Guest Blog Provided By: Cassandra Green
Throughout my 23 years of helping my tax clients, I have heard the same tax “myths” over and over. Unfortunately, by believing these falsehoods, small business owners are throwing away money and taking risks they shouldn’t take! Of course, there are more myths than just these five, but these seem to be the most common.
Myth #1: If I claim all my business deductions or home office, I’m sure to get audited
The volumes upon volumes of tax code are written to let us know what can be deducted and what can’t. The IRS doesn’t conduct audits because they enjoy them (although some may wonder).
One purpose of an audit is to find deductions that aren’t allowed and throw them out, resulting in more taxes owed. (The other is finding income you didn’t report.)
If they audit you for something they have already given you the go ahead to claim, what are they hoping to find? What would be the point?
The more legitimate deductions you claim, the less tax you pay. That means more profit from your business and more money in your pocket!
There is one way to get the IRS’s audit antenna up and that’s claiming unreasonable expenses. The tax code says that expenses need to be “ordinary and necessary”. Anything you feel would help your business, is a deductible expense unless it’s totally off the wall.
It’s actually hard to come up with an example, but here goes… Let’s say you feel it’s a good business decision to rent a Porsche every day to park outside of your pizza parlor to draw in customers that have more money to spend.
The IRS might not consider that an “ordinary and necessary” cost of running a pizza parlor (nor would most sane people).
That’s not to say they are going to throw out deductions that you thought were a good idea at the time, just because they didn’t work out the way you hoped.
Relative amounts are important too. If you’re spending $100,000 in marketing year after year to try to make $10,000 from a craft kiosk at the local Saturday Market, you’re probably going to stand out for an audit.
Myth #2: I don’t have to keep receipts for anything under $75 ($25, $??)
The best practice is to keep all your receipts! I know that may not be the answer you were hoping to hear, but it’s true nonetheless. Here’s my reasoning:
Most people underestimate the amount they are spending on their business. Actually adding up your receipts can be eye-opening.
There’s a sense of peace that comes with having undeniable proof for every item on your tax return.
For any business meals you claim, the IRS wants to see “who, where, when, why and how much”.
The “where, when and how much” are already on the receipt. How easy is it to write the “who and why” on the back of the receipt?
Under the “Cohan Rule” you are allowed to use “other credible evidence” and Publication 463 says you don’t need receipts for expenses under $75. But, you still have the burden of proof and now the IRS has the upper hand. You are at the mercy of the auditor to decide what they will accept as credible proof. What would be easier, showing the auditor the receipt for a case of copy paper, or trying to come up with some other way to ‘prove’ how much paper you must use in a year.
Once you get yourself in the habit, it’s just not that hard to keep your receipts. Ladies, have a special pocket in your purse just for receipts; guys, have a special place in the car or on your dresser for the day’s receipts when you clean out your pockets. From an accountant’s point of view, I would be much more comfortable knowing I could go into an
audit being able to prove every one of my client’s deductions. I just sleep better at night.
Myth #3: I don’t have enough expenses to make it worth claiming anything
You would be truly surprised at just how fast $5 or $10 dollars here and there can add up. The average business person pays 30.3% taxes on their business income (income tax plus self-employment tax).
That means that for every $1 you spend and claim, you’ll save 33 cents on your tax bill… or $30 dollars for every $100… or $303 for every $1,000. Just claiming your mileage alone could save you a couple hundred.
Myth #4: I have all my clients pay me in cash so I don’t have to claim the income
This one will get you in trouble with the IRS big time! The IRS wants to see you claim EVERY penny of income no matter what form of payment you received.
While they might be willing to slap your wrist for forgetting a payment or two, if you don’t claim income on purpose, they consider that fraud. Trust me, you don’t want to go there! For starters, you can be slapped with a 75% tax penalty.
Criminal charges can also be filed. On top of all that, if they can prove fraud, the statute of limitations can disappear, which means they can audit previous years as far back as they like (instead of just 3 years after you file).
Please keep in mind that there’s a HUGE difference between negligence and fraud. If you’re negligent, you’ll just have some extra taxes and penalties to pay.
If you forgot some income or misunderstood some deductions, that’s very different than purposely hiding income or making up deductions. There are so many ways to reduce your taxable income with LEGAL deductions.
It pays to do your research on what’s deductible or hire a good tax preparer. By all means, DON’T be afraid to take every legitimate deduction you have the right to take!
Myth #5: I know approximately what my business expense are, so I just make an educated guess on my return
This comes back to the receipt issue in “Myth 2”. Telling an auditor you ‘guessed’ is a really BAD idea, plus you just made the auditor’s day!
If you don’t have proof of some sort, the expense can be thrown out. Plus, if the auditor knows you guessed on one item, they may suddenly want you to prove every single entry on your return knowing they can find even more things to throw out.
The other issue is if you’ve estimated and used very rounded numbers on your return, you may get chosen for an audit based strictly on that. If your Schedule C shows you spent $300 on supplies, $1,500 on the cell phone and $800 on advertising, the IRS has a pretty good idea that you haven’t kept your receipts and an audit would result in plenty of extra revenue for them.
Cassandra Green, EA ABA, has been working in the financial and business fields for 23 years. An Accredited Business Accountant and an Enrolled Agent, she enjoys helping small business owners and sharing in their excitement about the future of their companies. Through her site BasicBusinessKnowHow.com, she offers step-by-step guidance to starting, running and growing your own business.