Running a successful small business isn’t easy these days, especially with so many mega-corporations finding ways to offer similar services at lower prices. And if this isn’t challenging enough, trying to ensure one doesn’t end up paying too much, or for that matter, too little in taxes only makes things worse. There are several small business tax issues along the way when it comes to paying just the right amount of taxes that business owners should watch for. Here are a few pieces of small business tax advice:
When running a small business, it can be surprising what is and isn’t deductible as a business expense. One cause of business tax issues is that tracking these expenses can be difficult at times, and it’s easy to lose track of expenditures along the way. Tax experts agree business owners should keep receipts for everything, to repeat that, everything. Why? The answer is two-fold. First, having all receipts for the year safely stored away makes referencing them easier when tax time comes along.
Secondly, many deductions now require business owners to provide substantiation, or they could be rejected. These may include things like entertainment, meals, or the use of a personal vehicle while doing business. Recently, the IRS has been cracking down on expenses such as these and denying many of them for lack of substantiation. In the event the IRS does decide to audit a business, it is the “low-hanging fruits” such as these types of deductions that usually hit the chopping block first. The simple answer is to keep everything because it’s better to have and not need than to need and not have.
Keeping Business and Personal Expenses Separate
There are many ways business tax issues can arise. Chances are good that when most business owners first started their small business, they used some personal assets to get started. Some may have even used their personal credit score to secure a loan for start-up capital. But, the more a business grows, the more important it becomes to keep business and personal expenses separate. In the case of corporations, the IRS requires these expenses to be kept separate.
However, in the case of a sole proprietorship, the law sees this as an unincorporated business. In this case, the IRS states there is no difference between the business owner and the business. Thus, all profits and losses, as well as liabilities, are tied directly to the owner. With this in mind, it’s more important than ever to keep business and personal expenses separate by utilizing both a business and personal bank account.
When audited by the IRS, the burden of proof falls on the small business owner. While the IRS doesn’t have any specific recordkeeping requirements, all business owners should be using a system that clearly defines all business income and expenses. More accurate records ensure that less time is spent locating receipts. Unless one is operating a sole proprietorship, separate business and personal bank accounts should be kept, as this will make record keeping much easier.
Avoid the Red Flag of Excessive Deductions
There are many stories about what causes the IRS to flag tax filings for an audit, ranging from just being unlucky to excessive changes in income. But, realistically, there’s no way to predict if or when the IRS may or may not select a business’s tax filings for an audit. Yet despite this, one thing that is most likely to raise the dreaded “red flag” of an IRS audit is an excessive number of deductions. While it may be enticing to deduct absolutely every little expense, doing so could be the one thing that triggers an audit.
To avoid business tax issues, be sure to keep every business-related receipt, but also keep in mind, the need to be reasonable with the number of deductions claimed. Don’t be afraid to claim legitimate business expenses, but be sure to have the documentation to back them up just in case the IRS decides an audit is in order.
How Many Years Can Losses Be Reported?
Technically, a small business owner can report business losses for as many years as he or she chooses, but there is a caveat to this. If one reports business losses for more than three out of the past five years, the IRS may deem the business no more than a hobby. When this occurs, the IRS may scrutinize the business records under a much more powerful microscope, and this may or may not initiate an audit.
The key difference between a hobby and a business is that business owners have the right to deduct business expenses on their taxes, but not everything is eligible as a deduction if the owner is using their business as a mere hobby to generate a small income on the side. The only amount that can be deducted while running a business as a hobby is an amount less than or equal to the amount received as income from the hobby. However, with a business, the owner can deduct more as expenses than income by taking a loss.
Filing taxes for a small business can be very confusing. Avoid business tax issues by having taxes handled by a tax professional to ensure the full maximization of deductions, minimization of tax liabilities, and most of all, reduction of risk regarding being audited and owing additional taxes.