The good news: your small business made money in 2016. The bad news: you’ve got to file and pay income taxes. For those of us who run small businesses or are self-employed, this can be a much more daunting task than for those who simply get a W2. You want to take every deduction you can, but be sure to avoid one of the six worst tax mistakes you can make if you’re self-employed or own a small business.
Those who file “Schedule C” tax forms — sole proprietors who file individual, not company, tax returns — under-report income by a whopping 57%. The IRS knows this, and it’s one reason that the IRS has small businesses and sole proprietors in its sights.
Make sure you avoid these six mistakes that can get you and your small business in big trouble:
1. Hiding income. If you do a lot of business in cash, it can be tempting to stash that cash rather than reporting it. The IRS knows that cash-heavy companies and independent contractors who typically get paid less than $600 (the threshold for filing a form 1099) often under-report income, and they’re on the lookout for them. One type of business that was frequently audited were gas station/convenience store combinations. Evidently, many people pay cash for gas and Slim Jims. Recently, the IRS identified “professional, scientific, or technical services” as being high in tax avoidance, so one-person consultants, be careful. And here’s an interesting fact: small business owners who spoke a language other than English at home – most likely immigrants – were more than twice as likely to pay all their taxes than people who spoke English at home.
2. Not reporting trackable income. If you’re an independent contractor, any company that paid you more than $600 in 2016 must send you and the IRS a “Form 1099” reporting your total income. Thus, the IRS knows how much you’ve earned. They’ve got your number, so report it.
3. Deducting startup expenses. You’re getting ready to launch your new company – buying computers, furniture, hiring lawyers, traveling to meet prospective partners. You can deduct all that, right? Wrong. Startup expenses are treated differently than other business expenses. You can only deduct $5000 of startup expenses incurred before the business starts. All expenses over that amount must be depreciated over 180 months. Bummer.
4. Going crazy with deductions. One of the benefits of owning a small business is you can deduct a lot of stuff. While I’m not suggesting this, of course, it’s unlikely the IRS will notice that some of your office supplies were used by your kids as school supplies. But trying to deduct all the costs of that week-long family trip to Hawaii because you met with one potential customer for an hour? Not so fast. Travel, entertainment, and meal expenses are the ones most likely to be scrutinized.
5. Having a hobby business. You love photography and every year, you buy thousands of dollars in camera equipment and take photography classes and trips to improve your skills. But just because you make a few hundred dollars taking photos for a handful of weddings every year doesn’t mean you can write off all your expenses. The IRS is skeptical of businesses that look like hobbies. If you don’t make a profit three years out of five, the IRS will need you to show you’re really working at making a profit and have a reasonable expectation of doing so.
6. Taking the home office deduction. The IRS allows you to deduct the expenses of using a portion of your home as your primary office or workspace, and they’ve actually made figuring out the deduction fairly easy. But a home office deduction is allowed only if you use that space exclusively and regularly for your work. In other words, if every day you use your guest room as your office but once a year your mother-in-law stays in it when she visits the grandkids, you no longer qualify for the home office deduction.
If everyone in America paid all the taxes properly owed, we could wipe out the national debt. And a whole lot fewer small business owners would be in trouble.
Copyright, Rhonda Abrams, 2017
This article originally ran in USA Today on April 4, 2017