If you’re like many small business owners, tackling your company’s federal taxes falls somewhere along the panic-procrastination continuum. You want to do the job right, but dread the possibility of an audit after filing. Three U.S. tax professionals discuss some common mistakes small businesses make at tax time, and how best to avoid them.
File Fail #1 - Miscalculating Mileage, Auto Use and Depreciation
Tax expert Paul Bardaro, founding partner of Rucci, Bardaro, & Barrett PC, one of the largest public accounting firms in the Boston area, reveals that claiming excessive auto expenses can trigger audits. Deducting an excessive percentage of business use for a passenger car, say somewhere in the 85 to 90 percent range, “would be considered low-hanging fruit for the IRS,” says Bardaro. He explains that the IRS uses aggregate stats from the North American Industry Classification System (NAICS) to identify drastic outliers.
Overstated adjustments, deductions, exemptions, and credits account for more than $30 billion in unpaid taxes annually, according to the IRS. As a result, taxpayers should be very familiar with tax law before deducting car and truck-related business expenses. To help clarify what’s what, consult the IRS’s comprehensive publication “Travel, Entertainment, Gift and Car Expenses.” It’s a 56-page document, so here are a few highlights pertaining to mileage, depreciation, and auto use:
- Standard Mileage for business: For the first six months of 2011, the rate was $.51 per mile, for the last six months, the rate to use is $.55 per mile. If you take the standard mileage deduction per business mile, then you can’t claim actual expenses. Actual car expenses include depreciation, licenses, gas, oil, tolls, lease payments, insurance, garage rent, parking fees, registration fees, repairs, and tires.
- Auto depreciation: This deduction can either be straight-line or a modified accelerated cost recovery system (MACRS). But if you use the standard mileage deduction, then you must use straight-line depreciation (see pp. 15-16 of the IRS Publication 463 for a detailed explanation). Also note: there is a maximum depreciation limit per year, depending on what year the vehicle was first placed into service.
- Personal use of a vehicle: For employees, this is taxable income, and must be included on the employees W-2, notes Bardaro.
File Fail # 2 - Home office deduction, pros and cons
Like the auto deductions, be careful when deducting home office expenses. Small businesses that operate out of the home can deduct a percentage of the home used for business purposes, but “if you claim 6/7ths of your house for business use, that’s going to be suspect,” warns Bardaro.
IRS Form 8829 covers expenses for business use of your home. The IRS publication “Business Use of Your Home” goes into greater detail about which expenses are deductible in full, which are deductible based on the percentage of the home used for the business, and which expenses are not deductible.
This deduction applies to real estate taxes, utilities, insurance, depreciation, and some other homeowner expenses. However, taking the home office deduction can have tax ramifications down the road when the home is sold, Bardaro notes.
File Fail # 3 - Not Knowing Tax Responsibilities
“Businesses have to know their tax responsibilities and make sure they are paying everything they might be responsible for,” says Gail Rosen, an award-winning CPA specializing in startups and small businesses in New Jersey. Here’s what Rosen says not to miss:
- Sales Tax: Will a business have to charge sales tax on their new product or service? If it should have and didn’t, then the individual business owner can be personally liable for the sales tax he or she should have charged but didn't.
- Use Tax: If you purchased something for your business without paying your home state’s sales tax. (For example: items bought in another state and brought into the home state, including mail order and Internet purchases, are generally subject to use tax, usually at the same rate as the home state’s sales tax.)
- Estimated Tax: If you are a sole proprietor, partnership, or LLC, you have to pay estimated federal and state taxes on profits from the business.
- Payroll: If you have employees, you must set up payroll. If you are a corporation, you have to include and pay yourself on payroll (versus paying quarterly tax estimates required of sole proprietorships, partnerships, and LLCs).
Besides identifying which taxes to pay, knowing which forms to file is another pitfall for small businesses to avoid. For example, if your business uses the services of contractors and other non-employee service providers throughout the year, Form 1099 –MISC enters the picture.
“Form 1099-MISC is something that comes up every January for the small businessperson, and the rules seem to change every year,” says Gina McCombs, a CPA for Loggins & Associates in Jonesboro, Georgia. “This year, something new is that businesses need to exclude any payment made to a 1099 vendor that was made by a third party (like a credit card),” she says.
The IRS has tightened its 1099 requirements, and here’s what business owners need to know:
- You are required to issue the 1099-MISC for any services over $600 from LLCs, sole proprietors, partnerships, and trust estates.
- However, if the service provider is either a C Corporation or an S Corporation, you do not have to issue a 1099.
- You only have to give 1099s to service providers you pay by check or cash.
- If you pay an attorney more than $600 during the year then you must issue a 1099, even if the law firm is incorporated.
“To make tax time easier, we recommend that all businesses record the payment type (such as check, cash, credit card, debit card, etc.) as a part of each transaction. It is something that is usually overlooked, but you’ll be glad you did it next January,” McCombs says.
File Fail #4: Small Employer Health Insurance Premiums Credit
“Sure, it’s easy to figure out what I spent on healthcare, but now I have to know the small business benchmark premium,” explains Bardaro of a new challenge facing entrepreneurs come tax time.
The Small Business Healthcare Credit is considered by some CPAs to be too complicated for non-tax professionals to navigate. However, failing to even consider it is perhaps the biggest mistake of all, says Bardaro. (To look at a few different health care tax credit scenarios, check out this IRS worksheet.)
The small employer health insurance premiums credit is a tax credit of up to 35 percent of employer-paid healthcare insurance premiums for small businesses that qualify: those with fewer than 25 employees, where employees earn on average less than $50,000, and the employer pays at least half of the insurance premiums. Form 8941 is used to calculate the credit.
And, Bardaro names other tax credits not to miss, such as the Work Opportunity Credit and the Pension Plan Start-up Cost Credit. The Domestic Production Activity Deduction (IRS Form 8903), is also worth investigating by those companies involved in manufacturing, production, and construction activities. Its benefit is nine percent of qualified income.
“A good set of books often makes these calculations a lot more tolerable,” says Bardaro.
More to Know…
The U.S. Small Business Administration provides further insight into tax breaks for small businesses, including the $500,000 small business expensing limit:
- For the 2011 tax year, small businesses can write-off a larger portion of the cost of new equipment purchased during last year rather than depreciating the cost over time. This provides an immediate tax benefit.
- The 2009 fiscal stimulus increased the maximum amount that small businesses could expense—ordinarily $125,000—to $250,000 for 2009. For 2010 and 2011, the Small Business Jobs Act doubled that to $500,000 and increased the phase-out threshold to $2 million.
Looking forward, working with a CPA throughout the year can significantly impact your small business’s tax consequences.
“After the year, tax preparers can only report on what happened during the year, and have very little opportunity to affect the outcome of your tax liability,” Damita Davis Wren, of DavisWren CPA & Associates in Dover, Florida. “Get tax planning for 2012 now, not in December 2012,” she advises.
For more tax help, here are some links to IRS publications of interest to small business owners:
- Publication 463, Travel, Entertainment, Gift and Car Expenses
- Publication 587, Business Use of Your Home
- Publication 583, Starting a Business and Keeping Records
- Publication 509, IRS Tax Calendars
Of course, since the details of your situation are unique, you should always seek the services of a qualified financial planner and tax advisor.
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