In 1789, Benjamin Franklin, one of America’s first entrepreneurs, wrote, “In this world, nothing can be said to be certain, except death and taxes.”
And so, while we all must pay taxes, many of us don’t understand them.
SCORE talked to Hal Shelton, SCORE mentor and member of the SCORE National Board of Directors. Shelton has experience as the CFO of a New York Stock Exchange listed company, an angel investor in early stage technology companies and a board member of for-profit and nonprofit organizations. He is the author/publisher of an Amazon best-selling book on business planning The Secrets to Writing a Successful Business Plan: A Pro Shares a Step-By-Step Guide to Creating a Plan That Gets Results.
This article is not intended to offer tax advice. For advice, please consult with your accountant or tax professional.
Q: Is there a tax advantage to incorporating? Does it matter if you’re a C corp, an S corp or an LLC?
A: A corporation pays Federal and State income tax in its “own name,” and the cash used to pay the taxes come from the Company. The owners may get a dividend from “excess” cash in the business, and this dividend is taxable to them when received. So sometimes this is called “double taxation.” With an LLC or S Corp, the business owners have the option to be taxed as a Corporation, so no difference. They also have the option to be taxed using their individual tax returns. Many LLC owners elect this second option since, for many of them, the personal tax rate is lower than the corporate tax rate. Even if you elect to be taxed as an individual, the legal personal liability protections that come with an LLC are maintained.
Q: What is considered a tax deductible small business expense?
A: According to the IRS, deductible expenses are the costs of carrying on a trade or business—if the business operates to make a profit. You can read more about this on the IRS website. There is no difference between small company and big company expenses.
Q: If you work at home, what are the deductible expenses?
A: These are known as home office expenses, and the IRS has a good discussion of this here. The basic requirements are that you must regularly use part of your home exclusively for conducting business, and you must show that you use your home as your principal place of business. The types of expenses that are usually eligible for deduction include mortgage interest or rent, utilities and internet fees. Generally, deductions for a home office are based on the percentage of your home devoted to the business use, and the burden of proof is on you to demonstrate you have appropriately made this calculation. If you work at the kitchen table, it will be difficult to take home office deductions. There is the “regular” method and a “simplified” method for making the calculations.
Q: What is the difference between current and capital expenses?
A: Capital expenditures are outlays that will benefit a business over a period of years. For example, buying a building, equipment, truck, computer, etc. And these are generally written off for their “useful life” (a set number of years). For example, if you bought a computer for $3,000 and you expect to use it for three years, then you have an annual expense of $1,000 in each of those three years. This is what will go into your income statement and tax return—even though your cash flow is reduced by $3,000 at the time of purchase.
Current expenses are outlays that will benefit the company in the current year—for example, rent, utilities, payroll, office supplies, insurance, marketing, contractors, etc. And over-simplifying the definition, it’s also inventory you buy for resale or use in manufacturing in the next 12-month period.
Q: For tax purposes, is there a difference between having employees and using independent contractors?
A: An employee is anyone who performs services for you and you can control what will be done and how it will be done. You provide employees a W-2 which states the wages paid, in some cases retirement benefits paid and taxes deducted. The taxes deducted from each employee’s paycheck are periodically remitted to the IRS. An independent contractor controls what work will be done and how it will be done. The payer has the right to control or direct only the result of the work. For independent contractors, you provide them a Form 1099 which states the fees paid and they are responsible for paying their taxes.
Q: I use the same car for business and pleasure. What part of my car usage is deductible?
A: If you keep good records of your business usage, you can deduct miles driven, parking fees and tolls related to the business use. You can read about it on the IRS website. Many entrepreneurs use the Standard Mileage Rate Method which for 2017 is 53.5 cents per mile, plus parking and tolls. The other approach is the Actual Expenses Methods, and for this you need to keep track of deprecation, lease payments, registration fees, gas, insurance and all the other expenses of acquiring and maintaining your car or truck.
Q: What about travel and/or entertainment expenses?
A: Travel expenses for a business purpose are deductible. If it is a combination business and personal trip, then you should allocate between the two. The IRS says these expenses should not be “lavish” or “extravagant.” Costs for commuting between home and your office are not deductible. Meals and lodging incurred on travel are also deductible.
Business-related meals and entertainment expenses are deductible if these are common and accepted practices in your trade or business or are helpful and appropriate for your business. Keep good records of each event, who attended and what the purpose was.
Generally, you can deduct only 50% of meals and entertainment expense.
Q: Should a business owner ever do their own taxes or hire an accountant?
A: Most business owners start out doing their own taxes since there are few transactions and few funds available to hire an accountant. In this case, I suggest using one of the available tax software products to guide you through the process. As soon as you have some cash, hire an accountant to ensure you are doing it right and claiming all the deductions you are entitled to.
Q: What are some common tax mistakes small business owners make?
A: Here are a few:
- Not keeping good records that can be used as a defense on an IRS audit
- Failing to report information as it is reported to you—e.g., you get a 1099, but do not include it.
- Misclassifying employees and independent contractors
- Deducting 100% of meals & entertainment, or deducting personal expenses for your business.