Tax Record Keeping Advice for Small-Business-Owning Technophobes
This is a guest post from Erinn Stam, the Managing Editor for nursing student scholarships. She attends Wake Technical Community College and is learning about nursing scholarships for working moms. She lives in Durham, NC with her lovely 4-year-old daughter and exuberant husband
Are you afraid of Quicken? Do you hate working on your computer? Is record keeping one of your least favorite things to do? If you feel this way but still want to get every tax deduction you possibly can qualify for, you’re not alone.
The following are tips for getting the most out of your small business tax returns without stressing yourself over software programs and techie stuff.
Invest in Good Old Fashioned Office Supplies
If you’re afraid of the computer and find record-keeping overwhelming, you’ll want to invest in a couple of crucial items that will save your sanity this year. Invest in:
- One expandable file folder (the ones that have about 12-15 files in them and close with a nice latch, looking like a little cardboard file cabinet you can carry by the handle)
- A box of business-sized envelopes
- A box of pens of your favorite kind
- A little notebook for mileage records
Once you have this file folder, devote it to your business and nothing but your business. Stick the pens inside so you’ll always have something handy to label new files with, and keep the envelopes by the file folder. Stick the mileage notebook in your car, purse, or laptop bag.
Use the Envelopes For…
I carry an envelope labeled “receipts for week of xx/xx/xxxx” in my laptop bag. I stuff all receipts from the week inside this envelope and jot down notes on the envelope for any expenses or payments that I might not be able to record with a physical receipt at the time. I also use the envelope to jot down mileage info if I’ve misplaced my mileage notebook.
Learn to Use an Excel Sheet and Forget About the Rest
You’ll only need to learn how to use one software program (and it’s easy-peasy) to keep all the records you need for your business, and that’s Microsoft Word’s Excel program (which is good on Macs, too – just use Open Office). Watch a YouTube tutorial on how to use Excel if you don’t already know the basics, or ask a friend to show you some basics.
Once you know how to perform the basics on Excel, set up several pages (tabs) for your business records. I like to use separate pages (tabs) for:
- Expenses
- Payments received from clients
- Payments made to clients
- Mileage records
- Questionable deduction expenses
You’ll find Excel is super easy to use and will allow you to enter dates and numbers, add numbers easily (learn how to use the “auto sum” feature – it’s the best!) and record progress on projects.
Devote One Hour a Week to Bookkeeping
You’re going to need to keep on top of this record-keeping task if you want to see results and save yourself a headache, so designate a weekly time to work on your business records. I devote every Friday night (around 5:00) to this and reward myself with a glass (or two, or three) of red wine and a bar of dark chocolate. During this time, I go through all my business transactions and make sure I have:
- Invoiced all clients and recorded the invoices on my client invoice page
- Paid all business-related bills and recorded the payments on my payment page
- Recorded (on my expenses page) and filed all physical receipts related to expenses (that were collected in that envelope I carried around all week)
- Calculated and recorded (on my excel mileage sheet) all mileage
- Stuck the receipts from the week (a purchase at Office Max, receipt from lunch with client at Panera Bread, etc.) into the “receipts” file in my expandable file folder box
- Printed out and stuck in my “receipts for payment” file all my payment records for the week
- Printed out and stuck in my “expenses for the week” file any electronic receipts for expenses (credit card record of an amazon.com purchase, paypal receipt of a paypal purchase, etc.)
- Recorded on my “Questionable Tax Deductions” page any expenses I think might qualify for a tax deduction but really don’t know about (and stuck my receipts into my file folder labeled the same)
How This Will Make Your Life Easier Come Tax Time
If you keep up with this simple system, you’ll find you end the year with a record of expenses, a record of your income, a record of your mileage, and a record of all things possibly deductible. With this handy dandy information, you can get advice from a tax accountant who will know exactly what you can and can’t deduct and who will handle the difficult filing stuff for you. For me, that’s the best I can hope for when it comes to the record-keeping and tax-filing end of running a small business.
Related articles
- How to Get Ready For Tax Season Early
- 3 Ways to Fail At Business Bookkeeping (And What You Can Do to Succeed)
- Audit Insurance
Last-Minute Tax Deductions for 2011
With tax day just around the corner, here are some ideas that can maximize your tax returns this year:
Invest more money in your retirement account – Your retirement funds actually aren’t taxed until that money is taken out of your retirement account. Contributions to retirement funds can be made as late as April 15th, and the taxable limits for 2011 are $5,000 for an IRA (this does not include catch-up contributions for those 50+) and $16,500 for a 401(k). Not only will you be saving money on your taxes this year, but you’ll be bolstering your retirement fund for the future.
Make charitable donations – Although you can only deduct donations given in the taxable year of 2010, now is the time to pull out those receipts and bank statements. If you haven’t been keeping track of the charitable donations you make in a year, remember to keep your receipts next time, or ask for Tax ID numbers. Not only do monetary charitable donations count: old clothes, books, furniture, appliances, and other odds given to charitable organizations qualify as deductions, too – to the benefit of your community! If you have any property that has appreciated in value from the point you bought it, donating it can let you deduct more than you originally paid. Using a simple tax calculator online can give you an estimation of the impact your donations have on your overall tax refund.
Consider a Roth account – While you don’t get a tax break when you put money into a Roth, the money you invest gets to grow tax-free as long as the account is open. Regardless of rising tax rates in the future, you have a haven to place your money where it can still accumulate growth.
Write off the interest on your student loans – That’s right. If you have qualified loans out for the purpose of pursuing higher education, you can get up to $2,500 in deductions towards paying off the interest on your loans. This type of deduction is not an itemized deduction, but it is used to calculate your AGI.
Casualty and Theft Loss – If you and your family were the victims of a natural disaster, theft, or even a car accident, it’s possible to get up to $100 back per occurrence as long as they are not covered by your insurance. A few examples include the loss of a bank account due to the fault of your bank; fire, flood and storm damage, including hurricanes and tornadoes, and even the replacement cost of trees and shrubs damaged in fires or storms.
There are numerous options to help you optimize your tax returns this year. Make sure you are getting back money wherever you qualify for it, and be mindful of the smartest ways to invest your money for the future.
Olivia Mungal is an award-winning writer with pieces of her work archived in the Library of Congress. With a background in Law, she tackles convoluted economic issues in entertaining and engaging ways.
The Home office
Guest post by Mariette Knoblauch of Ballard Beancounters
In the economic chaos of the past few years, many people have turned to self-employment. If you have a home-based business, you may very well have a home office, and a convenient deduction on your federal income taxes.
What makes a home office deductible?
There are several combinations of criteria that qualify.
Regular and exclusive use for business.
The area must used only for your business. It can’t be your kitchen table, no matter how much work you do there. It doesn’t have to be an entire room with walls and a door, just a separate identifiable area that isn’t used for anything else.
Principal place of business.
This is either the place you spend the greatest amount of time doing your work,
or
If you do the kind of work that’s performed at client job sites (like this intrepid anæsthesiologist), it’s where you do administrative tasks for your business such as invoicing, paying bills, (and filling out Form 8829 for your home office deduction), and you have no other place available to do these activities.
If you meet clients or customers in your home, an office that you use exclusively and regularly for that purpose can be deducted, even if it’s not your principal place of business and you have another office somewhere else.
If there is a separate structure on your home property, such as a free-standing studio or garage, that you use exclusively and regularly for your business, it can be a home office even if it’s not your principal place of business. (Why not put up a yurt in your backyard?)
Or, if you are a wholesale or retail seller who stores inventory, it doesn’t even have to be exclusive use. As long as you don’t have any other place to keep your items, wherever you keep your not-yet-sold products can be a home office.
To figure the deduction, measure the square footage of your office space, and divide it by the total square footage of your residence to get the percentage of your home expenses that will be deductible. Homeowners can take a percentage of mortgage interest and real estate taxes (the rest goes on Schedule A as usual), and renters can deduct a portion of their rent. Other partially deductible expenses include utilities and insurance. Homeowners can also take depreciation expenses – talk to your tax person about this.
Another often overlooked bonus of having an office in your home is that just about every place you go for work is business mileage. There’s no commuting exception for the first and last trip of the day. Going to see clients, vendors, business prospects, delivery, even a trip to Staples to buy more toner – it’s all business mileage the minute you leave your driveway.
Bruce here:
I want to Thank Mariette, who sent this in to help keep the blog going while I am doing tax work. Thank you very much for the post.
Financial Planning Dos & Don’ts
During these uncertain economic times, financial planning has become a challenge. Here are a few financial planning suggestions that can add to your peace of mind about financial matters and simplify your life:
- At least once a year, write down your investment goals and what strategy you will use to reach them. This will keep you focused.
- Instead of giving money to many different charities, pick a few that are important to you, and give them a larger amount. This type of directed giving not only makes more sense, but also makes it easier to track your donations at tax time.
- Inventory your household possessions, optimally with a camera or camcorder. Keep the inventory at work or in a safe-deposit box. This inventory will help should you need to submit a homeowner’s insurance claim.
- Use one insurance agent and one financial adviser for your transactions.
- If you have doubts about entering into a transaction, don’t do it. You will probably save yourself money, time, and aggravation.
Some Financial Tips
Make Charitable Contributions
Consider making charitable contributions before year-end both to obtain the maximum tax deduction and to fulfill any charitable programs or commitments you may have established.
Buy a New Car
If you need a new car, now is a great time to purchase or lease. Frequently, dealers are anxious to clear out last year’s inventory prior to year-end. In making your choice, consider the federal tax (and occasional state tax) advantages for buying fuel-efficient vehicles.
Examine Investments
Examine your current investments to determine those with unrealized losses. Consider selling those investments to take the loss this year. You can deduct up to $3,000 in capital losses in excess of capital gains. However, do not let the tax savings outweigh the investment potential. You might consider “swapping” for a similar company in the same industry if you like the potential of the industry.
Pay Tax-Deductible Expenses
Consider paying tax-deductible expenses prior to year-end. Some common examples are real estate taxes, quarterly state or local income taxes, investment-related expenses, and dues. These must be paid by December 31 to obtain a deduction this year. Professional guidance will be helpful here, so please call us.
Evaluate Your Progress
Evaluate your progress for the year. How close were you to your budget? Recalculate your net worth. Compare it to the value at the beginning of the year. How did you do?
Because of the Holiday I will see you all back here next week.
A Week in Perspective
HERE I GO ONE MORE TIME – This message cannot be repeated often enough
Don’t miss the Articles that TWTP is putting out over at mainstreet.com
How to Save the American Dream
IRS Increases Tax Deduction for Drivers
5 Money Moves to Make Before Year-End – I have thought about my finances and some things I need to do as the year comes to a close. There are tons of year-end money lists out there and they all talk about decreasing taxes, selling investments, and saving for retirement. There are a few other things I like to think about when the year ends.
“Be always at war with your vices, at peace with your neighbors, and let each New Year find you a better man.”
- Benjamin Franklin
Why None of Your Credit Scores are the Same – Many people are rather surprised when they look at their credit scores and see that they don’t match up. A credit score may differ across different credit bureaus, and those scores are often a little bit different than what you see when you get your score from FICO. Sometimes the difference is more than a “little.” In some cases, you might find that your credit scores vary by up to 20 points — or more. Why is this?
I try not to place things in here that promote advertising as the first thing you see when you get there but you need to see this article.
How To Instantly Increase Your Motivation For Sticking to Your Budget?
Tax Carnival #77: Stocking Stuffers 2010
2011 Mileage Rates Released – Despite the fact that many predict that the cost of gas will inch up to $4 per gallon by the holidays, the standard mileage rates for 2011 are just slightly different than those for 2010. The IRS has announced the standard mileage rates for 2011 as follows:
Free Spreadsheet to Track Business Expenses for Schedule C
I only lie to the IRS and my CPA, not to you! – Sometimes being too clever in doing taxes can come back to haunt a small business owner, as Steve Sink explains at IowaBiz.com:
How Do Banks Make Money? – Banks are in the business of money. Some companies sell goods and others sell services, but banks are in the money business. From credit cards to personal loans to mortgages, banks make money the old fashioned way. . .
Section 179: First, you have to have a business – The Section 179 deduction will be a huge part of year-end tax planning for countless business taxpayers this year. The ability to take a current deduction for the purchase of equipment that would otherwise be capitalized and depreciated opens many planning doors. But there are limits, as a Nevada tax preparer learned yesterday in Tax Court.
This weeks, must read – Struggling With an Ongoing Issue? Ask Yourself This
Are You Ready For The Big Payroll Tax Deposit Change? – The IRS is changing the rules in a BIG way, when it comes to payroll and corporation tax deposits. Are you going to be ready for this new change? If not, you don’t have long to get ready! The new change goes into effect on January 1, 2011. I got a letter from the IRS today that really surprised me. It said that starting on January 1st, I was no longer able to make manual payroll…
Opportunity is missed by most people because it is dressed in overalls and looks like work.
–Thomas A. Edison
And the big news last week: A proposal. . . .
THE FIRST STEP – It appears that BO has agreed to a final compromise with the Republicans to “get ‘er done” and temporarily extend the “Bush” tax cuts for two years.
How the Tax Deal Affects Taxpayers – President Barack Obama called the bipartisan tax agreement announced on Monday a “framework.” As yet there is no legislative language or even a comprehensive outline of the proposals, and its passage by Congress isn’t assured.
Small-Business Groups Parse Tax Deal – The trade group estimates that 75% of small-business owners pay taxes for their establishments at the individual level because those concerns are either S corporations, limited liability companies or sole proprietorships. Under the president’s proposal, such entrepreneurs would continue to be eligible for tax cuts available to couples earning more than $250,000 a year for at least the next two years.
What to Do With a Payroll Tax Cut – Working taxpayers will get a little, temporary raise, if the payroll tax reduction in the tax agreement reached by Congress goes into effect. It’s not life-changing money – the benefit tops out at $2,100 per year for anyone making $106,800 or more – but it is enough to have a ripple effect if used wisely.
Bush Tax Cuts Extended As Part of Unemployment Insurance Extension and Payroll Tax Deal
Payroll Tax Cut and Social Security Benefits – News came President Obama and Republicans agreed to a “payroll tax holiday” in 2011. For one year only, an employee’s portion of the Social Security tax will be reduced from 6.2% to 4.2%. This will replace the Making Work Pay tax credit in effect in 2009 and 2010.
Obama Woos Wary Party on Tax Deal – Democrats criticized the broad tax package for cutting taxes on high earners and setting tax rates too low on large inheritances, as well as for its effect on the country’s budget deficit. But Democrats also said they didn’t yet see a revolt spreading so far that it would derail the agreement in the Senate. Prospects for passage are more uncertain in the House, where many liberal members are balking at planned changes to the estate tax.
Defiant Obama defends tax cuts, eyes 2012 – WASHINGTON (AFP) – US President Barack Obama has come out fighting, urging Democratic allies to back a hard-won compromise deal on tax cuts and putting Republicans foes on notice ahead of the 2012 elections.
In face of criticism from many on the left of the Democratic Party, Obama passionately defended the deal that will see tax breaks extended for the wealthiest Americans saying his critics had to take a long-term view.
What the Tax Deal Means for You – The entire package would cost about $900 billion over the next two years, and would be paid for entirely by adding to the national debt. Here’s what it means for your pocketbook (this information was culled from our main story; we’ll update with more details later):
And you must read this from Kelly!
The Morning After: The Tax Deal Hangover – I’ll admit that I didn’t see yesterday’s tax deal coming. I was fairly certain that the drama would play out through this week. We still have drama but now it’s more of the “let me explain” variety.
Let me see if I can sort out for you what happened and why.
Why the Tax Compromise is a Mistake – Compromises often are defended as beneficial because both sides to a disagreement surrender something or some things, and both sides get something or some things. But there are times when compromise is a mistake.
Tax Package Makes IRA Conversions Easier
Bush Tax Cuts Likely Will be Temporarily Extended
Compromise Reached on Taxes; Will It Pass Congress?
And by all means please remember this is a tentative deal with Congressional Republicans to extend the Bush-era tax cuts at all income levels for two years as part of a package that would also keep benefits flowing to the long-term unemployed, cut payroll taxes for all workers for a year and take other steps to bolster the economy.
Please. . . use your head. Think responsibly.
“Why does a slight tax increase cost you two hundred dollars and a substantial tax cut save you thirty cents?”
~Peg Bracken
Get Ready for Tax Filing Season – Part 1: Reporting Employee & Contractor Wages
Get Ready for Tax Filing Season, Part 2 – New Laws & Credits that Impact 2010 Returns
What Does 13 Months of Extended Unemployment Mean? (Not What You Think.)
Increasing Your Business Confidence – We need outside proof to build confidence. When someone says that we are smart, talented, or amazing we can look back on those things as examples of our awesomeness. It can take someone else to give us proof of our own talents and amazing abilities.
Mortgage tax break in the crosshairs – Charged with finding ways to reduce the nation’s exploding federal debt, the bipartisan debt panel recommended Wednesday a wide range of controversial spending cuts and tax changes that would slash $4 trillion in deficits over the next 10 years.
Among the proposals was a major change to the mortgage interest deduction, which costs the Treasury Department an estimated $131 billion a year.
I have a few interviews working right now and they are scheduled to post. I am interviewing PF and tax bloggers alike. They won’t start posting until 2011. My first interview will post on Jan 3rd. In the meantime please check out TWTP weekly event, Tax Blogosphere Buddies, a weekly series of brief introductory interviews with some of RDFs favorite fellow tax bloggers, which will appear every Friday. I was lucky enough to be first.
Check it out.
TAX BLOGOSPHERE BUDDIES – BRUCE MCFARLAND
Asset Allocation for a 529 Plan
WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’ – The tax blogosphere has been a-BUZZ the past few days with postings on the idiots in Congress still arguing over BO’s compromise tax package. The problem appears to be with House Democrats who feel that the new Estate Tax exemption and rate is too generous. Quick answer and easy fix – return the federal estate tax to what it was for 2009 for the same two years as the rest of the “Bush” tax cut extension.
If you are interested you can check out the blogs of Kay, Kelly, Joe K and A, Russ, and others for the specific details of the fight.
21 Million Effected – 21 million are the number of taxpayers who didn’t pay AMT in 2009 but will in 2010 unless Congress does something constructive.
Pros and Cons of Giving Gift Cards This Holiday Season
SSA Revises Withdrawal Policy – On December 8, 2010, the Social Security Administration published a revision to their “withdrawal policy”, which we talked about in detail in the article “The Ultimate Do Over”. It’s important for you to know what has changed about this rule, especially if you have been counting on this in your planning for Social Security benefits.
10 Expiring Tax Cuts to Watch For – The expiring Bush tax cuts – and what will happen to them – are all over the place these days. Folks seem to have very definite opinions about what should (and shouldn’t) happen. But it also seems like, for all of the publicity over the cuts, taxpayers really don’t understand what it all means.
Banks or credit unions: Which will give you the best bang for your buck?
Contract Accounting Becoming Hot Option – Contract accounting, hiring a CFO or controller on a part time basis to do what your full time book keeper does? Hiring someone who is a specialist in contract accounting could save you big bucks and lots of headache. Jason Hermanson tells us why.
Year-end tax moves, December 2010 part 1
Year-end investing moves, Dec. 2010 part 2
Year-end retirement moves, Dec. 2010 part 3
Year-end giving moves, December 2010 part 4
Okay I really don’t like using this as a plug or even a pimp my practice for clients place however I have a new ad running with one of the local stations here. It is part of their web site dedicated to different areas around Kansas City. Feel free to check it out. I’d really enjoy your feedback on it. What you liked or don’t.
And for my clients in other states, the coupon will applies to you as well. So long as it accompanies your information
Just a reminder, you can go to my company web site Tax Center page where you’ll find this year I have a Free Tax Organizer. You’ll need a .pdf reader to open this 14 page organizer. You can also find my Online Tax Organizer, used mostly by clients and/or those who will be clients.
Enter your email to subscribe to the L & R Tax Preparation monthly newsletter.
The Home Office Deduction
The tax break has been expanded, but make sure you know the rules.
The Taxpayer Relief Act of 1997 included a modification of the IRS’s definition of “principal place of business” that will permit a larger number of taxpayers to qualify for the home-office deduction. For tax years beginning after 1998, the deduction will be available for home offices that are used for administrative or management activities related to the taxpayer’s business (for example, billing, maintaining records, ordering supplies, scheduling appointments, creating reports).
Business/Personal Boundaries Home-based businesses, by their very nature, often have less structure. While many consider this to be an advantage, working at home can be a double-edged sword. The lack of structure tends to result in home-based workers putting in more hours than when they did not work at home. Having set office hours and “closing up” at the end of the day will help you balance business and personal matters.
Under the amended rules, a taxpayer is allowed to deduct expenses of a home office that is used for business purposes only if the space is used “exclusively” on a “regular basis” as:
The principal place of business carried on by the taxpayer,
- A place for meeting with clients or customers in the ordinary course of business, or
- A place for the taxpayer to perform administrative or management activities associated with the business, provided there is no other fixed location from which the taxpayer conducts a substantial amount of such administrative or management activities.
The Taxpayer Relief Act of 1997 added this third provision to the definition of principal place of business.
The exclusive-use test will be satisfied if a specific portion of the taxpayer’s home is used solely for business purposes or inventory storage. The regular-basis test is satisfied if the space is used on a continuing basis for business purposes (that is, incidental business use will not qualify.)
In determining the principal place of business (first provision under the definition of principal place of business, above), the IRS considers two factors: Does the taxpayer spend more business-related time in the home office than anywhere else? Are the most significant revenue-generating activities performed in the home office? Both of these factors must be considered when determining the principal place of business.
Employees
To qualify for the home-office deduction, an employee must satisfy two additional criteria. First, the use of the home office must be for the convenience of the employer (for example, the employer does not provide a space for the employee to do his/her job). Second, the taxpayer does not rent all or part of the home to the employer. Employees who telecommute may be able to satisfy the requirements for the home-office deduction.
Expenses
Home office expenses are classified into three categories:
Direct Business Expenses relate only to the taxpayer’s business activity (for example, supplies, salaries). Expenditures for additional phone lines, long-distance calls, and optional phone services for the business may be deductible as direct business expenses. However, basic local telephone service charges (that is, monthly access charges) for the first phone line in the residence generally do not qualify for the deduction.
Permissible Expenses are expenditures that could be included as itemized deductions in the individual’s tax return (for example, mortgage interest, real estate taxes, and casualty losses).
Previously Non-deductible Expenses would not be deductible if not for the home office deduction (for example, insurance, utilities, and depreciation).
Limitation
Home office deductions are limited to the gross income from the business activity. Previously non-deductible expenses cannot create or increase a net loss from a business activity. However, a carryover to future years is available for unused, allowable home-office expenses.
Sale of Residence
Tax rules generally permit a $500,000 (married filing jointly) or $250,000 (single or married filing separately) exclusion on the gain from the sale of a primary residence. If part of the home is used for business purposes, the gain is divided into two parts — personal-use portion (the exclusion applies) and business-use portion (exclusion does not apply). For example, a taxpayer who qualifies for the exclusion, but has used 25 percent of the home for business purposes during the during past five years, will only be able to apply the exclusion against 75 percent of any gain recognized on the sale of the home.
As with many tax laws there are exceptions to this rule. If you’d like a clearer picture of the size of the exclusion you qualify for, please call us.
Taxes
The “office-in-home” tax deduction is valuable because it converts a portion of otherwise nondeductible expenses (for example, utilities and homeowners insurance) into a deduction. The treatment of home offices for income tax purposes is one of the more controversial provisions in the tax law.
An individual is not entitled to deduct any expenses of using his/her home for business purposes unless the space is used exclusively on a regular basis as the “principal place of business.” The IRS applies a 2-part test to determine if the home office is the principal place of business.
Do you spend more business-related time in your home office than anywhere else?
Are the most significant revenue-generating activities performed in your home office?
If the answer to either of these questions is no, the home office will not be considered the principal place of business, and the deduction will not be available.
Business use of the home by an employee must also be for the convenience of the employer. These rules make it very difficult for an employee to qualify for the deduction.
If these three tests are met, the deduction is limited to the gross income from the business activity. Furthermore, a deduction for home-office expenses cannot create or increase a net loss from the business. Any disallowed deduction may be carried over to future years.
Taxpayers taking a deduction for business use of their home must complete Form 8829. Some tax experts believe that taking a deduction for home-office expenses, whether clearly allowable or not, increases the likelihood of an IRS audit.
These are some thoughts to consider.
If you have a home office or are considering one, please contact me. This is a specialty of mine.
Misconceptions Business Owners Have About Their Returns
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 misconceptions:
All Start-Up Costs Are Immediately Deductible
Business start-up costs are the expenses you incur before you actually begin business operations. Your business start-up costs will depend on the type of business you are starting. They may include costs for advertising, travel, surveys, and training. These costs are generally capital expenses.
You usually recover costs for a particular asset (such as machinery or office equipment) through depreciation. You can elect to deduct up to $5,000 of business start-up costs and $5,000 of organizational costs paid or incurred in the year that you start a business. The $5,000 deduction is reduced by the amount your total start-up or organizational costs exceed $50,000. Any remaining cost must be amortized.
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).
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.
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.
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.
If you don’t take the home office deduction, business expenses are not deductible.
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.
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 date.
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.
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