10 small business tax mistakes that will cost you
– Donna Fenn has more than 20 years experience writing about entrepreneurship and small business trends. She is the author of “Upstarts: How Gen Y Entrepreneurs are Rocking the World of Business and 8 Ways You Can Profit From Their Success“. This article originally appeared on BNET. The views expressed are her own. –
Thereâs not an entrepreneur on the planet who likes thinking about taxes. I know, itâs only February, so youâre likely still in deep denial about April 15. But itâs time to get organized. Almost every aspect of your business has tax ramifications and if you donât know what they are, youâre inviting trouble down the road (can you say âaudit?â).
For tips, I recently spoke to Sandy Botkin, a CPA, attorney, former trainer of IRS attorneys, and the CEO of The Tax Reduction Institute in Germantown, Maryland. Heâs also the author of âLower Your Taxes â Big Time 2011-2012â. Botkin shared 10 common tax misconceptions that both fledgling and experienced small business owners are guilty of. How many of these phrases have you uttered?
1. âI can do it myself.â âMost small business owners do not have the tax knowledge they need to stay out of trouble, but they wonât pay for planning,â said Botkin. âTheyâre cheap so they use TurboTax. But TurboTax wonât represent them if they get into trouble.â Sure, as a member of the profession, Botkin has a vested interest in recommending that you hire a CPA. Maybe you really are capable of doing your own tax planning. Maybe you can also rewire your office, build your own website, and represent yourself in court. That doesnât mean you should. Just sayinâ.
2. âI keep my receipts so I donât need a tax diary.â Every small business owner must keep an accurate tax organizer, said Botkin, and itâs not the same thing as an expense log. âA tax organizer has all the questions that the IRS requires you to answer about travel, entertainment, and other expenses. It will bulletproof your records and eliminate procrastination, and if youâre audited, it shifts the burden of proof to the IRS,â he said. Anything that allows you to feel smug in the presence of an auditor has got to be worth its price, which is not cheap in this case. Youâll spend over $100 for a decent tax organizer/diary.
3. âYay! A big fat refund.” Many people are thrilled when they get a big check from the IRS. Wrong reaction, said Botkin. âA refund means youâve given the government interest-free money for a long time,â he said. âIf you have withholding, you want to adjust it to the point where you get very little refund.â
4. âIâll just borrow a little from employee withholding.â When theyâre short on cash, itâs often tempting for small business owners to dip into the trust fund thatâs used for employee withholding and Social Security. âMany employers think âthis is my money,ââ said Botkin. âIt isnât. If they borrow from withholding or Social Security, they are personally liable, with huge potential penalties.â
5. âLetâs make everyone an independent contractor.â Employees are expensive. Independent contractors, not so much. So why not make everyone independent contractor? Itâs not that easy, said Botkin. âIf youâre going to designate a worker as independent you have to treat him as independent,â said Botkin. Typically, independent contractors can make their own hours and have control over where, when, and how work is completed. If the IRS determines that you incorrectly designated an employee as independent, you may be subject to penalties for not collecting Social Security taxes, and for more than 40 percent of workers compensation for the specified time period.
6. âI can pay myself whatever I please.â If youâre incorporated, not really. Say you typically pay yourself $100,000 a year. After a good year, you decide to increase that to $300,000. âYou have to substantiate a reason for the increase, or part of the money can be disallowed by the IRS as unreasonable compensation,â said Botkin. âThen it can be taxed at the corporate level, and distributed as a dividend. And then youâll pay tax on the dividend.â Ouch.
7. âMy bookkeeper would never steal from me.â âItâs vital for every small business person to have one person who writes the checks and another person doing the accounting, and never the two shall meet,â said Botkin. He said heâs met hundreds of small business owners who have had their bank accounts cleaned out by embezzlers. So unless you have a trusted family member handling all your finances, make sure that you have different people handling accounting and accounts payable. Nope, this isnât a tax tip per se, but drop the ball on this one and you wonât have to worry about paying taxes because you may not have a business.
8. âThat canât possibly be deductible.â Not so fast. The dry cleaning for the suits you wore at that business conference in Duluth? If you were away overnight, itâs deductible, said Botkin. A movie and dinner with friends, with whom you also talked business? Also deductible he says, even if your business discussion didnât occur at dinner, but within the same 24-hour period as the social engagement. Just make sure itâs all documented in your tax diary (see #2). Educate yourself on all the juicy deductions you may be missing out on.
9. âThis isnât a hobby, itâs a business.â Say the âbusinessâ you started, selling seashell picture frames online, consistently loses money (those trips to Cape Cod are expensive, after all). The IRS may decide that you donât have a business at all, but merely a hobby. In that case, youâll no longer be entitled to the same deductions. âTheyâll also disallow your losses,â said Botkin. âThe government is the biggest bookie â theyâll subsidize your losses, but they want part of your profits.â
10. âI canât afford to hire my kids.â Well, sure you can. Especially your kids who are in college. Pay them a reasonable wage for the work they perform (Botkin paid his daughter to build and maintain his website, for instance), and youâll be able to deduct their wages as a business expense. Then, suggested Botkin, have them use the wages to pay for college. Voila, youâve just made college tuition deductible. Also, remember that up to $5,800 in income is tax-free for your children.
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