Tax planning is often the most overlooked business strategy applied by small business owners. Staying profitable in the current business environment takes skill and knowledge.
1. Writing It Off: Deductions. Businesses can deduct all “ordinary and necessary” business expenses from their revenues to reduce their taxable income. Some deductions are obvious — expenditures in such areas as business travel, equipment, salaries, or rent. But the rules governing write-offs aren’t always simple. Potential deductions to look for:
• Business losses. Business losses can be deducted against a business owner’s personal income to reduce taxes. Some of the year’s business losses can be used to reduce taxable income in future years and some losses can transfer to partners. Ask our firm about business entity formation to find out the best entity for you.
• Trips that combine business and pleasure. If the primary purpose of the trip is devoted to business, you can deduct the traveling costs, as well as other business-related expenses.
2. Employee Taxes. If a business has employees; a variety of taxes will have to be withheld from their salaries. The following withholdings can get businesses in trouble quickly when they are not paid on time:
• Withholding. Social Security (FICA), Medicare and federal and state income taxes must be withheld from employees’ pay.
• Employer matching. Businesses must match the FICA and Medicare taxes and pay them along with employees.
• Unemployment tax. Businesses must pay federal and state unemployment taxes.
3. Quarterly Estimated Taxes. Keeping up quarterly payments can make tax time more manageable. Many businesses get into a cash flow problem when they do not keep up with estimated tax bills. The IRS can also demand punishing IRS penalties. Some common questions:
• Who should pay? A business probably must pay quarterly estimated taxes if the total tax bill in a given year will exceed $500.
• How much should you pay? By the end of the year, either 90 percent of the tax that is owed or 100 percent of last year’s tax must be paid (the figure is 110 percent if a business’s income exceeds $150,000). Businesses can subtract their expenses from their income each quarter and apply their income tax rate (and any self-employment tax rate) to the resulting figure (their quarterly profit).
4. Sales Taxes. Most services remain exempt from sales tax, but most products are taxable (typical exceptions are food and drugs). If a business owner sells a product or service that is subject to sales tax, he or she must register with the state’s tax department. Then taxable and nontaxable sales must be tracked and included on the company’s sales tax return.
Typically the criteria used by the state to determine whether you are liable for paying state taxes is whether you have a “presence” in the state. If you do not have a physical presence in another state, but sell items by Internet or catalog in that state, you may be subject to a state’s “use tax,” but typically not to their state sales tax. A “presence” in another state does not necessarily mean that you have a retail outlet in that state. If you have an office, warehouse, or employees working for you in that state, the IRS may consider you to have a presence in that state. Make sure you are aware of your sales tax responsibilities in all states in which you are doing business.
5. Keep Tax Documents Forever. Over the years we have seen clients with good record keeping save money. Keep any tax-related documents (e.g., expense receipts, client 1099 forms, and vehicle mileage logs) forever. You may need these documents to prove a statute of limitation has run and be in the position of needing your records to prove the government is not entitled to examine you.
6. Charitable Contributions. Unless your business is a C corporation, charitable contributions typically “flow through” the business and are claimed as deductions on the individual tax returns of the shareholders of the company. That’s true whether you’re running a sole proprietorship, partnership, limited liability corporation, or S corporation.
If you want to get the maximum tax benefits, you should know these basic rules:
• Only contributions to charities listed as “qualified organizations” by the IRS are deductible. Consult IRS Publication 78 for a list of qualified organizations or search online at the IRS home page.
• Contributions of more than $250 require a qualified receipt from the qualified organization. For contributions of less than $250, a canceled check may be sufficient.
• In general, donations of property can be deducted for their fair market value at the time of the contribution. You cannot deduct a contribution that has already been written off as a depreciated asset.
• You cannot deduct the value of time or services that you volunteer but you may be able to deduct your related expenses.
• You cannot deduct the part of a contribution that benefits you. If you receive a gift in exchange for a charitable donation you can only deduct only the amount of the contribution that exceeds the value of the gift.
• In general, you can deduct contributions only in the year you make them. Pledged contributions cannot be deducted until they are actually paid.
7. Important Tax Deadlines for Businesses. Depending on our business entity and for other taxes due besides income tax, April 15 is not the only important date to keep in mind:
· Estimated taxes. Estimated taxes are due four times a year: April 15, June 15, September 15, and January 15.
• Sales taxes. Sales taxes are due quarterly or monthly, depending on the rules in your state.
• Employee taxes. Depending on the size of your payroll, employee taxes are due weekly, monthly or quarterly.
8. Deducting Loans. Most business loans are not considered business income. One notable exception is a situation in which you negotiate with a creditor or lender to reduce your debt. If any debt is forgiven, you will owe taxes on this amount, but you may have a different result if you have a bona fide renegotiation of the debt.
On the other hand, business loans can offer substantial tax benefits. The principal and interest you pay on your loan are business expenses, and you can deduct them from your taxes as such. In order to take advantage of a tax deduction, you must report the total amount of the loan, and the assets and expenditures financed must be necessary to operating the business.
9. Tax Audits. There are many different types of audits besides an IRS audit. Audits can range from a simple request for a particular piece of information to comprehensive reviews that cover every aspect of your business and your life. You are not alone in this; our tax law firm is here for you. Never hesitate to call even with the simplest of questions or concerns.
• Correspondence Audit. The IRS asks you to document an item or items on your return by a specified date. This is usually a test for compliance with certain items on your return.
• Office Audit. The IRS may ask you to report to a nearby IRS office and document one or more items on your return. You may be able to send them copies of this proof in advance of the appointment and resolve the issue without actually going to the office.
• Field Audit. The IRS will ask you to provide documentation of various items on your return and to meet with an IRS agent for a thorough review of your records and an interview of you. Answering the questions of an IRS agent is a complex matter. You should never lie to the IRS – that is a crime in and of it self. However, the law does not require you to provide testimony against yourself. It is very important to talk to us before you make the very important decision of meeting with the IRS agent
• Taxpayer Compliance Measurement Program Audit. This extremely lengthy and detailed audit asks you to document and prove every single item in your return. The IRS and Congress use the data from these audits for research and statistical purposes. These audits are arbitrary, and anyone can face them regardless of how carefully they prepare their tax returns.
• Criminal-Investigation “Audit.” If you are suspected of criminal tax evasion, the IRS may conduct a criminal-investigation of you and your business. If you are a target of a criminal investigation you should immediately consult with us prior to making the critically important decision of whether or not you want to speak to the criminal agent. A great deal of consideration must be given to this decision as it may be the difference between the criminal investigator referring your case for prosecution which could ultimately result in your being confined in a federal prison on felony charges or having the criminal agent close your case with no further criminal investigation or prosecution against you.
(About the author: Stephen M. Moskowitz is the Senior Partner of Moskowitz LLP, located in San Francisco. His practice of over 30 years covers the entire spectrum of tax law for individuals and businesses.)