There’s not an entrepreneur on the planet who likes thinking about taxes. I know, it’s only February, so you’re likely still in deep denial about March 15. But it’s time to get organized! Almost every aspect of your business has tax ramifications and if you don’t know what they are, you’re inviting trouble down the road (can you say “audit?”).
I will share 10 common tax misconceptions that both fledgling and experienced small business owners are guilty of. How many of these phrases have you uttered?
1. “I can do it myself.” “Most small business owners do not have the tax knowledge they need to stay out of trouble, but they won’t pay for planning,” says Rice. “They’re cheap so they use TurboTax. But TurboTax won’t represent them if they get into trouble.” . 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 doesn’t mean you should. Just sayin’.
2. “I keep my receipts so I don’t need a tax diary.“ Every small business owner must keep an accurate tax organizer, and it’s not the same thing as an expense log. “A 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 you’re audited, it shifts the burden of proof to the IRS,” Rice says. 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. You’ll spend over $100 for a decent tax organizer/diary.
3. “Yay! A big fat refund.“ Many people are thrilled when they get a big check from the IRS. Wrong reaction. “A refund means you’ve given the government interest-free money for a long time,” Rice says. “If you have withholding, you want to adjust it to the point where you get very little refund.”
4. “I’ll just borrow a little from employee withholding.“ When they’re short on cash, it’s often tempting for small business owners to dip into the trust fund that’s used for employee withholding and Social Security. “Many employers think ‘ this is my money,’” says Rice. “It isn’t. If they borrow from withholding or Social Security, they are personally liable, with huge potential penalties.”
5. “Let’s make everyone an independent contractor.“ Employees are expensive. Independent contractors, not so much. So why not make everyone independent contractor? It’s not that easy, says Rice. “If you’re going to designate a worker as independent you have to treat him as independent,” says Rice. 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% of workers compensation for the specified time period.
6. “I can pay myself whatever I please.“ If you’re incorporated, not really. Say you typically pay yourself $100,000 a year. After a good year, you decide to increase that to $300,000. “You have to substantiate a reason for the increase, or part of the money can be disallowed by the IRS as unreasonable compensation,” says Rice. “Then it can be taxed at the corporate level, and distributed as a dividend. And then you’ll pay tax on the dividend.” Ouch!
7. “My bookkeeper would never steal from me.” “It’s 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,” says Rice. 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 isn’t a tax tip per se, but drop the ball on this one and you won’t have to worry about paying taxes because you may not have a business.
8. “That can’t possibly be deductible.“ Not so fast! The dry cleaning for the suits you wore at that business conference in Duluth? If you were away overnight, it’s deductible, says Rice. A movie and dinner with friends, with whom you also talked business? Also deductible he says, even if your business discussion didn’t occur at dinner, but within the same 24-hour period as the social engagement. Just make sure it’s all documented in your tax diary (see #2). Educate yourself on all the juicy deductions you may be missing out on.
9. “This isn’t a hobby, it’s a business.“ Say the “business” 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 don’t have a business at all, but merely a hobby. In that case, you’ll no longer be entitled to the same deductions. “They’ll also disallow your losses,” says Rice. “The government is the biggest bookie — they’ll subsidize your losses, but they want part of your profits.”
10. “I can’t afford to hire my kids.“ Well, sure you can. Especially your kids who are in college. Pay them a reasonable wage for the work they perform, and you’ll be able to deduct their wages as a business expense. Then, have them use the wages to pay for college. Voila! You’ve just made college tuition deductible. Also, remember that up to $5,800 in income is tax-free for your children.
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