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Business Band-Aid

Bigger Deductions

One provision in the law especially beneficial to self-employed individuals increased the deduction they can take for the cost of health insurance for themselves, their spouses and their dependents. Under the change, the deductible amount gradually increases over a number of years, so that 100 percent of the cost is deductible by 2003. This year, self-employed individuals are allowed to deduct 60 percent of the amount paid for these premiums.

Although the change is helpful, it doesn't address an inequity in the tax code faced by the self-employed, says accountant Debbi-Jo Horton of DJ Horton & Associates in Warwick, Rhode Island. Namely, the fact that this group of entrepreneurs must still pay a hefty self-employment tax on the amount they pay for health coverage as compared to incorporated business owners not subject to the self-employment tax. (The self-employment tax of 15.3 percent consists of 12.4 percent for Social Security and 2.9 percent for Medicare.)

Horton explains how this works: The self-employed must deduct the cost of health insurance premiums on the front of their 1040 tax return, which in effect reduces the income tax they owe. But this deduction doesn't affect the self-employment tax they must pay, which is computed on Schedule SE. "If a self-employed individual is paying $10,000 annually for health insurance, he or she is paying the self-employment tax of 15.3 percent on the cost of the insurance," Horton explains.

Another important change for entrepreneurs with home offices is the liberalization in the deduction for those offices, says Horton. Under the '97 law, business owners who keep records, schedule appointments and perform other administrative or management activities from their home offices qualify for deductions as long as they don't have other fixed places of business where they perform a large amount of administrative or management work. However, the other requirements of the home-office deduction continue to apply, including the requirement for exclusive and regular use of the home office for business.

According to Horton, this change was especially beneficial. Before the change, many entrepreneurs thought that even though they had a home office, they didn't qualify for the deduction. With the liberalization, there is a clear definition of what constitutes a home office, making it possible for more business owners to qualify for deductions, she contends.

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This article was originally published in the May 2000 print edition of Entrepreneur with the headline: Business Band-Aid.

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