Small-business owner Spence Nelson rarely complains about the 80-hour workweeks at his Denton, Texas, manufacturing plant, or the cutthroat tactics of his competitors.
But mention taxes, and the usually placid Nelson launches an angry fusillade of complaints against the local, state and federal governments who, he says, take far more than their fair share of his income.
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“We can compete with anybody on a level field, but when our competitors in Asia are paying considerably less in taxes, it affects our ability to compete,” said Nelson, co-owner of Mayday Manufacturing Co., a maker of airplane parts.
While many American small-business owners probably share Nelson’s frustration, Congress has enacted at least a few measures over the last two years that should offer some relief to business owners and fledgling entrepreneurs. As small-business owners prepare their returns for the 1998 tax year, they will find a lower capital gains tax rate, higher deductions for health-care expenses, and new retirement options and tax credits, according to Susan Jacksack, a small business analyst at CCH Inc. in Chicago.
Under the IRS Restructuring and Reform Act of 1998, taxes on long-term capital gains have been simplified and reduced, said Jacksack. The tax rate on business and investment assets held more than one year has been reduced from 28 percent to 20 percent (or 10 percent for those in the 15 percent tax bracket).
“This should provide tremendous relief to small-business owners, both in reducing capital gain taxes on equipment sales as well as alleviating the complexity many faced last year in filling out Schedule D forms,” said Jacksack.
The self-employed also can deduct a larger portion of the cost of their health insurance in 1998. The percentage of this expense that can be deducted has increased from 30 percent two years ago to 45 percent in 1998 to 60 percent this year. They will be able to deduct 100 percent of the cost of health insurance for themselves and their dependents by 2003, Jacksack said.
For small-business owners who don’t want to spend the money or the time to set up a pension plan for their business, the Roth individual retirement account is an alternative. The traditional IRA didn’t serve small-business owners very well because if either spouse was covered by another employer’s pension plan, they weren’t eligible if their adjusted gross income was above $60,000.
“Often, their income exceeds the maximum for traditional IRAs,” said Jacksack. “They earned too much for a traditional IRA, but not enough that they can just forget about retirement.”
Individuals can contribute $2,000 annually to a Roth IRA, and while the contribution is not tax-deductible, the earnings and withdrawals in future years won’t be taxed. Although taxpayers can convert their traditional IRA to a Roth, federal income taxes must be paid at the time of conversion, she said. A provision allowing those taxes to be paid over four years has expired.
Jacksack also reminds small-business owners not to overlook the new tax credit for those who hire former welfare recipients. The credit amounts to 35 percent of an employee’s first $10,000 in wages in the first year and 50 percent of the first $10,000 paid in the second year.
Hefty tax savings still await those who claim a home-office deduction; in 1999, new rules will make it much easier to qualify for the deduction. But for 1998, the old rules still apply and they are strict, said Mark Watson, a tax partner at KPMG Peat Marwick in Washington.
The home-office deduction can be taken only if the office is used regularly and exclusively for work in a profession or business. To determine this, a taxpayer must meet one of the following requirements:
– To be deductible, the home office must be where the most important part of the work is performed.
– The space is used to meet customers or clients.
– If the office is a separate structure, not attached to the home, it has to be used only in the business.
“The old rules are very restrictive, and many people who had a home office couldn’t take the deduction,” said Watson.
But in 1999, the deduction can be taken even if the office is used only for administrative or management functions of the business, said Watson.
For those who qualify, an array of deductions becomes available. For example, the business portion of mortgage interest and depreciation, real estate taxes, insurance, utilities, trash collection, cleaning services and the security system are deductible.
If you have a 200-square-foot office in a 2,000-square-foot house, you can deduct 10 percent of those expenses as the business portion.
It’s anybody’s guess whether Congress will cut taxes during the 1999 session, but small-business groups are putting elimination of the estate tax at the top of its wish list, said Brian Reardon, manager of legislative affairs for the National Federation of Independent Business.
Currently, a business owner’s estate, which might include a house along with the business, is taxed at a 37 percent rate for valuations above $650,000, a 41 percent rate for estates valued at more than $1 million and 55 percent for estates above $3 million.
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“If you have a moderately sized business and want to leave it to your children, this tax represents a significant obstacle,” said Reardon. “The heirs often have to sell the business to pay the tax.”