In a few months there are going to be a lot of newspaper articles and blogs about IRS red flags. If you have a home-based business, there are some things that could get you in trouble before you even file your tax return.
Here are 5 things you need to avoid right now, and strategies that will help keep you out of trouble.
IRS Audit Red Flag #1: Failing to Comply with IRS Rules for Business Loss
Did you start a business recently? Or maybe have a business that had a downturn, and thus a loss? The keyword here is “loss”. If your business has a loss, then the IRS is going to want to make sure you really have a business.
Otherwise, the IRS could call your venture a hobby, and that means you’re subject to hobby loss rules.
There are 9 Factors that the IRS wants to see, which basically break down into 4 categories:
Category #1: You must run your business in a business-like manner.
Category #2: You must have expertise in the field.
Category #3: You must put in the time & effort.
Category #4: You must have profit.
If you don’t have one of the above, there are some additional tests to pass that prove you’re trying to get there. For example, if you don’t have expertise in the field with your home business (Category #2), you can show that you had previous experience or that you’re working with experienced leaders, mentors or advisors to help you gain the experience you need.
Please go to http://www.usataxaid.com/freebies/ to download your free copy of 9 Steps to Business Quiz.
IRS Audit Red Flag #2: Taking Tax Advice From a Non-Professional
There are some non-practicing tax ‘experts’ who have whole websites devoted to how home-based businesses can save taxes. It’s absolutely true that a home-based business, set up and run correctly, will save taxes.
But, let’s look at this a little further. When I say non-practicing, I mean these guys don’t prepare tax returns for clients. They aren’t CPAs. They aren’t attorneys. They aren’t Enrolled Agents (EAs). They aren’t even licensed tax preparers. In fact, they are BANNED from doing work in California and Oregon. But that doesn’t stop them from putting up a website and becoming self-proclaimed experts and charging for tax advice. That is, they keep doing it until the IRS stops them.
Make no mistake about this. If they cross the line, the IRS will be all over them. The IRS may move slowly, sometimes taking 2 years or more to bring a case against someone like this, but they always do come in and shut the scoundrels down.
If you take their advice and it’s wrong, you can’t sue them for malpractice. That’s because they aren’t practicing to begin with. In other words, they didn’t prepare your tax return. They may give you advice that costs you an audit (and one in guy in particular is doing JUST THAT) or they may give you advice that could cost you penalties, interest and even jail time, but because they didn’t sign your return, you have limited recourse against them.
And to make it even worse, most of these guys will turn you in when the IRS inevitably shuts them down. Yep, that’s right. Because they aren’t CPAs or attorneys there is no confidentiality with your records. In order to reduce, or even eliminate their fines and jail time, many have, in the past, turned over their database with the complete list of names, addresses, emails and phone numbers of everyone who purchased their erroneous tax information. And then the IRS starts auditing everybody on the list.
Trust ONLY licensed professionals: CPAs, EAs and attorneys. Don’t waste your time and reputation chasing tax-saving pipe dreams from people who have nothing at stake for giving your bad advice.
IRS Audit Red Flag #3: Filing a Form 5213 “Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit”
At first glance, you might wonder why on earth I even put that down as something a business owner would do. Filing forms is the job of your CPA, not you!
There is a problem, though, and I want to make sure I’m on record on saying why this is a REALLY BAD idea. Let’s look at both sides of this:
Possible benefit: It puts the IRS on notice that you want them to consider profitable years in allowing losses.
Downside: You just told the IRS that you were taking a loss and asked them to audit you. Until that time, you might have gotten audited or you might not have gotten audited. Now, you’ve raised your hand asked them to audit you.
Worst of all, you just gave the IRS an additional 2 years to audit you in. Normally there is a 3 year statute of limitations for audits. They only have 3 years after the filing date of your return to audit you in. The Form 5213 gives the IRS 5 years to audit you.
Why would you give the IRS such power? And why would anyone who is a tax professional tell you to file it?
And that’s the secret. A true experienced professional is not going to tell you to file the form, or if they do, he or she will carefully review the pros and cons with you first. Anyone who gives advice like this, telling you to blindly file a form that gives up some of your rights and purposely raises a red flag with the IRS, doesn’t have your best interests at heart. Or, they simply don’t understand the consequences and that’s a very dangerous advisor.
IRS Audit Red Flag #4: Being Overly Greedy With Deductions
When you go from being an employee to a business owner, you suddenly have a whole range of deductions that you can take. The rule is that the expense must be ‘ordinary’ and ‘necessary’ to the production of income.
What’s deductible? It depends. What expenses do you have that are really hidden business deductions?
For example, if your business includes doing videos, your expenses will likely include software, video equipment, music, maybe even hair and make-up. If you have branded uniforms, like we do, then you have a deduction for the cost of the clothes as well as laundry services.
If you and your family are working the business together, you have even more expenses. Employ your kids for work they legitimately do in the business. Write off meals that are true business deductions. But, and this is where some people get in trouble, just starting a business doesn’t mean everything is suddenly deductible.
My husband and I work together and that means that we discuss business at almost every meal. But we don’t take a deduction for every meal.
There is a saying that “Pigs get fat, Hogs get slaughtered.” If you have expenses that have some element of pleasure and maybe just a touch of business, you probably shouldn’t report those, at least in the beginning when income is low.
And of course, make sure you have good record-keeping and bookkeeping systems. Without those, you’re toast if the IRS or your home state does select you for business.
IRS Audit Red Flag #5: Messing Up On Payroll
Payroll…it seems like such a simple thing and yet it creates major headaches for many small business owners.
Here are some of the general rules about payroll and things you want to look at before year-end:
- If you have a Sole Proprietorship (Schedule C), your spouse can be employed by the business to qualify for a MERP (medical expense reimbursement plan). The MERP allows the business to take a deduction for all allowable medical expenses right off the net income. But your spouse needs to draw a salary and your business needs to prepare quarterly reports and annual W-2 reports. If you want a MERP with your Schedule C (and who doesn’t!) then make sure you have your spouse employed in your Sole Prop with legitimate payroll before year-end.
- If you have a profitable S Corporation, then the owners must take a reasonable salary. And that has to happen before year-end!
- If you want to fund a pension plan, the amount that will be paid depends on the amount of income that is subject to payroll tax or self-employment tax. That means you need to take a payroll before year-end if you wan a pension.
- If you have a partnership or an LLC that is taxed as a partnership, you don’t need to worry about paying yourself a salary. In fact, if you have a partnership, you aren’t supposed to take a salary. Instead, you take a guaranteed payment. In this case, you need to avoid taking a salary.
There are plenty of reasons to take a payroll from your company, but it can get complicated. Unfortunately, this is also something you need to do before year-end. If you wait until you see your CPA for tax prep on your business income tax return, you’ll be too late.
Are you ready for the TRUTH about your home-based business and taxes? Find out how affordable it can be to hire our services by contacting Richard at 888-592-4769.
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