Every week as SmallBizLady, I conduct interviews with experts on my Twitter talk show #SmallBizChat. The show takes place every Wednesday on Twitter from 8-9 pm ET. This is excerpted from my recent interview with @BarbaraWeltman. Barbara Weltman is a respected corporate speaker, contributing editor, author of more than a dozen books from major publishers, sought-after expert media source, newsletter publisher and more than ever, a trusted advocate for small business owners. More info at http://BarbaraWeltman.com
SmallBizLady: When are business taxes due to the IRS?
Barbara Weltman: 2012 federal income tax returns by calendar-year corporations are due by March 15; returns for partnerships and sole proprietors by April 15. If, for any reason, you can’t file on time, simply ask for a filing extension. Taxes should have been paid through estimated taxes, so only a final payment should be necessary to accompany the return.
SmallBizLady: What are the best tools to manage accounting records for a small business?
Barbara Weltman: Use software or cloud solutions to track income and expenses. You don’t need any accounting background to use them. And they create the records you need for tax purposes as well as providing you with financial reports and other data to help you run your business. I use QuickBooks, but there are other options that are good too.
SmallBizLady: How can you minimize your chances of getting audited by the IRS?
Barbara Weltman: Be sure to report all your income except amounts you’re allowed to exclude. Be very careful in reporting income that’s been reported to the IRS on 1099s, such as payments to independent contractors. Also avoid “risky” positions, such as unusually high deductions relative to your income (even if the deductions are legitimate, they may attract IRS attention).
SmallBizLady: Why is it so important to keep good records in a small business?
Barbara Weltman: While this won’t prevent an audit, it may avoid escalation into a broader examination by the IRS. Say the IRS sends a letter (which is a correspondence audit) asking for proof for a specific deduction. With good records, you can substantiate positions taken on the return if the IRS raises questions. Without the proof, the IRS may raise additional questions.
SmallBizLady: What are the new tax rules that small business owners need to know before filing taxes this year?
Barbara Weltman: As the old saying goes, the best defense is a good offense. Knowing the tax rules and following them will go a long way toward keeping you safe from an audit. At the very least, having a reasonable belief that you are following tax rules can help to avoid tax penalties if it turns out that you are audited and found to be in the wrong.
SmallBizLady: Are there tax changes for 2013 we need to be concerned about?
Barbara Weltman: Many of the deductions and credits allowed in 2012 are available in 2013 (although some dollar limits may be increased because of inflation). The big change is in the tax rate on high-income taxpayers, which may include successful small business owners, and the additional Medicare surtaxes on earnings (salary or net earnings from self-employment) and on investment income, including business income from a company in which you do not materially participate in (those in which you merely invest).
SmallBizLady: What are the top 5 things business owners often think are deductible, that aren’t?
Barbara Weltman: Health insurance for self-employed individuals. While it’s deductible, it is not a business write-off; it is a personal deduction.
Buying realty. The cost of a building can be depreciated over time but not deducted in full in the year of purchase.
Commuting costs. The cost of getting to and from work is a nondeductible personal expense.
Trademarks and other intangibles. The cost of acquiring or creating them may be amortized over 15 years.
Repayment of loan principal. While interest is deductible, payments of principal are not.
SmallBizLady: Are there any write-offs that should be avoided by small business owners?
Barbara Weltman: Certain deductions and credits may attract the attention of the IRS more than others. Some write-offs have been labeled audit red flags for business owners, so waiving or modifying write-offs may make sense:
- Don’t take a home office deduction. Some tax experts believe this deduction is an audit red flag. I don’t agree. Nonetheless, the deduction may not be significant, so those who want to err on the safe side, especially if there is a question about eligibility for the deduction, may want to forego it.
- Don’t claim 100% business use of a vehicle. While a van or truck used exclusively for business may merit the 100%-business-use claim, a passenger vehicle available for personal driving is suspect, especially if the owner has no other vehicle available for personal driving.
- Don’t claim T&E deductions for personal expenses. Most small businesses have deductions for travel, meals, and entertainment costs. But don’t use this write-off for wining and dining a spouse, relatives, and friends when there is no business reason. Don’t deduct your lunches in town unless you are treating a customer, client, or other business associate.
- Don’t claim higher-than-average deductions. While the IRS doesn’t publish what “average deductions” mean for particular businesses, a number of years ago the Government Accountability Office (GAO) reported data on sole proprietors. While the dollar amounts of deductions may no longer be relevant, they do indicate the portion of deductions to income that may still be useful today.
SmallBizLady: Are there things that business owners do that can invite an IRS audit?
Barbara Weltman: You are virtually guaranteed that your return will be examined if you take certain actions. In most cases, it’s advisable not to file the following forms:
- Form 5213, Election to Postpone Determination as to Whether the Presumption Applies that an Activity Is Engaged in for Profit. This form asks the IRS not to audit a new business until the expiration of a set period (generally five years). It allows a new business to demonstrate having a profit motive (and not being a hobby activity) by showing a profit in three of five years (two out of seven years for certain horse-related activities). Instead of filing the form, operate the activity in a businesslike manner in order to demonstrate your profit motive. Then, if you are audited, you can muster factors to support your profit motive.
- Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR).Partners and S corporation shareholders can, in some cases, choose to report business items on their personal returns in a way that differs from the entity’s reporting of the items on Schedule K-1. In most cases, don’t. Instead, report business items as they appear on the Schedule K-1.
SmallBizLady: What is the most common type of business entity to get audited?
Barbara Weltman: Audit statistics show that sole proprietors are much more likely to be audited than partnerships or corporations (S or C). For example, in the government’s fiscal year 2011, sole proprietors with gross receipts of $100,000 to under $200,000 have an audit rate of 4.3% ($200,000 or more, 3.8%). In comparison, the audit rate for all partnerships and S corporations was 0.4%.
Forming a limited liability company (LLC) with a single owner may not help with audit risk. The LLC files the same Schedule C of Form 104 as a sole proprietor.
SmallBizLady: How do you select a good tax advisor?
Barbara Weltman: The best strategy for minimizing the chances that you’ll be audited is to use a good tax advisor. Seek a referral from someone you know (e.g., your banker, your attorney, or another business owner). If you don’t know anyone, check your state’s CPA society for a referral.
Steer clear of any tax advisor that makes promises that sound too good to be true. If you’re guaranteed that you will get a refund or that you don’t need to show any documentation, this is a sign that the tax advisor is shady. Once an advisor comes under IRS scrutiny, his or her clients will likely be examined. And the IRS is cracking down on preparers who have taken questionable positions on clients’ returns.
SmallBizLady: What kinds of things can a small business do for tax planning in 2013
Barbara Weltman: Work closely with a tax advisor to monitor how your business is doing so that you can adjust your tax strategies throughout the year. You may want to buy machinery and equipment because write-offs for them are scheduled to decline or end after 2013. You can shelter profits in a qualified retirement plan. And be sure to follow developments on the employer mandate under the Affordable Care Act. For example, the small employer exemption for companies with 50 or fewer full-time employees is based on 2013 payroll.
If you found this interview helpful, join us on Wednesdays 8-9 pm ET; follow @SmallBizChat on Twitter. Here’s how to participate in #SmallBizChat: http://bit.ly/S797e
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Interesting Q&A. I have been looking into getting some software to help with some of the tasks at my workplace, and a better version of tax software is on that list along with a few other things. Would you suggest any specific project software for a small business?
This is very informative. Thank you.