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File Fail: Avoid These Four Common Small Business Tax Mistakes

File Fail: Avoid These Four Common Small Business Tax MistakesFile Fail: Avoid These Four Common Small Business Tax Mistakes by Sherron Lumley.

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 Avoid These Four Common Small Business Tax Mistakes #1 – Miscalculating Mileage, Auto Use and Depreciation

Tax expert Paul Bardaro, founding partner of Rucci, Bardao, & 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.

However, “if you are entitled to the deduction legitimately, you shouldn’t be afraid to take it,” says Bardaro. File Fail: Avoid These Four Common Small Business Tax Mistakes

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 Avoid These Four Common Small Business Tax Mistakes # 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 Avoid These Four Common Small Business Tax Mistakes # 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 Avoid These Four Common Small Business Tax Mistakes#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, Barbaro 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…File Fail: Avoid These Four Common Small Business Tax Mistakes

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.

File Fail: Avoid These Four Common Small Business Tax Mistakes 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

Small Business and Self-Employed One-Stop Resource Center

Publication 509, IRS Tax Calendars

Small Business Healthcare Tax Credit Questions and Answers

Of course, since the details of your situation are unique, you should always seek the services of a qualified financial planner and tax advisor. File Fail: Avoid These Four Common Small Business Tax Mistakes

Think Big, Tax Small

What Small Business Can Learn from Big Business Tax Strategies.

by Jen Hickey.

If you’re a small business, chances are you don’t have access to a team of accountants and lawyers to find savings in the tax code. But as it turns out, you don’t need to. Almost every expense is tax deductible if you’re a small business. And recent legislation has dramatically increased the thresholds for certain deductions dramatically for tax years 2010 through 2012.
Pull-Quote.pngTravel and entertainment expenses

Small companies, like their bigger brethren, can write off travel and entertainment expenses. But further savings can be had if a small business adopts an efficient reimbursement method for such costs. Most if not all big businesses have an “accountable plan” for T&E reimbursement. As Barbara Weltman, tax and business attorney and author of J.K. Lasser’s Tax Deductions for Small Business, points out, “these reimbursements are not only deductible, but businesses do not have to include them in their payroll taxes” if they have an IRS compliant accountable plan in place.
Health benefits

Benefit plans are another area often overlooked by small businesses for tax savings. For example, during tax years 2010 through 2013, the Patient Protection and Affordable Care Act provides up to a 35 percent tax credit for businesses that have 25 or fewer full-time-equivalent employees and that cover at least half the cost of their employee’s health insurance. Yet a 2011 Kaiser Family Foundation survey found that only 29 percent of small firms had made an attempt to find out if they were eligible for this credit. And don’t forget that any remaining premium costs (or all of them if your small business doesn’t qualify for the ACA tax credit) can be deducted as a business expense.

Offering a health savings account (HSA) is another way small businesses can achieve tax savings and offset the medical costs of a high-deductible health plan. An HSA is a tax-exempt trust or custodial account set up by an employer to pay or reimburse qualified employee medical expenses; contributions are allowed annually up to set limits for self-only or family coverage. Flexible spending arrangements (FSAs) work similarly by reimbursing employees for eligible medical expenses up to the plan’s limit (capped at $2,500 annually starting in 2013). They are funded through voluntary employee salary reductions. Most notably, contributions to HSAs and FSAs are not subject to payroll taxes, and withdrawals for qualified medical expenses are tax free.
Retirement plan costs

According to the U.S. Department of Labor, 64 percent of all employees in medium- and large-sized firms are covered by an employment-based retirement plan, yet only 34 percent of small firms offer this benefit. Start-up and maintenance costs are often cited as a deterrent.

But small businesses can claim a 50-percent tax credit to help offset the “ordinary and necessary” costs of starting a SEP, SIMPLE, or qualified plan (including a 401k), up to a maximum of $500 per year for each of the first three years of the plan. Even better, this credit dates back to any plans implemented since 2002. As a result, any unclaimed retirement plan startup costs can be retroactively redeemed by amending previous returns going back to that tax year.

“By setting up a small pension fund, you can deduct contributions for employees and, if a sole proprietor, deduct contributions made for yourself,” explains Stephen L. Nelson, a CPA who publishes the website S Corporations Explained and is author of QuickBooks 2011 for Dummies. “Earnings on contributions are tax free until employees receive distributions from the plan. It’s an inexpensive way to encourage savings while lowering your tax rate.”
Debt writeoffs

While the economy may be on a gentle upswing, many small businesses are still recovering from the loss of customers and suppliers swallowed up by the recession. Just like big banks and insurance companies, though, a small business can write off bad debts if it uses the accrual method of accounting. This means the amount must have been previously included in income. And if a bad debt is recovered, accounts can be adjusted for the next tax year.
Company structure

Ultimately, the structure of one’s business will determine how it’s taxed. This begs the question: which structure is the most tax friendly? Well, that depends on the nature of your business and average earnings. “As a sole proprietor or partnership, you’re legally liable for all debts,” Nelson explains. “In addition to income taxes on business income, the owner also pays another tax on business profits through the self-employment tax.”

For some companies, transitioning to an LLC offers the most tax flexibility while limiting personal liability for owners. S corporations do not pay income taxes, as profits/losses are passed through to shareholders who report them on their individual income taxes.

Whether you’re just starting out or considering a change, Weltman recommends meeting with a lawyer to help determine the best structure for your business. And, as Nelson points out, such tax-planning decisions should be made at the start of the year for the next tax season.
Capital investments and capital gains

“If it has a business purpose, it can be deducted,” says Nelson. And more recently, legislation relating to Section 179 deductions, bonus depreciation, and capital gains taxes on certain small business stock sales has become more accommodating. As a result, more and more large corporations are taking advantage of this favorable tax climate to make large capital investments in their production equipment and rolling stock inventory.

“Keep in mind ‘ordinary’ and ‘necessary’ when gathering those receipts,” Nelson reiterates. Internet service, cell phones/smart devices, office furniture and computers, production equipment, software: all these types of investments are deductible and many can now be completely depreciated within their first year of service.

For small companies that generally struggle with limited cash flow, taking full advantage of all these tax strategies can return real dividends in the long run. And it proves that an entrepreneur need not have access to offshore tax shelters or a team of accounting wizards to achieve big tax savings.