Business owners can avoid common tax time pitfalls
Small business owners who compile their own income tax returns can find themselves falling into some common quicksand pits. The mistakes can be costly if they raise a company’s tax bill unnecessarily or subject it to penalties and interest in the future.
Some of the problems are mechanical in nature, such as not filling out the right forms. Others are more strategic, including not considering how the deductions you take on your 2009 return might affect your taxes in future years.
Other mistakes are the result of owners not being well informed about the tax laws and the requirements they can impose, for example, on an owner’s salary or the way employees are classified.
A look at some of the common problems business owners encounter at tax time:
RECORDS, RECORDS, RECORDS
Accountants say many owners’ mistakes begin long before they start filling out tax forms because they keep poor records.
Joseph Maloney, a certified public accountant with Maloney Reed Scarpitti & Co. LLP in Erie, Pa., said that leads many owners to have a hard time determining, for example, how much of their vehicle expenses they can deduct. Without mileage logs or diaries, they don’t know how much a car or truck was used for personal errands or for business purposes. He said owners who don’t keep separate checking and credit card accounts for personal and business expenses can also run into problems.
FILE ALL THE RIGHT FORMS—AND FILL THEM OUT PROPERLY
Another common mistake occurs when owners don’t file the forms needed for some specific deductions.
One is related to the deduction for a home office. Many owners using Schedule C, Profit or Loss from Business, or one of the 1120 forms for corporations, don’t realize that they have to also complete Form 8829, Expenses for Business Use of Your Home,to deduct business-related home expenses. Instead, they’ll use the lines for items like “repairs and maintenance” or “other deductions” for deductible home expenses.
Similarly, owners claiming the Section 179 deduction for equipment purchases may lump those expenditures together under a Schedule C line like “supplies,” Maloney said. The deduction allows owners to deduct up front rather than depreciate over years the cost of many kinds of equipment. To claim it, owners need to complete Form 4562, Depreciation and Amortization.
Maloney said owners often make a mistake when they enter the amount they paid for their own health insurance. That goes on the front page of Form 1040. Employees’ health insurance is listed on Schedule C.
These are problems owners don’t have if they use tax prep software. The programs will remind users that additional forms need to be completed. And they’ll insert data in the right places.
INDEPENDENT CONTRACTOR OR EMPLOYEE
Many small businesses that laid off employees have taken on freelancers when they need extra help. That means the company doesn’t have to pay employment taxes including Social Security and Medicare. But it also means companies need to be completing 1099 forms and submitting copies to the government and the freelancers.
Owners also need to be sure that they’ve been treating these freelancers like independent contractors and not employees. If an owner controls aspects of the job including where the work is done and the hours that are put in, the IRS is likely to consider the worker to be an employee rather than an independent contractor. If the employer hasn’t been paying employment taxes, he or she faces penalties.
Alan Weiner, a certified public accountant with Holtz Rubenstein Reminick in Melville, N.Y., gives this example of an employee and an independent contractor: “A plumbing supply house has a delivery man working, gives him a truck, tells him what time to come in, gives him a lunch hour … versus someone with a delivery business and who works for several people.”
The IRS has information about the differences between employees and independent contractors on its website at irs.gov/businesses/small.
Weiner said a common mistake owners make, and that the IRS is on the lookout for, happens when a company has what’s known as S corporation tax status. Under an S corporation, the income passes directly to shareholders who are taxed on that money. The business does not pay its own income taxes, as is the case with C corporations, the status held by major corporations.
The problems that arise with S corporations happen when owners who are also employees take too small a salary and receive the bulk of the money as a shareholder distribution. Because it’s a distribution, and not a salary, they don’t have to pay employment taxes. That’s a violation of the tax code.
“The S corporation owner or owners have to pay themselves, in IRS language, a reasonable salary,” Weiner said. And pay the taxes on that money.
NOT SO FAST
Completing tax forms isn’t just a matter of plugging numbers into little boxes or lines. Owners need to be making decisions along the way. And thinking ahead. If you don’t you could be costing yourself money, and not just for 2009
For example, while it might be tempting to use a full Section 179 deduction, it might make more sense to depreciate the cost of the equipment over time. That’s especially the case if you think business will be picking up this year.
For example, “you have to think about whether the tax rate is going to be higher in 2010 and beyond than it was in 2009,” said Bob Steere, an analyst with Business Owner’s Toolkit, a division of Wolters Kluwer. “It might be beneficial to have more of those deductions and expenses when they’re potentially going to be at a higher tax rate.”
“You really want to think through how all of things are going to impact (your taxes) before you make the final decision,” he said.