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10 Not-So-Simple Tax Deductions & More

December 28th, 2011

The more tax deductions your business can legitimately take, the lower its taxable profit will be. Also, in addition to putting more money into your pocket at the end of the year, the tax code provisions that govern deductions can also yield a personal benefit: a nice car to drive at a small cost, or a combination business trip and vacation. It all depends on paying careful attention to IRS rules on just what is, and isn’t, deductible. And sometimes that’s more complex than you think. Still, don’t overlook these important business tax deductions.

1. Auto Expenses
If you use your car for business, or your business owns one or more vehicles, you can deduct some of the costs of keeping it on the road. Mastering the rules of car expense deductions can be tricky, but well worth your while.

There are two methods of claiming expenses:

• Actual expense method. You keep track of and deduct all of your actual business-related expenses.
• Standard mileage rate method. You deduct a certain amount (the standard mileage rate) for each mile driven, plus all business-related tolls and parking fees. In 2011 the standard mileage rate is 51 cents per business mile driven from January through June, and 55.5 cents per business mile driven from July through December.

As a rule, if you use a newer car primarily for business, the actual expense method usually provides a larger deduction at tax time. If you use the actual expense method, you can also deduct depreciation on the vehicle. To qualify for the standard mileage rate, you must use it the first year you use a car for your business activity. Moreover, you can’t use the standard mileage rate if you have claimed accelerated depreciation deductions in prior years, or have taken a Section 179 deduction for the vehicle. (For more on Section 179, see “New Equipment,” below.)

If your auto is used for both business and pleasure, only the business portion produces a tax deduction. That means you must keep track of how often you use the vehicle for business and add it all up at the end of the year. Certainly, if you own just one car or truck, no IRS auditor will let you get away with claiming that 100% of its use is related to your business.

2. Expenses of Going into Business
Once you’re running a business, expenses such as advertising, utilities, office supplies, and repairs can be deducted as current business expenses, but not before you open your doors for business. The costs of getting a business started are capital expenses, and you can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs for a business started in 2011; any remainder must be deducted in equal amounts over the next 15 years.

If you expect your business to make a profit immediately, you may be able to work around this rule by delaying paying some bills until after you’re in business, or by doing a small amount of business just to officially start. However, if, like many businesses, you will suffer losses during the first few years of operation, you might be better off taking the deduction over five years, so you’ll have some profits to offset.

3. Bad Debts
If your business has uncollectable invoices from customers or clients, then bad debt may or may not be deductible. It depends on the kind of product your business sells.

• If your business sells goods, you can deduct the cost of goods that you sold but were not paid for.
• If your business provides services, no deduction is allowed for time you devoted to a client or customer who doesn’t pay.

4. Business Entertaining
If you pick up the tab for entertaining present or prospective customers, you may deduct 50% of the cost if it is either:

• directly related to the business and business is discussed at the event,  for example, a catered meeting at your office; or
• associated with the business, and the entertainment takes place immediately before or after a business discussion.

On the receipt or bill, always make a note of the specific business purpose, for example, “Lunch with Doug Boswell  of Solid Growth Accounting Services to discuss the monthly financial reports.”

5. Travel
When you travel for business, you can deduct many expenses, including the cost of plane fare, costs of operating your car, taxis, lodging, meals, shipping business materials, cleaning clothes, telephone calls, faxes, and tips.

It’s OK to combine business and pleasure, as long as business is the primary purpose of the trip. However, if you take your family along, you can deduct only your own expenses.

6. Interest
If you use credit to finance business purchases, the interest and carrying charges are fully tax-deductible. The same is true if you take out a personal loan and use the proceeds for your business. Be sure to keep good records demonstrating that the money was used for your business.

7. New Equipment
Some small businesses can write off the full cost of some assets in the year they buy them, rather than capitalizing them and then deducting their cost over a number of years.

Section 179 of the Internal Revenue Code allows you to deduct up to $500,000 of the cost of new equipment or other assets in 2011. This is subject to a phase-out if you place more than $2 million of equipment in service. Some assets don’t qualify for this Section 179 deduction, including real estate, inventory bought for resale, and property bought from a close relative. The annual deduction amount goes down to $125,000 in 2012.

There is also a first-year bonus depreciation deduction in effect for 2010 through 2012. This special deduction allows taxpayers to depreciate an additional 50% or 100% of the adjusted basis of qualified property during the first year the property is placed in service. This deduction can be taken in addition to the Section 179 deduction and offers tremendous tax savings. For the calendar year 2011, the first-year bonus depreciation is 100%. For calendar year 2012, the first-year bonus depreciation amount is 50%.

8. Taxes
Taxes incurred in operating your business are generally deductible. How and when they are deducted depends on the type of tax:

• Sales tax on items you buy for your business’s day-to-day operations is deductible as part of the cost of the items; it’s not deducted separately. However, tax on a big business asset, such as a car, must be added to the car’s cost basis; it isn’t deductible entirely in the year the car was bought.
• Excise and fuel taxes are separately deductible expenses.
• If your business pays employment taxes, the employer’s share is deductible as a business expense. Self-employment tax is paid by individuals, not their businesses, and so isn’t a business expense.
• Federal income tax paid on business income is never deductible. State income tax can be deducted on your federal return as an itemized deduction, not as a business expense.
• Real estate tax on property used for business is deductible, along with any special local assessments for repairs or maintenance. If the assessment is for an improvement — for example, to build a sidewalk — it isn’t immediately deductible; instead, it is deducted over a period of years.

9. Education Expenses
You can deduct education expenses if they are related to your current business, trade, or occupation. The expense must be to maintain or improve skills required in your present employment. The cost of education that qualifies you for a new job isn’t deductible.

10. Advertising and Promotion
The cost of ordinary advertising of your goods or services, such as business cards, yellow page ads, and so on, is deductible as a current expense. Promotional costs that create business goodwill, for example, sponsoring a peewee football team, are also deductible as long as there is a clear connection between the sponsorship and your business. For example, naming the team the “Solid Growth Accounting Dodgers” or listing the business name in the program is evidence of the promotion effort.

Here are some additional routine deductions that many business owners miss. Keep your eye out for them.

• DVDs, CDs, audiotapes and videotapes related to business skills
• bank service charges
• business association dues
• business gifts
• business-related magazines and books
• casual labor and tips
• casualty and theft losses
• coffee and beverage service
• commissions
• consultant fees
• credit bureau fees
• moving expenses
• office supplies
• online computer services related to business
• parking and parking meters
• petty cash funds
• postage
• promotion and publicity
• seminars and trade shows
• taxi and bus fare
• telephone calls away from the business

Note: Just because you didn’t get a receipt doesn’t mean you can’t deduct the expense, so keep track of those small items.

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6 Common Bookkeeping Errors

July 11th, 2011

 

Since keeping a complete, accurate and up to date set of books on a company’s financial activity is the core of every business, it is important to recognize the most common mistakes made by small businesses. From cash flow problems to tax compliance issues, small errors can have big consequences. Below is a list of six of the most common problems I see which can and should be avoided.

1. Thinking that no Accounting System is Necessary
One big mistake made early on is especially common with start-ups. The neophyte business owner sometimes thinks they can make do without a real system. Instead of using software, like QuickBooks, the business owner just collects receipts in a box and/or keeps a check register by hand. Or maybe the owner creates the illusion of an system by using Excel to make lists of expenses and payments that add up the numbers. Unfortunately, before having your taxes done, the tax preparer needs to cobble together some sort of makeshift system that will allow your tax return to be prepared, but it almost surely won’t capture all your deductions. And the information that this crude system provides will be too late to help you make the “smart” decisions to run your business in the best possible manner.

2. Doing Your Own Books
The DIY approach is one of the biggest pitfalls I see from business owners and managers. QuickBooks and other software programs essentially promise proficiency with just a few simple clicks. However, unless you are familiar with general principles, any software can be confusing and frustrating. You often end up spending a lot of time trying to figure out where you went wrong. Having a professional bookkeeper with the knowledge and skills necessary to complete your books quickly and accurately, and then analyze your financials, is crucial to small business success.

3. Slow Entry of Accounting Data
Most business owners intend to keep their system up to date, but often they don’t. Taking too long to enter the data into your system creates a problem such that any useful insights that come from your financial numbers will come too late to be really useful. Whoever is doing your books should keep up to date on the data entry. Within a few days of transactions occurring, the system should reflect the activity

4. Inconsistent Reconciliation of the Books with the Bank Statements
One of the key elements of good bookkeeping is to consistently reconcile the books with the bank statements (and your business credit card and other statements too). Many businesses either fail to or improperly reconcile on a regular basis. A major benefit of reconciling the bank statement is ensuring that the cash on a company’s books equals the amount of cash shown by the bank.

Errors will be made in using any system. But the nature of a double-entry bookkeeping system means that it’s usually pretty easy to catch errors as long as you reconcile the bank accounts at the end of each month when the statements arrive. Furthermore, if you hold other valuable assets like inventory or investments, you should periodically compare what the system shows to an actual physical inventory count, or to the statements you receive from external sources. Reconciling your books to your various statements is a kind of reality check that cleans up all sorts of easy-to-miss errors. This is important for all decisions made by the company and it is one of the best reasons for outsourcing your bookkeeping.

5. Incorrectly Tracking Expenses
In order to get the most accurate picture of your business, you need to properly track every business expense. A major issue with small businesses is forgetting to record reimbursable expenses. Often small business owners or managers make business purchases with a personal credit card. These purchases can get lost in the shuffle and consequentially not be submitted for reimbursement. Additionally, the owner may mislabel personal expenses as business deductions. Co-mingling personal and business assets and liabilities makes financial records and books pretty much useless for tax preparation and for use in managing the business.

6. Not Being in Close Contact with Your Bookkeeper
Bookkeepers are only as valuable as the information you give them. Unless you keep them current on all of your financial decisions and transactions, the accuracy of your books will suffer. It is the job of a professional bookkeeper to be able adapt to a surprise or an unexpected inflow of information.

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Posted in accounting, best practices, bookkeeping, cash flow, compliance, entrepreneur, financial management, management, profit, small business, tax

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Paying Your Use Tax… the Party’s Over

May 11th, 2011

If you own a California business that has made in excess of $100,000 in gross receipts in the last calendar year, you are required to pay use tax. This makes you what is called a qualified purchaser, and you are required by Section 6225 of the Revenue and Taxation Code to register with the Board of Equalization (BOE) to whom you must pay the use tax.

Actually, the state government has automatically registered every business in California that grosses $100,000 or more and given them an account number and password. The use tax, which has been around since 1935, is the tax that applies when you purchase some tangible merchandise like supplies or equipment for your business from another state where California sales tax is not charged. Most such merchandise purchased, ranging from books to millions of dollars worth of equipment, are not reported and thus not taxed. Sales tax is the tax that is paid on purchases made within California. Both of these taxes are calculated based at the same rates. For California, Publication 71 lists the various rates applied to each county and city.

But the process of collecting the use tax has not been without problems. For one thing, when this went into effect in 2010, all qualified purchasers were required to file their BOC-401-DS Use Tax returns  for the previous three years even if they had no purchases to report. There were complaints that the approximately 180,000 qualified purchasers were not given enough time to compile their records from three years back since the letters from the BOE informing them of their automatic registration only started going out as of March 1st of that year. What’s more, it was, and still is, virtually impossible for most business owners to track whether every website from which they purchased merchandise as far back as 2007 paid California taxes. But since you’ve been tracking those items ever since, you now know exactly what your use tax obligation is for each item, right?

But there are still plenty of headaches left. The use tax must be filed each year by April 15 and no extensions are allowed, even if the qualified purchaser files an income tax extension. Additionally, the use tax filing can only be done online. What can further inconvenience and complicate the matter is that some of the information required in filing the use tax is the same as that for filing income tax.

Failure to comply with paying the use tax results in a 10% penalty plus interest consistent with the law. The BOE has the authority to waive the penalty, and has typically done so for the retroactive years, but does not have the authority to change the deadline. That can only be accomplished by a change in legislation. Even your tax preparer is not spared. They are fined $50 for each client they fail to ask about purchases made outside California, unless they check every invoice, because credit card statements do not give this information.

It gets better. Let’s assume that instead of purchasing a book you bought a computer monitor and were not charged sales tax. You register for use tax, duly pay the use tax, but the Board of Equalization asks you, “Have you registered to pay the eWaste fees?”

A couple of years ago California added a fee; some would call it a tax, on sales of LCD and cathode ray tube devices (generally, computer monitors, flat screens and laptops). This program, administered by the BOE, is separate from sales and use tax.

So what would your response be to the BOE? Perhaps you’d say, “OK, how can I pay the fee on my use tax return?” Well, you can’t. The program is separate and has separate registration and reporting. So if you are impacted by this, you must register separately, and make your payment separately from the use tax payments.

Adding to the joy is the thought that once you register for the eWaste program, you must file a form every year even if you never again have to pay an eWaste fee. It’s yet another registration number to keep track of, and more paperwork to handle.

So the next time you see a great deal on the Internet for something you need for your business, think again about loading up your shopping cart, and consider the true cost, especially if it’s a computer. Oh, and by the way, the use tax applies to your non-business purchases as well. Sweet.

 

Disclaimer: All of the items above are for information only, and are not meant as tax advice. Please consult your own tax advisor to see how each item impacts your own situation.

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Using Independent Contractors

February 24th, 2011

Independent contractors are workers who provide their services, usually on a short-term or part-time basis. They work with multiple clients, operate out of their own workplace, have their own tools and equipment, and may have a business license or a company name.

Generally, it makes sense to consider going with an independent contractor when you don’t have enough steady work to justify a permanent position. There are three main reasons companies hire independent contractors instead of employees.

1. The task requires specialized skills that are not available in your existing staff.
2. The task is short-term, and will only take a few weeks or months to complete.
3. The workload fluctuates, so is not consistent enough to warrant creating a permanent staff position 

Unfortunately, many companies consider using an independent contractor instead of an employee because it is less expensive. Although an independent contractor can be about 20 to 30% less expensive than an employee, if this worker is determined later to be a misclassified employee, that savings will rapidly disappear.

Business owners may not realize their decision to classify a worker as an independent contractor can get them into serious trouble with the IRS, and possibly the state. Employers pay federal and state unemployment tax and worker’s compensation insurance, plus a matching share of Social Security and Medicare. In addition, employers must collect and deposit income taxes withheld, and are required to file quarterly and annual payroll tax reports. That’s a lot of work and a lot of reporting.  It’s tempting to treat workers as independent contractors to save both time and money.  The use of independent contractors, or vendors, will spare the company all these costs with only a simple 1099 form to file at the end of the year.

What will it cost you if you get caught misclassifying employees? Back taxes can add up to 40% of the independent contractor’s payment. Consider the social security tax, federal and state income tax, and the unemployment insurance you will now have to pay. And if it is determined that your vendor is actually an employee, the Tax Man will want that money from you even if the independent contractor already paid their proper taxes on the payments you made to them.

Penalties and interest will probably also apply. The IRS has broad latitude to assess penalties depending on whether a business acted with reasonable care or purposeful disregard for tax requirements. The penalties could even cause you to lose your business.

The IRS looks at three main factors to determine the relationship between a business and a worker. Behavioral Control, Financial Control and the Type of Relationship. How the worker can be classified depends on the answers to a series of questions.

Behavioral Control
Does the business control, or have the right to control, what and how the worker does their job? Do they provide instructions or training? A general rule is that a paying business has the right to control or direct the result of the work done by an independent contractor, but not the means and methods used to accomplish that result.

Financial Control
If the payer controls the business aspects of the worker’s job, then the worker is probably an employee.

Does the worker have un-reimbursed expenses? Can the worker make business decisions that would affect their profit or loss? This “risk of loss” is a key defining component of a business and not of an employee. But if the worker were paid regardless of whether the work is completed, then that would indicate an employee. Owning tools, equipment, supplies, a computer, and such, represent business expenses that an employee doesn’t normally have, and so are consistent with independent contractor status. If the paying business provides the tools, supplies, etc. needed to perform the job, then the worker is probably an employee.

How is the worker paid? Generally, employees are paid by the hour and receive pay on a specific pay-period basis.  If the worker were paid by the job when the work is completed, that would indicate an independent contractor. However, some professions do charge clients in advance and/or an hourly rate for their services, such as lawyers, bookkeepers, or accountants, so that does not automatically determine employee or independent contractor status.

Is the worker available to provide services other clients? When a worker spends 40 hours per week at one company, the IRS views the worker as an employee. A good test of a worker’s independent contract status is if they have multiple clients. The more the better.

Type of Relationship
Is there a written contract?  Are there any employee benefits, such as a pension plan, insurance, vacation pay, etc? Will the relationship continue over the long term? Is the work performed a key aspect of the business?

When considering the use of an independent contractor, evaluate all the above factors. If any of these criteria point toward the worker being an employee, then that is the classification you should most likely use. If you decide that the worker is indeed an independent contractor, realize that should you be audited, the IRS will make their determination independent of your reasoning and may still classify them as an employee, making you liable for back taxes, interest and penalties. And then your Workers Comp carrier will start in on you. It will get expensive very fast.

Still, you can maximize your chances of prevailing by making certain that your vendor is indeed a true business entity and deserving of the independent contractor status.

You should always have a proper written and signed independent contractor agreement that defines all the relationships and the duration of the work, and lists the responsibilities of each party to pay certain taxes and insurance. Of course a contract alone will not be a determining factor, but it will be a positive factor.

An independent contractor should also have all the licensing and business registrations required to provide their services. They should at least have a business license and have filed a Fictitious Business Name Statement. If they were incorporated, that would provide the best possible evidence to prove the validity of the independent contractor status (unless you have set them up as a corporation yourself). Remember, an independent contractor must be determined to not only be a business, but to be a separate business entity.

Here is a sample checklist of documents you should require from an independent contractor:

– Signed contract
– Signed W-9 form
– Copy of Fictitious Business Name Statement
– Information on how business is structured (sole proprietorship, partnership, corporation, or LLC)
– Business address and phone number
– Unemployment insurance number and Employer Identification Number (if contractor has employees)
– Copies of professional or business licenses
– Contact information for other clients
– Samples of marketing materials (ads, website info, Yellow Pages listing, etc.)
– Business card, professional stationary, invoice form, etc.
– Copies of insurance certificates

If You’re Still Uncertain About a Worker’s Status
Both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS. If you do ask for an IRS determination, keep in mind that it may take five or six months for them to respond.

You can find out more about the determination of a worker’s status as an independent contractor or an employee at the IRS website.

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Minimize the Tax Filing Ordeal

December 27th, 2010

I know from speaking to other small business owners that virtually all of them are concerned about taxes. But the real issue is typically about all of the filing requirements, the things you have to do to keep in compliance with the revenue collection practices of various governmental entities.

There are so many tax related activities required for small business that the IRS publishes a small business tax calendar every year. It’s a really useful tool that is normally released during the fourth quarter of the year. If you want to make sure you don’t miss any deadlines, you can subscribe to the tax calendar in your Outlook calendar.

So here are some of the key tax related obstacles facing small business owners, where they go wrong, and what they should do about it.

Key Obstacles for Small Business
The biggest obstacles for small business owners are knowledge and understanding, because tax law is constantly changing. Most small business owners have no time or desire to keep up with these changes.

The variety of taxes a small business faces often is a shock to start-ups. In addition to the well-known federal income tax, businesses also face various types of state and local taxes, including income, franchise and/or sales taxes. If you have employees, you must deal with payroll taxes, including not just payments but information filings to the government and your employees. Many businesses also face specific excise taxes. And even the type of business entity you’ve chosen, such as sole proprietor, partnership, LLC, or corporation, affects your taxes. Too often a small business overlooks or misfiles some of these tax responsibilities.

That’s why so many small business owners take the wrong steps when it comes to taxes.

Common Tax Mistakes Small Business Owners Make
The most common mistakes are not keeping good records, not planning for the payment of taxes, and not setting aside the funds to pay the taxes owed.

They also need to be conscious about classifying workers properly. Classifying workers as independent contractors when they should be employees could get you in serious trouble. Make sure you follow the IRS guidelines fully to save potential fines and penalties.

Do-It-Yourself or Hire a Professional?
There are plenty of software packages that will help walk you through the steps, so it’s very tempting to be a “do it yourselfer” when it comes to filing taxes. However, you would serve your business better by focusing on what you do best and hiring a professional who specializes in small business to have them do what they do best, prepare your taxes.

A professional knows the ins and outs of applying allowable deductions and can help you not only file properly, but will make sure you get the deductions you deserve along with identifying things you can do to reduce your taxes for the following year.

And remember, small business taxes aren’t just a do it once, set it and forget it activity. A tax professional can help you manage all the changes in tax compliance, and to meet the ever-present deadlines.

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