Who Ya Gonna Call? TAX BUSTERS!
Tax returns for calendar year businesses are generally due in less than a month but here are but a few “Small Business Tax Myths” we at Abo and Company have already busted in client meeting. Why is that? Well, the complexity of the tax code generates a lot of folklore and misinformation that could lead to costly mistakes such as penalties for failing to file on time or, on the flip side, not taking advantage of deductions you are legally entitled to take and giving the IRS more money than you need to. With this in mind, let's take a look at some of these business tax myths we’ve seen.
1. Start-Up Costs are Deductible Immediately
Business start-up costs refer to expenses incurred before you actually begin operating your business. Business start-up costs include both start-up and organizational costs and vary depending on the type of business. Examples of these types of costs include advertising, travel, surveys, and training. These start-up and organizational costs are generally called capital expenditures. Costs for a particular asset such as machinery or office equipment are recovered through depreciation or Section 179 expensing. When you start a business, you can elect to deduct or amortize certain business start-up costs.
Business start-up and organizational costs are generally capital expenditures. However, you can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs. The $5,000 deduction is reduced (but not below zero) by the amount your total start-up or organizational costs exceed $50,000. Remaining costs must be amortized.
2. Overpaying the IRS makes you "Audit Proof"
It is never a good idea to knowingly or unknowingly overpay the IRS. You should only pay the amount of tax that you owe. The IRS doesn't care if you pay the right amount of taxes or overpay your taxes; however, they do care if you pay less than you owe and you can't substantiate your deductions with good recordkeeping. The best way to "Audit Proof" yourself is to properly document your expenses and make sure you are getting good advice from your tax accountant (we hope you know who that is).
3. You can take more Deductions if your Business is Incorporated.
The good news is that self-employed individuals (sole proprietors, LLCs and S Corps) qualify for many of the same deductions that incorporated businesses do. As such, becoming incorporated is often an unnecessary expense and burden that many small business owners don’t need. For instance, start-ups can spend thousands of dollars in legal and accounting fees to set up a corporation, only to discover soon thereafter that they need to change their name or take the company in a different direction. Furthermore, plenty of small business owners who incorporate don't make money for the first few years and find themselves saddled with minimum corporate tax payments and no income.
4. The Home Office Deduction is a Red Flag for an Audit.
While the home office deduction used to be a red flag, this is no longer true. In fact, with so many people operating home-based businesses the IRS rolled out a new simplified home office deduction in 2013, which makes it even easier to claim the home office deduction (as long as it can be substantiated with excellent recordkeeping).
Furthermore, because of the proliferation of home offices, tax officials cannot possibly audit all tax returns of small business owners taking the home office deduction. In other words, there is no need to fear an audit just because you take the home office deduction; however, a high deduction-to-income ratio, however, may raise a red flag and lead to an audit. You’ll want to take a look (or ask for a copy) of Abo and Company’s February 2019 “Tip of the Month”.
5. You can’t Deduct Business Expenses if you don't take the Home Office Deduction.
You are still eligible to take deductions for business supplies, business-related phone bills, travel expenses, printing, wages paid to employees or contract workers, depreciation of equipment used for your business, and other expenses related to running a home-based business, whether or not you take the home office deduction.
6. An Extension to File gives you an extra Six Months to Pay any Tax you Owe.
Extensions enable you to extend your filing date only. Penalties and interest begin accruing from the date your taxes are due.
7. Part-time Business Owners Cannot Set up Self-employed Pension Plans.
If you start a company while you have a salaried position complete with a 401K plan, you can still set up a SEP-IRA for your business and take the deduction.
8. Tapping money from your IRA, SEP, 401K or other retirement plan before you turn 59 ½ will cost you an extra 10% penalty.
Sometimes life intervenes and you may need to access these funds. However, while the early distributions may be taxable, there are some exceptions to the rather harsh 10% penalty. These include distributions due to the death or total/permanent disability of the owner; higher education expenses; IRS levy; medical expenses that exceed certain income thresholds; up to $10,000 for first time homebuyers (not from 401k); and for military reservists called to duty.
9. All entertainment related expenses are no longer deductible.
If you host a company picnic or holiday party, even at your home, then the cost is a deducible expense and you can deduct 100% of such meal expenses. According to the IRS, a standard 50% limit for deducting business-related meal and entertainment expenses does not apply to the expenses of providing recreational, social, or similar activities for your employees. As long as your party is held primarily for the benefit of your employees who are not highly compensated (making less than $120,000 per year), then you can take the full deduction. However, as described in IRS Publication 535, if your holiday party has a business motive and your guest list includes clients, potential clients, and/or customers, then you will be subject to the 50% limitation rule.
If you have any questions about these and other tax myths, don't hesitate to set up a meeting with us to discuss. The world doesn’t stop for us just because it’s tax season. Oops, gotta go. Sunday and need to get back to work!