Professional tax preparers for small businesses are already hard at work for the fast-approaching April 15 deadline. S corporations, which almost always follow a calendar tax year, are even shorter on time with a March 15 deadline.
Now that the reporting year has ended, most options to optimize a small business tax return lie in the deductions and credits you choose to claim, or in deciding to file for an extension. The estimated 85 percent of small business owners who file taxes as individuals should also review their returns for any claims that could raise suspicions with the IRS.
Home office deduction changes
Small business tax expert Barbara Weltman says the first thing to do is learn about changes in the tax code that affect entrepreneurs, especially those who work out of their homes.
“The good news is there is a new, simplified home-office deduction, since 52 percent of all small businesses are home-based,” says Weltman, author of J.K. Lasser’s Small Business Taxes.
Up until this year, most entrepreneurs working out of a home office had to make some complicated calculations about the percentage of their home’s square footage that they used for business, the portion of utilities and Internet that went to business use, and so on. Now, a home-based business can deduct $5 per square foot up to a limit of $1,500.
The original calculation method is still available, too. Which one should you take? Weltman advises business owners to compare the flat rate to the deduction they claimed in years past. “If you have a space that’s larger than 300 square feet, you might consider calculating it the old way. That’s the maximum you can have on the simplified method,” she says. The IRS also has an online comparison.
Use your time wisely
If you’ve been keeping good records throughout the year, tax time will be a lot less painful. But it’s also important to give yourself time to go over your paperwork and make sure you have everything you need to complete your return, says Chris Whitcomb, tax counsel for the National Federation of Independent Business.
Give your accountant or tax preparer enough time to complete your return and let you review it, Whitcomb says. Among NFIB’s 350-plus members, Whitcomb says nine out of 10 use an outside tax preparer, tax software, or both.
For sole proprietors, independent contractors, and home-based businesses, doing your own taxes isn’t out of the question. The Small Business Administration notes that tax preparation software is a good option, with one caveat: many free products don’t support business tax filers with necessary forms such as Schedule C. Check to make sure your software has everything you need.
Whitcomb adds that getting organized early also helps you find out if you owe money, and to plan accordingly. “You don’t have to file until April 15. You can plan for that cash flow ahead of time if you have to pay,” he says.
Weltman says tax time is your opportunity to make smart elections. One example is the Section 179 deduction, which allows business owners to write off the entire cost of new equipment in one year rather than taking depreciation over multiple years. Eligible items include machinery, computers, certain software, and furniture. Or, a business can take bonus depreciation, which allows half the cost of qualifying equipment to be deducted this year, with remaining depreciation amortized over the item’s lifetime.
“Depending on your tax picture, you should sit down with your tax advisor to figure out the best depreciation strategy for your business,” Weltman says.
Enjoy these deductions while you can. They’re two of 55 tax breaks that Congress allowed to expire at the end of 2013. Congress could retroactively reinstate them, but for now Weltman says that makes 2014 tax planning difficult. For 2013, a business can write off up to $500,000 under Section 179. That number drops to $25,000 next year, and bonus depreciation is on track to be eliminated altogether.
If you laid the groundwork for a business in 2013, some startup expenses can be deducted, such as money spent on product and market analysis and visiting potential business sites. For more small business expenses and deductions, check out the SBA’s guide.
Finally, some states also have special incentives for businesses that aren’t available from the federal government, Weltman adds. Check the rules and deadlines in your state before you finalize your return.
The SBA advises business owners to avoid these common audit triggers:
- Large sum miscellaneous deductions – The IRS takes notice at long lists of itemized deductions that don’t seem to fit your income. Be specific about every deduction and keep the documents to back them up.
- Classifying employees as independent contractors--Failing to classify correctly could mean you’ll owe back wages under the Fair Labor Standards Act, and you may pay back taxes and penalties. Visit this guide
- Keep business and personal expenses separate – It’s best to maintain a separate bank account or credit card for the business, Weltman advises. But if you didn’t do that in 2013, recordkeeping is the next best defense, especially if you used personal property like a vehicle for your business. Failing to keep business and personal activities separate can mean losing out on business write-offs if your records aren’t clear, she says.
Where Weltman parts ways with the SBA, however, is over the home-office deduction. SBA repeats the long-held belief that having a home office increases your odds of being audited. “Is it a red flag? My opinion is no, because look at how many people work from home today,” Weltman says.
Just make sure you qualify for the deduction, she adds. If your business has a commercial address and you work from home occasionally, that doesn’t pass the test.
And if you’re doing really well, expect extra scrutiny. Those who report $200,000 or more in income automatically fall into a high audit risk category, Weltman says. This year, there is also an additional 0.9 percent Medicare tax on earned income and 3.8 percent tax on net investment income for single filers making $200,000 and married couples filing jointly who make $250,000.
Need more time?
You can file for an extension if April 15 is coming too fast. NFIB’s Whitcomb says it’s better to get your return right than to rush through it just to meet the deadline, especially if you’re missing key supporting documents.
If approved, an extension will give you five to six extra months to prep your return. But remember, you don’t get extra time to pay. Estimate what you owe and send the payment when you file Form 7004 to request the extension. If you’ve already made quarterly payments, furnish that information to the IRS as well. If you owe money but don’t pay, the IRS could reject your application, and interest and penalties will kick in.
When wrapping up your 2013 return, remember that it’s also time for the first payment of quarterly estimated taxes for 2014, Weltman says. Stay on top of your cash flow projections so you have enough on hand when these payments come due.
Although the expiring tax breaks make for a lot of moving targets, she says it’s best to peg your 2014 tax liability to your 2013 tax obligation. “No matter how much you ultimately owe, at least you won’t have underpayment penalties,” she says.
Disclaimer: Since the details of your situation are unique, you should always seek the services of a qualified professional for advice specific to your business.