By learning how the income tax system affects an owner-operator business and by having an effective tax strategy, you can minimize how much comes out of your wallet when Uncle Sam extends his hand.
By learning how the income tax system affects an owner-operator business and by having an effective tax strategy, you can minimize how much comes out of your wallet when Uncle Sam extends his hand.
You can reduce your tax burden in three ways: through income adjustments, deductions and credits.
INCOME ADJUSTMENTS
Let’s say your gross earnings equal $100,000. You don’t pay taxes on that amount. The law provides for certain adjustments, or subtractions, that leave you with an adjusted gross income (AGI). This is the first reduction in the amount on which you are taxed.
Automatic adjustments, subject to some restrictions, include:
- Contributions to a retirement plan, such as an individual retirement account, a Keogh plan, a Simplified Employee Plan or a SIMPLE IRA.
- Contributions to a medical savings account.
- Moving expenses.
- Half the self-employment tax you owe for the year.
- Up to 100 percent of self-employed health insurance premiums.
DEDUCTIONS
Deductions and personal exemptions further reduce your AGI. These items don’t cut your tax bill dollar for dollar, but they’re still a big help. If you are in the 15 percent tax bracket, every deductible dollar reduces your tax bill by 15 cents. If you are in the 28 percent bracket, your tax burden goes down by 28 percent.
Business deductions are reported on IRS Schedule C. Every reasonable and necessary trucking-related item you purchase is deductible as a business expense. If you’re in doubt, don’t assume that an item isn’t deductible; document the purchase, and let your tax preparer decide.
Some deductions, such as those for meals, can be more complicated in the way they are calculated. Certain other costs, such as deadhead miles, cost of deadhead or time waiting at a shipper or receiver, are not directly deductible, contrary to what you might hear. However, they might be incorporated in other costs on Schedule C.
Deductions are often referred to as “tax write-offs,” which sounds as if the entire expense comes back to you in the form of income tax you don’t pay, but that’s not the case. Some truckers pay $100 a month to get their trucks washed because the expense is tax-deductible, but those in the 28 percent tax bracket save only $28 of taxes for that $100 expense. If they had put that $100 a month into an IRA instead, not only would they have reduced their taxable income by $100 each month, but they would have earned tax-deferred interest or dividends on it for years.
CREDITS
After you subtract your business deductions, standard or itemized deductions and personal exemptions from your AGI, you have the income from which your tax is figured. Available tax credits will reduce your tax dollar for dollar. If you owe $5,000 in taxes and have credits amounting to $2,000, you will owe the IRS $3,000.
There are many tax credits and restrictions. Qualified tax credits can save you hundreds of dollars, but some phase out as your AGI rises to certain levels.
Credits can include a fuel-tax credit, which applies to purchases of taxed fuel not used for driving. If you pull a reefer, for example, you should be able to recoup the tax charged for reefer fuel. This credit sometimes raises a red flag for the IRS, so be sure to keep separate receipts for reefer fuel.
Other credits include tuition credit; earned-income credit; child and dependent care credit; child tax credit, which allows up to $1,000 per child (including dependent grandchildren, stepchildren and foster children) younger than 17; and adoption credit.
Credits are your most valuable tax breaks. If you’re in doubt, ask your tax expert whether you qualify for any credits.
QUARTERLY ESTIMATED TAX
As a self-employed person, you are responsible for paying your federal income tax in estimated quarterly installments. It’s a tax that’s easy to ignore or forget because the IRS doesn’t send you reminders. It simply adds penalties and interest to your tax bill.
When you worked as a company driver, your carrier withheld federal and state income taxes from your checks and sent the money to the government. If you still owed at tax time, you paid the difference; if you overpaid, the IRS sent you a refund.
As a sole proprietor, however, you take care of the withholdings by estimating how much you’ll owe the IRS for the next year and paying it in four installments. Form 1040-ES is the form that accompanies your payment. You can get this form from the IRS or your accountant.
When you make your first payment, the IRS will send you a year’s worth of vouchers to use to pay your taxes. Your estimate should be close to what you’ll actually owe. The IRS is usually happy if you pay a quarter of last year’s total tax liability each quarter; check with your accountant to be sure about your situation.
SELF-EMPLOYMENT TAXES
As an owner-operator, you have to pay into the federal Social Security (FICA and Medicare) coffers, just as you did when you worked for someone else. The only difference is that you pay all of the tax, whereas you paid only half when you worked for someone else.
The tax amounts to 15.3 percent of net income. When you were an employee, your employer paid 7.65 percent, and you paid 7.65 percent. The company was responsible for getting the money to the IRS. As an owner-operator, you’re responsible for getting it to the IRS quarterly.
You are taxed on net income – that is, gross revenue minus expenses, as determined on Schedule C. Both the income tax and the self-employment tax are paid together each quarter in one payment with the 1040-ES.
DEPRECIATION
Depreciation is usually an owner-operator’s largest deduction. It’s perhaps the most complicated part of your tax picture, but your understanding of depreciation will help you work with your accountant and give you a better foundation for making long-range plans for your business.
Depreciation involves any item that is expected to last more than one year, that gradually wears out and that’s used exclusively in your business. For most truckers, that means tractor and trailer, but it can apply to other equipment. A tractor is depreciated over three years, though deductions actually span four tax years because the first year you are allowed only a half-year of depreciation. A trailer is depreciated over five years, though deductions actually span six years because the first year you are allowed only a half-year of depreciation.
If you plan to buy a truck in any given year, try to get it before Oct. 1. After that, the amount you can depreciate in the first year can be severely limited.
Under normal depreciation, if you bought a truck in 2004 for $100,000, you can deduct a percentage of the $100,000 in tax years 2004, 2005, 2006 and 2007. Accountants use two methods to figure normal depreciation: straight-line and accelerated. The straight-line method generally evens out your expenses over the four years, whereas the accelerated method helps you a great deal the first two years and not so much the last two years. An alternative to normal depreciation, using Section 179 of the tax code, allows you to recover all or part of the cost of equipment, up to a certain amount, for the year it is put into service.
HEAVY-VEHICLE USE TAX
For people who already own a truck and have been paying the heavy-vehicle use tax, or 2290 tax, the tax is due Aug. 31 each year and is as high as $550. When you buy a truck, you should file this form with the IRS by the last day of the month after the month when you bought the truck. If you buy a truck in June, for example, you have until the last day of July to file.
Since the American Jobs Creation Act went into effect Jan. 1, it is no longer possible to pay the 2290 tax in four quarterly installments.
MILE MARKERS
- You can reduce your tax burden in three ways: income adjustments, deductions and credits.
- As an owner-operator, you are responsible for self-employment tax, quarterly estimated income tax and heavy-vehicle use tax.
- Understanding how depreciation works will help you make long-range plans for buying and selling equipment.
This article comes from the 2005 edition of Overdrive’s Partners in Business, a comprehensive manual for new and experienced owner-operators. The cost is $14.95, which includes postage and shipping. To order, call Jennifer Lancaster, (800) 633-5953, ext. 1135.
The next Partners in Business seminar will be presented by Overdrive and American Truck Business Services Aug. 27 at the Great American Trucking Show in Dallas.
