by Pete McAllister | Accounting News, IRS, News, Tax, Tax Planning
Filing taxes puts stress on small business owners, because most know that mistakes on business tax returns can affect your business’s success. Here are some common tax mistakes to avoid.
Mixing Business and Personal Expenses
Be sure not to report personal expenses on your small business’s tax return. It’s always a good idea to have separate credit cards, bank accounts, and filing folders for each. Sometimes an expense isn’t as cut-and-dry and you may have difficulty determining if it is indeed business or personal. In this case, turn to the IRS’s Publication 535 at www.irs.gov, which provides an overview of expenses that are and are not deductible.
Being Disorganized with Recordkeeping
This may seem like second nature to some business owners, but staying on top of tax documents, receipts, and copies of bank and credit card statements will go a long way toward avoiding overwhelm at tax time. While you don’t need to submit receipts or other proof of tax deductions to the IRS, you will need them on hand if the IRS decides to probe into your taxes further. If you get audited and you don’t have required documentation on hand to prove any claimed deductions, your tax bill could increase significantly.
Filing the Wrong Tax Forms
There are different types of tax forms required for different types of businesses (C corporations, S corporations, etc.), and if you have employees, you’ll need to fill out additional forms that document their payment through the year. Simply put, it can be a lot to track. A tax advisor can help you determine which forms you should be filling out.
Taking Too Many Deductions
Simply stated, taking deductions means that you get money back for certain purchases that assisted your business. Just keep in mind that too many deductions could raise a red flag for the IRS. If you’re unsure, a tax advisor can ensure that you’re adhering to deduction limitations and only claiming expenses that qualify.
Forgetting or Underestimating Your Tax Payments
Many small business owners are required to make quarterly estimated tax payments. Typically, the deadlines for these payments are the 15h of April, June, September, and January of the following year. How much you owe is based on your income. If you miss a payment, or if your payment falls short of your actual tax liability for the year, the government could saddle you with penalties, thereby increasing your tax liability. Furthermore, if the IRS suspects an intention to defraud it, the fine can be as high as 75%, and you could face criminal tax fraud charges.
by Pete McAllister | Accounting News, IRS, News, Tax
In general, the likelihood of an IRS tax audit for a small business is slim, but there are various factors that can greatly increase the chances of being targeted. The IRS checks for a range of red flags to pinpoint businesses that are more likely to have discrepancies in their taxes. Read on for seven triggers that could raise your odds of an IRS audit in the future.
Multiple Net Losses
If you report net losses in more than two out of five years of operation, your chances of an audit increase. After all, the purpose of a business is to generate income. Consistent loss of income is a red flag for the IRS. Sole proprietorships are even more at risk than other small businesses due to the commingling of personal and business funds that tend to occur in these setups. The IRS may want to investigate whether your sole proprietorship is actually a business or a hobby, as business expenses are deductible while hobby expenses are not. Be sure to keep detailed records for any deductions you are legitimately entitled to.
Filing Payroll Taxes Late
If you’re aiming to fly under the IRS’ radar, regularly missing filing deadlines is not the way to do it. Aside from penalty fees, late filing can lead to scrutiny that timely filing wouldn’t invite. It’s in your best interest to get ahead of the game in order to avoid dealing with IRS headaches in the future.
Low Shareholder-Employee Salaries
It’s a common move for small business owners to structure their business as an S-Corp instead of an LLC in order to avoid the 15.3% self-employment tax. S-Corp owners must offer their shareholder employees “reasonable” compensation, which is reported as wages on a W-2. The IRS specifically keeps an eye out for S-Corps with extremely low salaries paid to shareholder employees. Double check that all shareholder-employee salaries are within the average pay range according to position, company size, industry, and profitability. It is typically the individual tax return of a shareholder-employee that flags the audit, which then generates an investigation of the company.
Excessive Deductions
Though sole proprietors run a greater risk of scrutiny from the IRS, all small-business owners should be mindful of whether every meal and travel expense truly qualify as a business deduction. According to the IRS, this means the expense is “ordinary and necessary”. Be sure to review year-over-year deductions to remain consistent.
Business Use of a Vehicle
When deducting vehicle use as a business expense, choose between the actual vehicle expense (use the appropriate calculation for this) and the IRS standard mileage rate. Choosing both will alert the IRS. If your vehicle is used solely for business purposes, you may be able to claim a deduction for the depreciation on the vehicle. However, you’ll need evidence in the form of mileage logs that record the dates and purpose of every trip you made throughout the previous year.
Cash Transactions
It is difficult to track and verify cash business deals, thus large cash transactions, such as business equipment or investment property, tend to send a red flag to the IRS. It’s best to use a credit or debit card for these transactions, but if you choose to use cash, be sure to record your transaction meticulously to create your own paper trail. You will also need to file IRS Form 8300 to report any cash payments exceeding $10,000.
Calculation Errors
Make no mistake: the IRS checks your math. When small businesses do their own taxes, it might be easier to round numbers or use averages, but this throws off the math. Be sure to work in decimal points when you report earnings and expenses. Even small blunders, such as erroneous totals for expenses, missing 1099s, or transposed numbers can attract unwarranted attention from the IRS.
by Pete McAllister | Accounting News, Audit and Accounting, Bookkeeping, IRS, News, Tax, Tax Planning
The IRS uses a computer program called the Discriminant Function System (DIF) to analyze tax returns and red flag them if they deviate from statistical averages. When a return draws a high DIF score, an agent evaluates it and decides if an audit is necessary. Your business should always be prepared for an audit, and that includes avoid these audit triggers when filing your small business taxes.
Higher Than Average Income
If you report a high amount of income, this may draw red flags for the IRS. Approximately 50% of the returns audited belong to taxpayers earning more than one million dollars per year. For taxpayers who earn more than $5 million, their odds of being audited more than doubles those of taxpayers who earn less.
Underreporting Cash Transactions
Don’t make the mistake of thinking that the IRS has no way to trace cash transactions. Credit card processors submit 1099-K forms to the IRS, which include a report of the total credit card transactions your business processed for the year. The IRS then applies these figures to an undisclosed formula in order to calculate the amount a business should have generated in cash sales. Therefore, if your reported cash sales reflect a lower figure than their formula detects, your business could be at risk for an audit. It’s a smart idea to keep detailed records of both cash and credit card transactions so you can support your claims should your business be audited.
Taking Too Many Deductions
Deductions are important to a small business owner, but claiming too many can raise red flags. Higher than average meal expenses and claiming your car as 100% business can set off alarm bells for the IRS and trigger and audit.
The IRS states that a legitimate business expense must be both ordinary and necessary to qualify as a deduction.
- Ordinary expenses = common and accepted in your trade or business
- Necessary expenses = helpful and appropriate for your trade or business. Note that an expense does not need to be indispensable to qualify as necessary.
Claiming Consistent Business Losses
Given the primary purpose of a business is to generate money, reporting losses year after year can lead the IRS to question the legitimacy of your business. If your business gets audited and you claimed losses, be prepared with documentation to demonstrate your business’ earnings and expenses throughout the year.
Be Prepared for an Audit
Your business may never need to go through an audit process, but you should manage your business always knowing that it’s possible. Keep precise records, make sure the numbers on your tax return are accurate and honest, report all income, and take suitable deductions. Lastly, consult with an accountant to be sure the totality of your revenue, expenses, and documents are free of missteps or miscalculations.
