Large Tax Blunders For Small Businesses
Flying blind when it comes to filing taxes? Learn from the mistakes of others: Don't pay for poor advice, miss deductions or keep shoddy records.
Like many new business owners, Karen McClafflin, now 45, started her business, Secret Canyon Realty in Colorado Springs, Colo., out of her home. When prospective buyers called about a house, she happily drove them there in her own car. But when her accountant did her taxes each spring, he never mentioned that she might be eligible for home office and auto deductions.
Last year, another Colorado Springs business owner, Darren Oliver, founder of the Tax Recovery Group, offered to take a free peek at Ms. McClafflin's tax forms in exchange for half the refund. TRG discovered so many ignored deductions that Ms. McClafflin and the firm split $11,000. "I'm a real-estate broker," says Ms. McClafflin. "If I had to know all about taxes, too, my head would explode. So I trusted a tax specialist. My biggest regret is that TRG can only go back and amend tax returns for three years, because I've probably been overpaying since 1994."
Whom Do You Trust?
Among the top tax blunders made by new small-business owners, the worst may be getting-and worse, paying for-poor advice. Mr. Oliver says, "Tax preparer is one of the only professional positions that requires no formal education or license. All you need is a sign in your front yard. Too many new business owners think anybody can do the work, so they hire somebody they like."
At least they hire someone. According to the National Federation of Independent Business, a Washington, D.C.-based lobbying group, 25% of the small businesses (1 to 249 employees) it surveyed in 2003 file their own business taxes. The other 75% pay an average of $84 an hour for tax-preparation services. But even that can't buy you someone's full attention.
Small business is booming. The Small Business and Self-Employed Division of the Internal Revenue Service serves 45 million taxpayers, 33 million of whom are fully or partially self-employed. One-to-four-person operations make up 70% of all U.S. businesses and are the prime market for Certified Public Accountants and uncertified practitioners who, Mr. Oliver says, each complete an average of 480 tax returns every tax season. No wonder they miss a deduction or two.
Even if it's as big as a truck. Jean Golda and her family have built American Landscaping in Schaumburg, Ill., from "a shovel and a wheelbarrow" to a thriving business with 40 employees. "Finding the right accountant can make or break a small company," she says. "For example, our accountant alerted us to a new IRS provision that allowed a small business to write off $100,000 of equipment purchased between May and December 2003. We bought two super-duty dump trucks at $35,000 each and got two more pick-up trucks just under the wire."
Small businesses with less-alert accountants or, more likely, who hire CPAs just for tax season, missed the 2003 equipment deduction entirely. "It's sad to think of the amount of money left on the table," says Van Ballantyne, a Greenland, N.H., franchisee with Fiducial, an international business-outsourcing and financial-services company.
Even sadder are small-business owners who send truckloads of extra money to Washington, D.C., each year because they started their businesses with the wrong formats. "Too often small-business people think all they have to do to get started is incorporate over the Internet and open the door," says Allan Jacobs, a partner with Evoy, Kamschulte, Jacobs & Co. LLP, a CPA firm in Waukegan, Ill. "A few months later they're in our offices, complaining that they've had to pay thousands of dollars in taxes because they made the wrong decision."
You can easily register your new consulting company or quilt-making business online as a C corporation, but that puts your operation into the same category as an International Business Machines Corp. or Wal-Mart Stores Inc. This means that both the corporation and you, personally, must file separate tax returns, often resulting in unnecessary double taxation.
If you expect to have losses in your start-up years-and most new businesses do have losses-you're better off electing to be an S corporation, says tax attorney Barbara Weltman, president of BWideas.com in Millwood, N.Y. Ms. Weltman, who wrote "J.K. Lasser's Small Business Taxes, 6th Edition" (John Wiley & Sons, 2003), says an S corporation files an "informational return," then passes any losses through to your personal return, where they can offset your spouse's salary or your investment income.
Even money-losers need workers, but new business owners who are nervous about payroll taxes and worker's compensation try not to hire employees outright and turn to subcontractors, independent workers who pay their own taxes and FICA-Social Security and Medicare assessments, says Mr. Ballantyne. This strategy can be a big mistake, because the IRS has strict rules about who qualifies as a subcontractor. Once you start setting the subcontractor's hours and workload, you really have an employee relationship, he warns, and are subject to substantial IRS penalties and interest. "We have three clients with employment-tax-issue cases pending now and penalties on one are in the thousands of dollars," he says.
Then there is the A-word-audit. Each year thousands of small businesses are subject to IRS audits. "The biggest mistake new business owners make," says Ms. Weltman, "is not keeping good records." This results in what one might regard as a triple penalty.
First, almost any expense you spend on your new business can be deducted from your taxes. "But we see a lot of tradespeople, contractors and even consultants spending a lot of cash and not properly keeping track of it," says Mr. Ballantyne. "That means they're paying taxes on a much higher profit than they need to."
Second, when you are meeting with your $84-an-hour tax preparer, she will want to see documentation of the client dinner you hosted in February and receipts from the convention you attended last August. "It's foolish not to take legitimate travel-and-entertainment deductions, when all you have to do is keep up with the paperwork," says Andy Martin, tax-support manager for Fiducial.
Finally, Mr. Martin says, good records make good audits. "If the IRS agent asks for your travel expense receipts for May, for example, and you can pull them right out of your briefcase, he might stop there. But if you fumble around and it takes you a while, the agent will think he can find something, and he'll start looking at other items."
Remember you're far from alone. When the NFIB polled its members about their biggest problems, four of their top eight gripes concerned some form of taxes. If the tax questions had been combined, the survey report says, taxes would have far outstripped the cost of health insurance as the biggest problem facing small-business owners.
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Julie Bennett is a freelance writer.