It’s no coincidence that taxes are due around Easter each year. Anyone who’s ever needed an answer to a tax question will be familiar with the rabbit hole that they call the IRS Website.
If, like tens of thousands of individuals, you started a business last year, this year might be the first time you’ve ever needed to file business taxes. You might think that they’re just like individual taxes, but you’d be wrong. Business taxes are the Complete Works of Shakespeare. Your individual taxes are the Cliff Notes of “Where’s Waldo?”
Call the Internal Revenue Service, and they’ll direct you to their website to answer your questions. You should review its checklist for starting a business. But for the non-CPA, non-tax attorneys out there, the Web site can more confusing than an average episode of “Lost.”
This article isn’t going to talk about those differences. Instead, we’re going to discuss what can trip you up and precipitate an IRS audit, how valuable a good CPA can be, what to do if you screw up (or worse, lie) on your business taxes and bring the Feds to your door and, finally, what you need to do for your employees.
The IRS has 14 PDF files in their “Recommended Reading for Small Businesses” section, totaling over 600 pages. It recommends that you read them all. We think you should, too, but if you don’t read anything else, read at least the following:
P1635 – Understanding EIN
P1779 – Contractor or Employee?
P587 – Business Use of Your Home
P583 – Starting a Business and Keeping Records
P334 – Tax Guide for Small Businesses
P505 – Tax Withholding and Estimated Tax
P535 – Business Expenses
P15 – Employers’ Tax Guide
If you are starting a business and you can’t be bothered to read about how to do your (and your employees’) taxes right, you’re not going to be in business very long. So read them. All of them. Sorry.
The first, and most valuable, piece of tax advice is this: Find a CPA you trust.
Overwhelmingly, small-business owners advise using a CPA. Have one audit your accounts, listen to his or her recommendations, and plan your business accordingly.
Good CPAs will probably save you as much money as they cost – from making sure you get all your deductions in a row at tax time, to alerting you to cash-flow crunches, to keeping you off the IRS audit radar, their advice will help you limit your exposure to the risk of being audited.
How much does an audit cost? Diane Kennedy, author of Smart Business, Stupid Business, says, “you can count on paying $5,500 in extra taxes. And that’s before you count penalties and interest and accounting and legal fees,” which Kennedy says make the real cost closer to $8,000. Kennedy also says that the chances of being audited are 1 in 3 for sole proprietorships, but only 1 in 100 for S corporations.
Large corporations can much more easily afford to fight an audit. The National Small Business Association claims that “the IRS is preying on those least able to defend their businesses, and giving large corporations a pass. In 2007, IRS audits of the nation’s largest corporations plunged to its lowest level in the past 20 years.” The NSBA also say that the IRS learned that “a far easier way to raise tax revenue is to target small-business owners who may not have the resources to defend themselves.”
So you’re probably wondering what someone like you might do to keep the IRS from knocking on your door, asking for all your receipts.
Forbes Investopedia has a list of 10 things that will trigger a red flag or audit:
1. Large Charitable Deductions
2. Large Business Expenses
3. Inaccurate W-2 or 1099 Reporting
4. Excessive Itemized Deductions
5. Concealment of Cash Receipts
6. Tax-Shelter Losses
7. Informant reporting you to the IRS
8. Prior Tax Problems or Audits
9. Complex Business Transactions
10. Complex Investment Transactions
Avoid these, and you should reduce the chance of being audited. You can never eliminate that chance, because a perfect tax return will be suspicious, too (who files perfect taxes?) Company.com has its own ten ways to avoid an audit – we figure that most small businesses don’t have big accounts in the Caymans or Switzerland, and that if you’re reading this you haven’t run into significant tax problems in the past.
A good CPA is essential. If you aren’t an accountant – and the fact that you’re reading this article indicates that you probably aren’t – you don’t deal with tax and accounting issues all day. Unless you deal with them all day, you probably won’t have the kind of in-depth understanding of these issues that a CPA has. And even if you know what the rules are, you might be guessing at how the IRS wants you to apply them. So get a good CPA and talk to them regularly. It’s a relationship worth investing in.
If you think you want to enlist the services of a tax preparation company, that’s probably not going to work for you. Tax preparation companies that handle individual tax returns are generally not equipped to handle business taxes.
Whomever you get to handle your taxes, help them as much as you can. The easier you make your tax preparer’s job, the more time and attention they’ll devote to getting your taxes right instead of chasing you for information, the less likely they are to make errors that can cost you money.
If you’re going to choose between a retained CPA and a one-off payment to a tax prep company, you should consider that a CPA you call a couple of times a month is going to be far better acquainted with your business than a seasonal hire tax preparer who may not even be an accountant. If you fail to provide documents to your CPA, chances are they’ll probably know your business well enough to ask if you have them. If you fail to submit documents to a tax prep company, they have no obligation to chase you to get them – and that’s important because ....
Pritchett v. Commissioner, 63 T.C. 149,174 (1974) is a tax law precedent that says, “The general rule is that the duty of filing accurate tax returns cannot be avoided by placing responsibility on an agent.” Since you’re responsible for the accuracy of your taxes, whether you prepare them or not, leads us to the question of whether it’s worth doing them yourself.
Only you can answer that question. If you’ve worked in financial or legal services for years, you probably are in a better place than most to handle the nuances of the paperwork. If this is your first year of business and you’re planning to do your own taxes, see the section above about audits and penalties. Then reconsider your plan. If you’re going to insist on preparing them yourself, buy some up-to-date software that includes all the latest changes to tax law. Then take the return to a CPA to review it before you file it.
If you prepare your own taxes and you screw up and catch it, file an amended return as soon as possible. If you don’t, there’s a chance that the auditors will be heading your way. If you flat-out lie on your taxes and get caught, there’ll be heavy fines and maybe even jail time in your future.
The IRS isn’t evil. It doesn’t spend 8 months of the year hatching Machiavellian plots to catch taxpayers out in the other 4 months. They just want to make sure that all the money the government said it needed to run the programs outlined in the budget get collected. And that means they’re actually (gulp!) patriots (seriously.) And all they ask from you is honesty and diligence.
Your employees don’t expect much from you at tax time. Really, it’s simple:
1. Make sure you’ve paid your employees’ payroll taxes throughout the year.
2. Make sure your employee records and documentation are up to date.
3. Send them accurate tax statements – W2 for employees, 1099 for contractors.
4. Stay in business. Do your taxes right and that will help a lot.