business by allowing a $5,000 write-off for start-up expenses. This $5,000 deduction is reduced by the amount that your total start-up expenses exceed $50,000. Any start-up costs that are not allowed to be expensed can be amortized over a 15 year period, beginning in the month you start operations.
Start-up costs include amounts paid either to create a trade or business or to investigate the creation or acquisition of a trade or business. Once the enterprise actually begins operations all business expenses are deductible. Examples include: advertisements for the opening of the business; and travel and other necessary costs for securing prospective distributors, suppliers or customers.
For those small business owners with children, there are a few additional tax breaks that may help to put more money in your pocket:
Hiring a family member
One of the benefits of operating your own business is being able to hire a family member, such as a spouse, sibling, parent or child. Payments for the services of a child under 18 who works in a parent’s business are not subject to social security and Medicare taxes (sole proprietorships and partnerships only). The business entity will get to deduct the wages paid to the child and the child will escape taxes up to the income tax threshold. Remember that hiring a child in the family business still requires that he or she do bona fide work for the business and for a reasonable wage.
Dependent care credit
This is an individual tax credit, and the amount can be up to $1,050 for one child or $2,100 for two or more children. (Employers are allowed to provide a related benefit for their employees too.) You may be eligible for this credit if you paid someone to care for either: your dependent child age 12 or younger, or your spouse or dependent over age 12, if they are physically or mentally incapable of self-care. The most common types of expenses that qualify for this credit are those paid to child care centers or for in-home care.
To qualify, the care must have been provided so you could work or look for work. One key here is that if you are married filing joint, both you and your spouse must have earned income (including small business income). One spouse may be considered as having earned income if they were a full-time student or disabled.
Saving for college
The average full-time student at a four year, nonprofit private university will pay $32,410 a year in tuition and fees. Add in room and board and the price balloons to nearly $45,000. Like planning for retirement, saving for a college education is very expensive, but you have many years to plan for it. The smart way to go about it is to start early, save a little money each year and let the money grow. The government provides tax incentives to help with college savings, such as a 529 Plan, Coverdell Education Savings Accounts (ESAs) and IRA Plan.
Tax breaks for college bound students
The tax code provides a number of education tax credits and tax deductions that will take some of the sting out of college expenses, even before the school year starts. Parents can only claim education credits and deductions if they claim the child as a dependent. If your child files their own tax return and claims a personal exemption, they can claim the education tax credit or deduction. Tax breaks include: tuition and fees deduction, American opportunity credit, lifetime learning credit and student loan interest deduction.
As discussed, there are a multitude of tax breaks associated with being a small business owner and a parent. These tax breaks will help to reduce your tax liability and put more money in your pocket, which you can roll back into your business or use to pay for a nice family vacation. Please note that there are other breaks for family members, such as more preferable tax rates when married and filing a joint return, the child tax credit and the adoption credit. Please consult with a tax professional if you need help understanding these tax breaks.
Mike D’Avolio, CPA & JD, is tax law specialist and staff program manager for Intuit’s ProConnect Group. He is a customer and employee instructor, customer and government liaison. @mikeatintuit.