Self-Employed getting dividend income hurting tax revenues?

[San Onofre Guy]

This isn't an attack against the self-employed but rather something that I have pondered for some time now.This issue varies state by state and can be huge from a tax revenue perspective if your state has a high reliance on income tax versus corporate taxes. The numbers of self-employed individuals has skyrocketed over the past decade or so. My thought is that to a certain extent, if people structure their business in a certain manner, the amount they pay in taxes is drastically reduced.We all know how businesses are able to depreciate "commercial vehicles" and other equipment quickly. I think this is one of the reasons why so many pickup trucks and large SUV's ply the roads. I know many "businesses" in which dad is a general contractor but both dad who drives a pick up and mom (homemaker) who drives an Expedition drive company owned, maintained and fueled vehicles. The accelerated depreciation along with expenses to operate these vehicles lowers the taxable income of the business. There are other expenses that get written off as well due to the nature of allowing many expenses to be bourne by the business.The business as such has no employees. No payroll taxes are incurred and here is where tax revenues to government are impacted. The business pays no income to employees but rather distributes dividends. Dividends are taxed at a much lower rate than ordinary income. Also there is a huge hit to FICAAm I being too simplistic in my thinking here? I welcome critical comments to my theory.Thanks

[Life_is_Simple]

I know many "businesses" in which dad is a general contractor but both dad who drives a pick up and mom (homemaker) who drives an Expedition drive company owned, maintained and fueled vehicles. The accelerated depreciation along with expenses to operate these vehicles lowers the taxable income of the business.
This part sounds illegal. There might be differences with different business entities, but normally the vehicle can only be deducted for the portion that is used for the business. If the mom in your example is not employed in the business, I don't think she can legally deduct her vehicle, and the dad should only be deducting the proportion that is being used for business purposes.

Let them sit through an audit.

[Yossarian]

The business pays no income to employees but rather distributes dividends. Dividends are taxed at a much lower rate than ordinary income. Also there is a huge hit to FICAAm I being too simplistic in my thinking here? I welcome critical comments to my theory.Thanks

Google "reasonable compensation". Plenty of law around this.

[bae]

Then there's the "pay the employees in US $20 gold coins" scam :-)

[Gregg]

This part sounds illegal. There might be differences with different business entities, but normally the vehicle can only be deducted for the portion that is used for the business. If the mom in your example is not employed in the business, I don't think she can legally deduct her vehicle, and the dad should only be deducting the proportion that is being used for business purposes.

Let them sit through an audit.

You're basically right. Using a company vehicle for private use is another form of compensation and so the IRS taxes that. How much is what is far grayer than say cash tips in a restaurant. In our own case DW drove a vehicle for years that was leased by the company. She was a legit (and valuable!) employee and did all kinds of errand running. She was smart enough to combine those errands with other things that needed to be done. If the office was running low on coffee there was no reason to not pick up groceries for home while you were at the store. We had blueprints copied at a printer that was a block from the school and they were always ready to pick up by 3:00. You get the idea. Now, when we took her vehicle on a family vacation we had a few choices. We could either keep track of the mileage and reimburse the company or we could add the value of that usage to her salary on a W2 or send her a 1099-Misc, depending on how the accountant handled it. The other thing we could do, and I'm pretty sure this is what most people do, is find a business related reason for the trip. Something, almost anything really, that is related to the business that we could check out while on the trip. There is nothing illegal or shady about that as long as you really do look into what it would take to open in a different location, how similar businesses in that location operate or are gathering other information that would help your business back home. We were lucky to have had a pretty extensive network so could legitimately do that just about anywhere we went. Does everyone go to that length? Hmmm....

[iris lily]

Are there actually small businesses set up to pay dividends that do not have any employees? I'm thinking, not many. This is much ado about nothing I suspect.

DH who has a handyman/light construction business with 0 employees (on purpose--keeps it simple) absolutely claims mileage for his truck in his business, but not much else. We don't bother to claim a percentage of our house as his business expense because our housing expenses are pretty low anyway, we don't have a mortgage.

and along those lines--our friend recently learned a hard lesson about claiming business expenses in using her home as a business--when she sold it there were major taxes consequences, I mean a BIG bill for her. I had no idea of this but that's just another reason not to bother with using a portion of our house as a tax deduction for his business.

[Gregg]

and along those lines--our friend recently learned a hard lesson about claiming business expenses in using her home as a business--when she sold it there were major taxes consequences, I mean a BIG bill for her. I had no idea of this but that's just another reason not to bother with using a portion of our house as a tax deduction for his business.

You get around that by LEASING the part of your house used for business to the business. As long as it is "fair market value" for the lease rate you are fine. People get in trouble when they charge their company $100,000 a year for a garage then don't report the income on their personal taxes. If you're set up as a sole proprietor and don't have house payments you're probably right about it being more hassle than its worth.

[puglogic]

It seems that the family you're referring to, san onofre guy, might not be entirely on the up-and-up. No way to tell, really, as Gregg points out, they may just be smart about how to structure their day and driving. And I'm not sure what you're referring to with dividends; most firms that are in a position to pay dividends have long since moved out of the realm of self-employment and into larger quarters.

There are those who look askance at the ability of a small operator like myself to deduct things like mileage, health insurance payments, home office, etc. They obviously don't know that I also pay 15.30% in FICA (SECA) rather than the 7.65% they generally pay as wage slaves, being both employer and employee. In the end it balances out. I welcome the trend toward self-employment, as more and more corporations seek ways to economize by going offshore and/or cutting pay & benefits for domestic employees on the lower rungs of the ladder. As an independent I naturally applaud any tax benefits that come my way, but I also play by the rules. Some do not.

[iris lily]

... If you're set up as a sole proprietor and don't have house payments you're probably right about it being more hassle than its worth.

Yup, that's how his business is set up.

[San Onofre Guy]

My point being that I think that there are many "businesses" skirting the law. I'm not slamming small business or the self-employed. I just have had a lot of experience with the self employed asking to be paid in cash and having what I know are company owned vehicles that get very little company use.

I'm not making dispersions against any of you. Just raising the issue which I have yet to hear raised.

[puglogic]

Small businesses skirting the law is not new - when you're IN one, it's raised every day of your life pretty much :) I get what you're saying exactly. I certainly wouldn't mind a little more oversight, as it makes the law-abiding among us look bad when there are people like your neighbors doing what they do.

[Gregg]

If the ability of entrepreneurs and small business owners to manipulate the gray areas of the tax code really bothers anyone then all roads, as usual, lead back to the logic of a flat tax. Also works for big business owners.

More on point, the Supreme Court has ruled that no one has an obligation to pay any more in taxes than what is effectively the minimum that can be calculated using every deduction available to them. There are ways to take advantage of that well beyond what the authors of the tax code intended. Start a hotel management consulting business, for example. You can write off travel to anywhere if you stay in a hotel, write off almost all your food (restaurant menu research), bedding and furniture (amenity research), your leased car (company vehicle), parts of your house (home office deduction/garage storage expenses), internet/telephone/cable connections (gotta be wired) and so forth. Is that legit? It COULD be. Tell that same 'consultant' that there are no deductions, but they only have to pay a flat 15% of what they make in taxes. If they're legit they will very quickly become much more efficient. If they're not they will very quickly find something else to do.

[jennipurrr]

Some of these very small businesses with vehicle deductions kind of boggle my mind. I have a relative who always drives one of the large vehicles for the quick depreciation. She drives a lot and has no true business need for a large vehicle...do the gas costs of a 15 mpg, selling the car every three years, etc make up for driving a fuel efficient car for a good while? In these small businesses with only one or two folks, they are the business...there is not some nebulous entity allowing them to benefit from getting the perks of a company car. Sure the business deducts the cost of the car, but when they sell, the business only gets a small percentage of the original purchase price. Every increased dollar they spend on gas is a dollar less of profit. I don't really get it in those cases, like your example of the wife driving the Expedition.

I think if a lot of small business owners did the math it would work out to being better than buying these gas hogs and selling them so often if there wasn't the deduction, but I don't think it would come out to be a profitable venture.

[Float On]

The last time we bought a new show truck (used) the personal loan rate was cheaper than the commercial rate. So we own it and the business leases that and the studio from us.