Tax season can be a pain for small business owners, especially as taxes seem to get more complicated every year. To help us navigate through the complexities of the tax code, we talked to Barbara Weltman, a business and tax attorney, and author of the long-time best-selling series, J.K. Lasser’s Small Business Taxes 2014. Find out what to look out for when filing your return this year.
Fundera: What recent changes to the Tax Code should small business owners know about?
Barbara Weltman: For 2013 returns, the major changes for small business owners relate to the Affordable Care Act. If you earn more than a threshold amount — which is determined by your filing status ($250,000 for joint filers; $200,000 for singles; $125,000 for married persons filing separately) — you have to pay an additional 0.9% Medicare tax on earnings (wages from your corporation or net earnings from self-employment). Also, there’s a 3.8% additional Medicare tax on net investment income, which includes income from a business in which the owner does not materially participate.
Other changes are not in the Tax Code, but arise from cost-of-living adjustments and IRS policy revisions, such as the higher mileage rate for business driving and a higher deduction limit for contributions to SEP IRAs.
Fundera: More small business owners are running virtual businesses. What do small business owners need to know about taking a home office deduction without raising a red flag to the IRS?
Weltman: This year, the IRS created a simplified way to figure the home office deduction; it’s a flat $5 per square foot up to 300 square feet of space (top deduction is $1,500). The previous method — figuring the actual costs related to the home office — is also still an option. Either way, you have to meet home office deduction rules: the home office must be the principal place of business and the space must be used regularly and exclusively for business. As long as a business owner qualifies, he/she should not fear an audit on this issue.
Fundera: Speaking of audits, there’s a lot of buzz that the IRS is auditing more small business owners this year. Is this true? Are certain forms of business (sole proprietors, for example) audited more than others?
Weltman: According to current statistics, there has not been an increase in the number of audits. However, that’s little comfort if you’re selected for an audit. Sole proprietors have the highest audit risk, especially very successful ones. The reason: a “tax gap” report found that self-employed individuals are the most likely to omit income, overstate deductions, or fail to pay self-employment tax.
Fundera: What are the riskiest deductions — the ones that are often taken improperly and can raise red flags?
Weltman: The IRS is always looking at T&E (travel and entertainment) because of the opportunity for misuse (e.g., writing off personal entertaining).
Fundera: What are the most common mistakes small business owners make when doing their taxes?
Weltman: Two very common mistakes are failing to make the best choices when there are options (e.g., whether to depreciate equipment or write it off immediately using the Sec. 179 deduction), and failing to note limitations (e.g., only 50 percent of meals and entertainment costs are deductible in most cases). When in doubt, check with your accountant.
Fundera: What are the most valuable deductions that every small business owner should be taking but may not be aware of?
Weltman: In addition to deductions, look for tax credits, which are even more valuable. Examples of credits exclusive to small businesses:
Small employer health insurance credit. [Per the IRS: if you have fewer than 25 full-time equivalent employees, who earn average wages of less than $50,000 a year, and you pay at least half of their employee health insurance premiums.]
Credit for starting a retirement plan. [It must cover at least one employee who isn’t the owner or spouse].
The disabled access credit. [According to the IRS: “For small businesses that incur expenditures for the purpose of providing access to persons with disabilities. An eligible small business is one that that earned $1 million or less or had no more than 30 full time employees in the previous year.”]
Fundera: What is the single most important thing small business owners should do to pay less in taxes?
Weltman: Starting with great records to back-up positions taken on the return gives you the most options. Work with a good tax advisor who can help you assess the tax implications of your business decisions. And do tax planning throughout the year.