7 Common Myths About Business Taxes (And What You Should Know Instead)September 23, 2019 September 13, 2019 /
The tax code is well-known for being complex and a source of confusion. It’s huge, covers many different areas and is often changing.
This complexity has lead to a few myths circulating about business taxes. Who knows where they get started, but it seems that sometimes, someone got away with something or noticed an apparent correlation and the event became folklore.
Here we’re breaking down some of the common myths that circulate – remember, if you hear something and you’re not sure, you can always ask us!
Myth #1. You can prevent an audit by overpaying taxes
Okay, we can see how this misconception might get started. Overpaying isn’t a requirement so someone might feel that their good will in doing so will put them above “suspicion” for any sort of audit.
This simply isn’t the case.
In reality, the IRS doesn’t care that you’ve overpaid on your taxes. Doing so has no bearing on whether or not you get selected for audit, or the outcome of that audit if you do. In fact, generally speaking, overpaying does not make sense from a business perspective. That overpayment is potential cash flow that might be needed to help boost growth activities in your business.
Is there anything you can do to avoid an audit? Not really, as it can happen at random. The best thing to do is to stay on top of your records and make payments on time.
The only time the IRS does care is if you underpay on your taxes. This is when you can be hit with fees and penalties. Say you operate two different business entities and overpay your taxes for one, but underpay for the other. The overpayment isn’t considered to make up for the underpayment – you’ll still be charged those penalties.
There is no “rule” to avoid getting audited by the IRS Click To Tweet
Myth #2. You can claim startup costs right away
Startup costs – those which are incurred before your business starts trading – can be a large amount depending on your type of business. Many people assume that these expenses can simply be written off right away, but this is another common myth.
Only expenses for existing trade or business can be deducted right away. In the case of startup costs, you can only deduct the lesser amount of the following two options: your actual expenses or $5000. Where your startup costs exceed $50,000, then the $5000 deduction is reduced by the amount that exceeds that figure (so you would deduct $4000 if your startup costs were $51,000). This reduction never goes below zero.
The rest of your expenses are deducted ratably over 180 months, beginning with the month that you started trading. Which expenses are included? Here are some common startup costs that qualify:
- Market research
- Salary and wages
- Professional and consulting fees
Myth #3. You will be audited if you claim home office deductions
There used to be an element of truth to this one. There was a time when claiming the home office deduction was a red flag for an audit, but this is not the case anymore.
When you consider the volumes of home-based or remote businesses these days (now, around 5% of Americans work from home), it would be extraordinarily impractical for the IRS to audit all of their tax returns. They’d have to hire a small army of auditors, or there would be little chance of tax officials being able to keep up with the audit workload.
With that being said, it doesn’t pay to be blasé about claiming your deductions when you work from home. One thing that will raise a red flag with the IRS is if you have a high deduction to income ratio. This could trigger them to investigate what you’re claiming and whether you have sufficient evidence to be claiming it.
Myth #4. You don’t need to pay taxes on money earned online
We’re not too sure where this myth came from. It probably originated because some online sellers have managed to get away with not declaring income and have thus far avoided paying taxes on what they’ve made.
There’s a high chance this will catch up with them sooner or later though. The bottom line is that any income you make online is as taxable as your offline income.
Any time you sell a product or service and make more than $400 doing so, you are required to report this income to the IRS. In terms of taxes, you also need to be aware of your “nexus” for state and local taxes too. You may be required to collect and file sales taxes on transactions that fall under this nexus.
Myth #5. My accountant will be liable for any mistakes
If only it were that simple! In the eyes of the IRS, however, it doesn’t matter if you’ve hired a top accountant; your business is ultimately responsible for any filing mistakes. If you get audited or if you face penalties for mistakes, it’s your business the IRS is penalizing, not your accountant.
This might not sound particularly reassuring, but here’s what we can tell you: as an accountancy firm we take utmost care in all our preparatory research and advice given to clients. If you find suitably qualified accountants, they’re going to work to the best of their ability to ensure everything is correct. They wouldn’t be in business for very long if they didn’t!
For the client’s part, one thing you can do is ensure that your record-keeping is accurate and up-to-date. Your accountants should be given all pertinent information so that they can offer the best possible advice. If you’re not sure what they need, they will tell you!
Myth #6. All CPAs are tax experts
While a CPA has undergone comprehensive training and testing, not all CPAs specialize in taxation. For example, some may specialize in business governance, auditing or mergers and acquisitions. When it comes to tax advice, you specifically need a CPA who specializes in taxation.
When you choose a true tax expert, you can expect them to have specific tax preparation experience, thorough knowledge of tax laws, and up-to-date training on any changes to the taxation system.
The recent Tax Cuts and Jobs Act (2017) is a good example. This reform was the most comprehensive update to the tax code in decades, and its implications are wide-reaching. Any taxation expert should have undertaken specific training on the updates to ensure they give current advice.
You can also expect that the best CPAs who specialize in taxation are able to offer tax planning. Speaking of which, just because you worked with an accountant to file your taxes doesn’t mean you have received any tax planning advice. Tax planning should happen well in advance of filing, and it involves making a plan with your accountant to minimize your tax liability. It’s important to understand the distinction.
Myth #7. We can avoid payroll taxes by hiring contractors
This is an approach to be very cautious about adopting. There has certainly been a trend over the last few years of hiring people as independent contractors to help keep a business running. However, you must be very careful to correctly classify anyone doing work for you – companies have been known to be penalized for misclassification.
In the words of the IRS:
“Worker classification is important because it determines if an employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. Businesses normally do not have to withhold or pay any taxes on payments to independent contractors. The earnings of a person working as an independent contractor are subject to self-employment tax.”
What determines classification? These three factors:
- Behavioral Control: A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised.
- Financial Control: Does the business have a right to direct or control the financial and business aspects of the worker’s job?
- Relationship: The type of relationship depends upon how the worker and business perceive their interaction with one another. (For example via written contracts and benefits).
There are a few business tax “myths” that keep cropping up, and these misconceptions have the potential to impact your business negatively if you believe them.
Our final word on this is that it pays to invest in professional tax planning, and it’s wise to do so as early as possible. Your qualified CPA can help guide you through the myriad of laws that apply and ensure that you are taking the right steps. Always ask the professional if you’re unsure!