Taxes: How to Maximize your Deductions
Do you have a closet of ‘keepers?’ You know, financial records—invoices, receipts, revenue and expense reports. Are they categorized and filed? If asked, could you produce an accurate profit or loss report?
Do you know whether your company is in the green, the black or precariously close to being in the red? Are your records accurate and will they enable you to get all the available deductions come tax time?
Surprisingly, many small businesses put off record-keeping and tax duties in favor of seemingly more rewarding activities, such as installing an irrigation system or designing a new landscape. But building a beautiful landscape and preparing for April’s “tax season” have something very important in common; they are year-round pursuits. Just as you can’t just drop a few bushes into a yard and expect to satisfy your client, you can’t hand a box of crumpled receipts and disorganized files to the IRS and expect a refund.
DIY or professional assistance?
Yes, you can do your taxes yourself, but just as your clients hire you instead of trying to do a project themselves, you might be better served by hiring a tax professional. They should, whether they are an enrolled agent, a certified public accountant (CPA) or a tax attorney, be able to ensure that you get the maximum tax benefits allowed.
Filing and understanding taxes used to be simpler, but now there are books dedicated to explaining each tax rule and how it should be applied. It is the job of tax professionals—particularly CPAs—to “stay on top of tax rules and regulations and utilize them to benefit your business,” says Jonathan Winterkorn, a CPA with Plante & Moran, PLLC in Cincinnati, Ohio. “As a business owner, your time is best used developing and growing your business. It is unrealistic to expect that most small business owners can develop and run their business, while also knowing, understanding and taking advantage of all the tax laws, deductions and credits.”
“Small business owners can either learn through the school of hard knocks or they can find an accountant who will work with them as a partner and advisor,” says Brian Setzler, MBA, CPA and owner of TriLibrium, a firm offering accounting and business advisement services in Portland, Oregon.“The mindset is often that a CPA is just another cost, but your CPA should be adding value to your business by helping you with your record keeping, financial and tax-related issues and finding remedies for them,” says Setzler.
“You want to look for an advisor who is going to work hand-in-hand with you on making your business grow. A good CPA is going to help you capture the value of your sales and help ensure that you are following good business practices, like keeping proper records, customer lists, etc.,” he says.
Whether you seek professional help or choose to do it yourself, keeping good records will make your business life easier at tax time and on a daily basis. Messy books “drive up the cost of tax preparation,” says Robert Tobey, a CPA and Tax Principal at Keiter Stephens in Charlottesville, Virginia. “Use a spreadsheet, a ledger, a program—whatever helps you keep your business finances organized. Quickbooks is a great place to start; many local accounting firms, including mine, offer training. The training is important because you need to know how to set it up and use it properly so that you have orderly records for you or your accountant to use at tax time.”
Getting all the deductions and credits
Every year, the IRS makes changes in the type and amount of deductions businesses are eligible to take. Below are just some of the deductions your business may be eligible for this year. For more information on these and other possible deductions, see our resource list below and/or consult a tax professional.
Charitable donations: According to Tobey, you can deduct the value of any supplies, plant materials, etc., that you donate to charity.
However, for tax purposes you cannot deduct the value of any time donated by you or your employees.Section 179: This allows you to expense any purchases of fixed capital assets, such as lawn mowers, tractors and even computer software, in the year they are placed in service. This deduction was once limited to $100,000 worth of assets but, according to Winterkorn, the IRS has “sweetened the deal so that a company can purchase more than two million dollars in deductable assets, providing an immediate benefit, because businesses no longer have to take those costs over a number of years through depreciation.” Note: this deduction is only applicable to businesses that have turned a profit.
Bonus depreciation: If you are operating at a loss, under Section 179, you can apply 100% of equipment depreciation costs this year.
However, only new equipment qualifies.
Green Credits: A 30% credit/grant is available for installing a geothermal heat pump for heating and cooling your business, or credits for purchasing an alternative fuel vehicle for company use and even credits are also available for companies manufacturing and selling alternative fuels such as biodiesel.
Patient Protection and Affordable Care Act: It provides a nice tax credit of up to 35 percent of the health care premiums paid by employers, says Setzler. The maximum credits are for small employers (less than 25 full-time equivalents) paying an average wage of less than $50,000 per year. Reduced credits are still available for organizations outside these ranges.
HIRE ACT, social security tax exemption: Effective from March 19 – Dec. 31, 2010, employers were eligible for a payroll tax exemption that exempted employers from paying their 6.2% share of social security tax on wages paid to previously unemployed employees. In order to be eligible, newly hired employees had to meet specific criteria in terms of the duration and quality of their unemployment period.
HIRE ACT, the retained worker credit: In addition, for each of these qualified employees retained for 52 consecutive weeks, businesses will be eligible for a general business tax credit in 2011.
The retention credit is the lesser of $1000 or 6.2% of the wages paid by the employer. Note: the qualifying employees’ wages during the last 26 weeks of the period must equal 80% of the wages during the first half of the period.
Mileage: Mileage is currently 51 cents per mile and is adjusted every December. Occasionally, if the prices go up significantly over the summer, the IRS may adjust the rate in September. Remember, the mileage deduction reflects what the IRS thinks it costs to operate a vehicle and in order to take it, you need to keep a dedicated log that reflects your business driving, every day on a notepad in your vehicle or a spreadsheet log.
Net Operating Loss: If your business lost money in 2010, you may generate a Net Operating Loss (NOL). Special rules allow you to apply the NOL to either past or future years, so a 2010 NOL could be carried back to a profitable year to offset the earnings and taxes paid in that year, resulting in an immediate refund this year,” says Setzler.
Note: NOL rules are pretty complex so it is wise to seek a tax specialist on this topic.
Preparing for 2011 and beyond: While the cost of hiring an accountant can seem expensive, the cost of doing your taxes incorrectly can be far more costly. “Business owners should see CPAs and accountants as an insurance policy,” says Tobey. “A CPA will make sure you comply with the law and meet all of the rules and regulations.” But if you insist on doing your taxes yourself, here are some tips to consider so you can avoid receiving a day-ruining audit letter from the IRS.Properly document employees: According to Setzler, misclassification of employees exposes business owners to huge liabilities and aren’t worth the risk. “Say you hire a temp employee and pay him as an independent contractor, at $15 per hour and then write him a check at the end of the job. If that person is injured on the job, he is not covered by workman’s comp. However, depending on the state, if an employee gets injured operating a piece of heavy equipment and has no worker’s comp, you could be looking at medical bills, back taxes, interest and penalties.”
Employee or independent contractor? Businesses like to hire independent contractors so they don’t have to pay the labor burden, i.e., social security, Medicare, unemployment taxes and such on the wages. But it is crucial that employers make sure that their independent contractors meet the 20 points which classify whether you are hiring an employee or independent contractor. Make sure subcontractors give you a W-9 form so you can send them a 1099 form at the end of the year. Willful failure to file 1099s can result in a penalty of $250 per 1099 form.
I-9 workers: All employees should be documented to ensure that they can work legally in the U.S. If a worker is undocumented, employers are still supposed to pay social security, Medicare, and employment taxes on them. Workers can and are encouraged to apply for a tax ID number rather than using fake documents.
Company setup : To b e y encourages sole proprietors to set themselves up as a single member limited liability company. The same holds true for business partnerships. “You are still filing your taxes the same way, but you’re limiting your liability. You’re protecting yourself against mishaps that might happen in the course of business or your personal life. Without the limited liability protection, if you hit a pedestrian in a company vehicle after work, you might have to pay for the pedestrian’s injuries and medical bills personally. Becoming a limited liability company is just good business and it is not expensive to do. In most states, you can set one up for $1,000 or less, including filling fees. Think of it as an inexpensive insurance policy.”
Avoid red flags In addition to documenting employees correctly, the IRS will be curious if you do things such as purchase a luxury car and claim it as a business vehicle or funnel all your meals and entertainment through the company credit card.
Beware of tricky deductions:
In order to claim deductions for items such as a home office, telephone, computers, etc., you have to pass the IRS’s exclusive use test and other qualifications. In the case of a home office, you have to be a sole proprietor filing a schedule C. “Say you are using a bedroom in your house as the office for your business, but your Aunt Tilly happens to sleep in there when she comes visiting, even if she only comes once a year. You can’t claim it as a deduction because it fails the exclusivity test,” says Tobey. Same holds true for computers; you may use it for work but if the kids are using it to check their Facebook page or your spouse is playing World of Warcraft on it, you can’t claim it. Setzler notes that “the IRS has been pretty aggressive about people claiming deductions that don’t meet the exclusivity test. It isn’t worth the risk of an audit when there are other deductions available.”
2012 and beyond: Next year, 2012, will be the last year that we have our current tax rates, which were set in December 2009. At the end of 2012, barring any new legislation, we revert back to Clintonera tax rates. According to Winterkorn, “business owners will have to think a little counter-intuitively and may want to accelerate their income into 2012 rather than deferring income into 2013. Say you have an outstanding bill at the end of the year. Normally, if you pay that invoice before the end of the year, you get to take that expense deduction at tax time. But at the end of 2012, business owners might not want to pay that invoice until after the start of 2013, because it will allow them to take that deduction in the year where their income will possibly be taxed at a higher rate. The same holds true for the income side deductions.”
Plastic, Banks and Programs: Setzler, Winterkorn and Tobey all agree that keeping good records includes establishing a bank account and credit card for business use. “Credit cards are great because you have a concrete record of your purchases,” says Winterkorn. Using software will allow you to transfer information to your accountant quickly and easily. The software makes tracking and categorizing expenses easy and enables business owners to create complex expense, profit and loss and other reports with a touch of a button. There is also a Premier Contractor program that is specialized towards helping contractors specifically.
So, how will your tax garden grow? Will it be filled with crumpled and lost receipts and blossoming anxiety, or will it mature and grow because you took the time to apply the right tools and experts to help your business succeed?
Additional tax help resources:
Patient Protections and Affordable Care Act: https://www.irs.gov/affordable-care-act
General Tax Assistance: IRS Helpline 800-829-4933 or visit https://www.irs.gov/businesses/small-businesses-self-employed
Tax Payer Identification Numbers: https://www.irs.gov/businesses/small-businesses-self-employed/employer-id-numbers-eins
Business Tax Credits: https://www.irs.gov/businesses/small-businesses-self-employed/business-tax-credits