The Ins and Outs of Tax Laws

The government is more focused on the practices of small business, according to the Internal Revenue Service, and there are more tax laws and regulations that small-business owners need to know. Not all of them are painful, either. Some might actually allow you to put more cash into your business.

The best advice for small-business owners is to be honest because the IRS uncovers a lot in an audit. “The IRS has access to all your accounts: cash, credit and your assets,” says Linda Horn, master financial planner and CEO at Capital Concepts, a Cincinnati-based financial planning company. “They can do a lifestyle audit and see that some things don’t add up.”

As you do your taxes, understand the most critical developments that could have an effect on your business in 2008.

Audits are increasing. The number of overall business audits increased to more than by 7,000 in 2007. Small businesses set up as ‘S corporations’ received nearly 17,700 audits in 2007, compared to less than 14,000 in 2006. Small businesses set up as partnerships have seen audits increase to nearly 12,200 in 2007, up from less than 9,800 in 2006.

Small businesses are vulnerable to audits because their accounting procedures might not be as firmly grounded as larger ones. “The IRS has improved auditing techniques to find unreported income and over-reported expenditures,” says George Paulsen, a partner with the San Francisco-based CPA firm Hood and Strong LLP, and a member of the California State Society of CPAs tax committee. “They are increasing scrutiny and hiring and training more auditors, and they are focusing more on small businesses.”

Bad news at the pump means good news on tax returns. You’re likely getting hit hard with fuel costs for your crew’s trucks. But using a car, van, pickup or panel truck for business now allows for a deduction of 48.5 cents per mile. “Make sure you have a good mileage log, though,” Horn says. “They [the IRS] want solid records for your miles, or they will disallow the deduction.” The mileage increases to 50.5 cents a mile in 2008, Horn says.

Buy now. Deduct now. One of the biggest changes in the tax code: Small businesses can expense certain new purchases all at once. “This is a great benefit for small-business owners,” says Bill Rys, tax counsel for the National Federation of Independent Business. “Instead of deducting the cost of a purchase over a number of years, the business can generally deduct the entire cost of the property in the year it is purchased. In addition, this simplifies the tax filing since the business owner does not have to consider depreciation schedules and the value of the property over time.”

Late fees can be costly. In addition to avoiding an audit, filing on time can help contract-shop owners avoid late fees. For a small business facing a cash squeeze, fees could crush future prospects. “If you owe tax and don’t file on time, the total late-filing penalty is now usually 4.5 percent of the tax owed for each month or part of a month, that your return is late, for up to five months,” says Susan Wilson Solovic, CEO of SBTV.com, the Small Business Television Networks. “If your return is over 60 days late, the minimum penalty for late filing is the smaller of $100, or 100 percent of the tax owed. Most likely, you can borrow the money you need to pay your tax at a lower effective rate than the combined IRS interest and penalty rate.”

Classify workers appropriately. If you classify your employees as independent contractors, you don’t have to withhold federal income and payroll taxes. Many small-business owners get in trouble here by erring on such classifications, resulting in back-taxes owed and significant penalties.

The IRS is now issuing forms for individuals who have done jobs for businesses that can trigger a red flag when it comes to failing to properly classify these individuals as employees. “Also, the IRS and 29 states recently announced a program to participate in side-by-side examinations of businesses in order to discover worker misclassifications,” Rys says. “It’s important that owners consult with their tax professionals to make sure they’re making proper classifications, especially with all the heightened scrutiny this year.”