Tax Best Practices for Small Business
There's been widespread media coverage about letters that the Internal Revenue Service has sent to thousands of small business owners. While those letters focus on cash receipts of small businesses, there are other tax issues that could be problematic for small business owners if not addressed appropriately.
Kogod Tax Center at American University's Kogod School of Business in Washington, D.C., compiled the following tax best practices that small business owners can reference to help comply with IRS rules and regulations.
Be sure to consult your tax advisor for guidance specific to your business and unique circumstances, as well as to discuss potential planning opportunities
- Keep good records about who is an "employee" and who is an "independent contractor."
- Keep track of where you may have a "physical presence" (even unknowingly) to properly comply with state rules governing sales tax collection.
- Invest in good tax software accounting systems-those that track your records and regularly provide updates to new IRS rules.
- Hire a tax accountant who has experience in your type of business, whether it's a coffee shop or a construction business (see #13 and #17).
- Keep good records on how much you paid for, and the date you placed in service, all business equipment, business vehicles, etc.
- Don't consider using funds you have withheld for employee payroll taxes (or any taxes, for that matter) as a short-term loan to tide you over during a shortfall in working capital (see #19).
- One of the biggest traps for small business taxpayers is estimated taxes - paying them on time, calculating them correctly, and knowing the safe harbors that can protect you against underpayments. Miscalculating any of these steps can be a major headache, so speak with someone, most likely a tax accountant or enrolled agent, who knows the rules cold.
- If your spouse, child, mother-in-law, or other close relative, works in your business, make sure he/she abides by the same employment rules as your unrelated employees.
- Select a "tax year" for your business that reflects the natural ebb and flow of your business's receipts and disbursements. This way, you won’t get caught in a cash crunch when tax time comes.
- You (or your accountant) should retain all relevant tax records for at least three years, and if your records relate to property and depreciation, keep them until the property is disposed of, plus an additional three years.
- Keep detailed records of how you use your personal or business-owned vehicle for business vs. personal purposes.
- Hire a reputable third-party administrator (such as Fidelity or Vanguard) to manage your 401(k) plan and other tax-favored employee benefits.
- Make sure that you (or your tax accountant) are familiar with the tax rules, including favorable tax credits and deductions that are unique to your business.
- If it becomes necessary for your small business to open a foreign bank account in order to pay vendors or others in another country, make sure you (or your tax accountant) are vigilant in following the new rules on foreign bank accounts, known by the acronym FATCA.
- If your hope is that your business will continue after you die, under the leadership of another family member or designated heir, take steps to protect the business against a forced sale in order to pay inheritance taxes.
- Don't become foolishly emboldened by thinking that the IRS will have to "prove" that you may have done something that doesn't comport with the tax law - the burden of proof is always on you, not the IRS
- Become familiar with the tax rules surrounding starting, running, selling, and shutting down a business. Determine whether you should operate as a partnership, an S corporation, an LLC, or a sole proprietorship. Your tax accountant should be closely familiar with these rules.
- Have a one-on-one conversation with your accountant about the Affordable Care Act.
- If you can't pay the taxes you owe the IRS, or another tax agency, contact your accountant right away. This situation won't get better by ignoring it.
- When someone pays you in cash, it doesn't mean that payment is nontaxable. The IRS has state-of-the-art technology and statistical models based on spending habits and bank accounts to build a case against alleged tax cheats.