Posts Tagged ‘tax deductions’

5 Ways to Avoid Tax Audits

March 19th, 2015

Tax Audit 1When you’re self-employed filing a Schedule C with your tax return, your chances of being audited are greater than if you were a wage earner.

This is because the IRS catches many such individuals that attempt to either hide income or write off personal expenses as business deductions. When all you are reporting on your tax return is income from a W2, what’s there to audit? Even if you enter the numbers wrong, the IRS will match it up with the copy it got from your employer and send you a correction letter along with the adjustment. So, with scrutiny of the self-employed on the rise, here are 5 things you can do to reduce the chances of an audit:

1. Use professional software such as QuickBooks

Track the income and expenses of your business with accounting software. Your credibility increases in the eyes of an IRS agent if your tax return is based on professionally-prepared financial statements, especially if maintained by an outside firm.

2. Document sources of all income

If you are audited, the first thing the IRS agent will do is add up all of the deposits from your personal and business bank accounts. If more money went into the bank than was declared on your tax return, the agent will want to know where the money came from and whether or not the income is taxable. If you use QuickBooks for your personal and business books, you will automatically tie out this income, but you still need proof. If the income you record is not taxable (e.g. gifts, inheritances, loans, transfers from personal funds) keep a copy of the check or document that accompanies the income to prove the source is not taxable.

3. Let a professional prepare your income tax return

Self-prepared returns are more likely to be audited because the IRS thinks a nonprofessional has limited knowledge. Tax law is complex. And if you are self-employed, no matter how small your business, your tax return is now a complex creature.

4. Rethink your legal form

Corporations, LLCs, and partnerships are less likely to be audited, but that should not be the sole reason to incorporate. Discuss this option with a tax professional and your attorney before making any changes.

5. Document the Red Flags

You are allowed to deduct all ordinary and necessary business expenses which means thinking in terms of “Would I make this purchase if I didn’t have this business?” If the answer is no, than you more than likely have a deductible business expense. But it’s important to know the rules and to have proper documentation to substantiate the deduction.

Some expenses receive considerably more scrutiny than others:

Automobile expenses

Taxpayers are required to keep a mileage log if they want to take these kinds of deductions, which can be a lot of work. The IRS loves to investigate these because very few business owners will bother with this. Fortunately there are other ways to substantiate the deduction to the satisfaction of the auditor.

  • If you use an appointment book or calendar, save it along with your copy of the tax return. A mileage log can be reconstructed from those pages.
  • Save vehicle repair receipts as the odometer reading is recorded on them and total mileage for the year can be extrapolated if there is more than one receipt.
  • Record your beginning and ending odometer reading in your appointment book on Jan. 1 and again on Dec. 31.
Travel, meals and entertainment expenses

These are also very common when it comes to tax audit scrutiny. Go to www.irs.gov and read Publication 463 to determine what you can and can’t deduct.

  • Travel, especially to vacation destinations like Las Vegas or Hawaii should be documented with more than purchase receipts to prove the business intent. Save anything that can substantiate your claim that you were traveling primarily for business; such as flyers advertising the trade show, or the continuing education seminar, or letters from prospective clients at that location in your tax file.
  • Write the name of the person entertained and a brief note describing the business purpose on receipts for meals and entertainment.
Home office expenses

These are another red flag for the IRS to take a closer look at your expenses.

  • Take photographs of the house and the office area. The photos will serve two purposes: they will show the proportion of the business area compared to the personal living area to substantiate the amount of space claimed as well prove that there is in fact a business area.
  • Know the rules: The home office must be your principle place of business and must be used exclusively and on a regular basis for business purposes.

 

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Hiring Your First Employee

October 7th, 2012

Is your business ready to make its first hire? Finding and hiring the right employee is a critical step in the process. However, there are a few other steps you’ll need to take to ensure you meet the legal, regulatory and tax obligations of being a new employer.

In California many employment related tasks, including some of those listed below can be done from the Employment Development Department’s e-Services for Business page.

For California businesses about to become employers, here’s a checklist of the things you’ll need to do either before, or soon after you make that first hire:

1. Apply for an Employee Identification Number
Many businesses operate without an Employer Identification Number (or EIN), but if you hire employees, you’re going to need one. Think of it as the social security number equivalent for employers. An EIN is used to report the taxes you withhold on behalf of employees. You can apply for an EIN online from the IRS during their hours of operation Monday through Saturday. Apply for an EIN online.

2. Set-Up Withholding Taxes
Either on or before the date of employment, you’ll need to give your employee a copy of IRS Form W-4, to fill out and hand back to you so that you can withhold the correct federal income tax from their pay. To help you figure out what you should be withholding, refer to the IRS’ Employer’s Tax Guide(for use in 2012). Most California employees use the same number of Federal withholding allowances for their state income tax withholding. But under certain circumstances, especially if a person has income from multiple sources, they will want to use Employment Development Department Form DE-4 to determine if they should use a different number for their state withholding.

3. Verify That Your Employee is Eligible to Work in the U.S.
Employers are required to ensure their workforce is legal, and must verify each employee’s legal right to work in the United States within three days of the hire date. Go the U.S. Citizenship and Immigration Services website if you need to learn more about this process. Mainly, you will need to examine acceptable forms of ID presented by the employee and complete the Employment Eligibility Verification Form (I-9), and then verify the data on the form with the U.S. Citizenship and Immigration Services’ E-Verify online tool. You don’t need to file the form; just keep it on file for three years after the hire date, and one year after a termination date.

4. Register with the New Hire Reporting Program
Within 20 days of the hire date, you must report all new hires to the Employment Development Department’s New Employee Registry. The easiest way to satisfy this requirement is to fill out and submit a Report of New Employee(s) Form DE-34. Actually you can submit the necessary information in any format you like, as long as it’s all there. Some employers just add the employee’s start date and their California employer account number and the Federal employer ID number to the W-4 and send that.

5. Obtain Workers’ Compensation Insurance
In California, once you have employees you are required to carry worker’s compensation insurance. The insurance is available through commercial insurance carriers, on a self-insured basis, or through your state’s program and is considered a cost of doing business. If you need a referral to a commercial insurance agent who will help you minimize this cost, email me at doug@solidgrowth.com.

6. Unemployment Insurance Tax (UI), Employment Training Tax (ETT), and State Disability Insurance (SDI) for 2012
The UI program is part of a national program administered by the U.S. Department of Labor under the Social Security Act. The UI program provides temporary payments to individuals who are unemployed through no fault of their own.

UI is paid by the employer. Tax-rated employers pay a percentage on the first $7,000 in wages paid to each employee in a calendar year. The UI rate schedule and amount of taxable wages are determined annually. New employers pay 3.4 percent (.034) for a period of two to three years. EDD notifies employers of their new rate each December. The maximum tax is $434 per employee per year. (Calculated at the highest UI tax rate of 6.2 percent x $7,000.)

New employers are assigned a 3.4 percent UI tax rate for a period of two to three years. This will depend on when you meet the criteria under Section 982(b) of the California Unemployment Insurance Code (CUIC). If you purchased an established business, you have the option of acquiring the previous owner’s UI tax rate (see purchasing a Business with Employees).

The Employment Training Tax (ETT) rate for 2012 is 0.1 percent. The UI and ETT taxable wage limit remains at $7,000 per employee per calendar year.

The State Disability Insurance (SDI) withholding rate for 2012 is 1.0 percent. The taxable wage limit is $95,585 for each employee per calendar year. The maximum to withhold for each employee is $955.85.

The UI, ETT, and SDI tax rates are combined on a single rate notice, Notice of Contribution Rates and Statement of UI Reserve Account (DE 2088). The DE 2088 will be mailed to you in December, with a mailing date of December 30. Employers will have 60 days from the December 30 mailing date to protest any item on the DE 2088 except SDI and ETT, which are specifically set by law.

7. Display Workplace Posters
Check with the Department of Labor’s “Poster Advisor” online tool to see which posters you need to display that explain employee rights, etc. To determine what posters are requited of you in California check the Department of Industrial Relations Workplace Postings site.

8. Filing Taxes as an Employer
It’s a good idea to talk to your accountant or tax advisor about your new tax obligations. Typically, you’ll need to report income tax withholding, social security, and Medicare taxes each quarter on the IRS Form 941. If you paid wages of $1,500 or more in any quarter or had an employee on the payroll for any 20 weeks of the year, you’ll also need to file an Employer’s Annual Federal Unemployment (FUTA) return.

To see what applies to you, read the IRS Employer’s Tax Guide.

9. Keep Good Records and Stay Informed on Employment Laws
Once your employee is on board, make sure you maintain good employee records, pay close attention to workplace health and safety laws, and understand what benefits you must establish by law. Each of the following links will provide useful guides and tools that can help you stay compliant.

Labor Recordkeeping Requirements

Occupational Safety and Health Act (OSHA)

Fair Labor Standards Act (FLSA)

Family and Medical Leave Act (FMLA)

Equal Employment Opportunity Commission

Employee Handbook information

If you will be providing benefits to your employees, you should become familiar with the uniform minimum standards required by federal law to ensure that employee benefit plans are established and maintained in a fair and financially sound manner. See the chapter on Employee Benefit Plans in the U.S. Department of Labor’s Employment Law Guide for more information.

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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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