Taxes are a challenge for many small business owners. What’s tax-deductible? What would cause the IRS to audit you? With so much going on in your world, it’s easy to make mistakes with your small business return. Here are some of the biggest issues that tax professionals see, as well as how to avoid them.
Mistake 1: Not Properly Deducting Startup Costs
CPA Gail Rosen says startup costs often give new small businesses trouble when it comes to taxes. “Many small businesses assume they can deduct all of their costs in starting a new business but they cannot until they have their first sale,” she says.
She says the expenses your business incurs before your first sale are considered startup costs (think: buying computers and equipment, renting office space). These costs cannot be deducted until the first sale, and are then deducted over 15 years. You can, however, elect to deduct the first $5,000 in your first year of business for startup costs, and another $5,000 in organizational costs (think: costs for setting your business up as a corporation, legal fees, etc.) — but you can only deduct these if your total startup costs were $50,000 or less. If your costs were over $55,000, you don’t even get that initial $5,000 deduction at all.
How to avoid it: If you started your business in 2014, make sure you’ve got all your receipts for purchases. Check with the latest IRS laws to make sure your expenses qualify for deduction.
Mistake 2: Not Maximizing Your Medical Expense Reimbursement Plan
If your spouse works with you, how are you paying her and categorizing her? If you’re not claiming her as an employee, says Lawrence J. Danny, CPA, JD, CTC (who happens to be a former IRS agent), you’re missing out on serious medical expense deduction through a Medical Expense Reimbursement Plan (MERP). Through a MERP, you can, tax-free, pay for your employees’ medical expenses not covered by insurance, such as office co-pays.
“[Not setting a spouse up as an employee] can thwart their chance to set up a Medical Expense Reimbursement Plan and allow them to deduct medical expenses at the business level that are otherwise non-deductible because of the 10 percent of Adjusted Gross Income limitation.”
If your spouse is set up as an employee at your company, both of your medical expenses, as well as those of your children, can be tax-deductible under your qualified MERP. Being able to deduct family medical expenses, including health insurance premiums, can be a boon when small business owners have to pay for their own health costs.
How to avoid it: If your spouse works with you, treat her like an employee, complete with time sheets and a paper trail. She doesn’t have to work full-time with your company, but there must be evidence that she works there.
Mistake 3: Mixing Business with Pleasure
While it might seem easier to just put all your business and personal expenses into one bucket, it actually makes tax time a lot more complicated. Anil Melwani, a CPA at 212 Tax & Accounting Services, says he’s seen many business owners running expenses through their business that are clearly personal, such as home rent, pet expenses, groceries, clothing, and personal items.
This is going to be a red flag to the IRS, and you don’t want any undue attention from the agency.
How to avoid it: Keep them separated. Having a separate business account for your company will help with this. Resist the urge to use your business card for personal expenses, but if you do, don’t claim them on your taxes.
Mistake 4: Choosing the Wrong Business Structure
Benjamin Rucker, owner and founder of Rucker Tax & Consulting, LLC, says many small businesses make the mistake of filing as a C Corporation, which means double taxation for the company. Because the profit of a corporation is taxed to the corporation when earned, and then taxed again to the shareholders (including you) when that profit is distributed as dividends, you essentially pay taxes twice.
How to avoid it: Look into other more tax-friendly business structures for small business. The S Corp is a popular choice for small businesses, because you only pay taxes on profits through your personal taxes, so you pay once and pay less.
Mistake 5: Not Paying On Time
Venar Ayar, a tax lawyer, says one of the big no-nos he sees with small businesses is paying taxes late.
“The IRS usually adds a penalty of 0.5 to 1 percent per month to an income tax bill that’s not paid on time,” he says. “This penalty is automatically tacked on by the IRS computer whenever you file a return but don’t pay the full amount owed or when you pay late. Late payment penalties for failing to make payroll tax deposits on time are much higher.”
How to avoid it: If possible, pay your tax bill before it’s due. If it’s not possible, contact the IRS about setting up a payment plan. There will be a flat-rate fee, but it’s lower than the monthly percentage they would charge you otherwise.