|Regardless of how life changes, one of the biggest hurdles
you’ll face in running your own business is to stay on top of your numerous
obligations to federal, state, and local tax agencies. A tax headache is only
one mistake away, be it a missed payment or filing deadline, an improperly
claimed deduction, or incomplete records.
You can safely assume that a tax auditor presenting an
assessment of additional taxes, penalties, and interest will not look kindly on
an “I didn’t know I was required to do that” claim. The old legal saying that
“ignorance of the law is no excuse” is perhaps most often applied in tax
settings. On the other hand, it is surprising how many small businesses actually
overpay their taxes. They often neglect to take deductions they’re
legally entitled to, or just don’t know about certain breaks that can help them
lower their tax bill.
Adding to the mayhem, we have tax codes that seem to be in
a constant state of flux. Creating exceptions for special groups has resulted in
a steady stream of new and revised tax laws, which have lengthened the
Internal Revenue Code to over 4,500 pages and rendered it barely
understandable to even the most experienced tax professionals. Often one section
can run up to several hundred pages. A special tax service used by tax
professionals explains the meaning and application of each part of the code. It
is contained in another 12 volumes! The harder Congress tries to simplify the
code, the more complex it becomes.
Preparing your taxes and strategizing how to keep more of
your hard-earned dollars in your pocket becomes increasingly difficult with each
passing year. Your best course of action to save time, frustration, MONEY, and
(God forbid) an auditor knocking on your door, is to have a professional
accountant handle your taxes. Tax professionals have years of experience with
tax preparation, religiously attend tax seminars, read scores of journals,
magazines, and monthly tax tips, among other things, to correctly interpret the
changing tax code and gain the advantage over the IRS.
Nevertheless, many accountants don’t understand the
mammoth tax code and end up being too conservative with your tax deductions. The
more conservative they are, the more taxes you end up paying.
Unfortunately, the cryptic and mystifying nature of the
tax code generates a lot of folklore and misinformation that also leads to
costly mistakes. Here is a list of some common small business tax
1. All Start-Up Costs Are Immediately Deductible
The American Jobs Creation Act of 2004 allows new small
business owners to immediately deduct up to $5,000 of their start-up costs as
long as they don’t exceed $50,000. The only catch is that in order to take
advantage of the immediate deduction you must spread out the remainder of your
start-up costs over 15 years (180 months).
So the immediate deduction is a good option for businesses
with less than $14,000 of start-up expenses. If you’re startup expenses are
greater than $14,000, then you’ll do better by not taking an immediate deduction
but spreading your start-up costs over 5 years (60 months).
2. Overpaying The IRS Makes You “Audit Proof”
The IRS doesn’t care if you pay the right amount of taxes
or overpay your taxes. They do care if you pay less than you owe
and you can’t substantiate your deductions. Even if you overpay in one area, the
IRS will still hit you with interest and penalties if you underpay in another.
It is never a good idea to knowingly or unknowingly overpay the IRS. The best
way to “Audit Proof” yourself is to properly document your expenses and make
sure you are getting good advice from your tax accountant.
3. Being incorporated enables you to take more deductions.
Aside from health insurance, deductions for the
self-employed (sole-proprietors and S Corps) are pretty much equivalent to
corporate deductions. For many small businesses, being incorporated is an
unnecessary expense and burden. Start-ups can spend $1,000 in legal and
accounting fees to set up a corporation, only to determine shortly after that
they want to change their name or company direction. Plenty of small business
owners who incorporate don’t make money for the first few years and find
themselves saddled with minimum corporate tax payments and no income.
4. The home office deduction is a red flag for an audit.
This is no longer as true as it once was. Because of the
proliferation of home offices, tax officials cannot possibly audit all tax
returns containing the home office deduction. A high deduction-to-income ratio
tends to lead to an audit.
5. If you don’t take the home office deduction, business expenses are not
You are still eligible to take deductions for business
supplies, business-related phone bills, travel expenses, printing, wages paid to
employees or contract workers, depreciation of equipment used for your business,
and other expenses related to running a home-based business, whether or not you
take the home office deduction.
6. Taking an extension on your taxes is an extension to pay taxes.
Extensions enable you to extend your filing date only. If
you do not pay taxes on time, penalties and interest begin accruing from the due
7. Part-time business owners cannot set up self-employed pensions.
If you start up a company while you have a salaried
position complete with a 401K plan, you can still set up a SEP-IRA for your
business and take the deduction.
Besides avoiding these pitfalls, possessing basic knowledge of how the tax
system works is also beneficial. After all, even if you delegate the tax
preparation to someone else, you are still liable for the accuracy of your tax
returns. If your accountant messes up, you pay the penalty, not him.