So much is involved in starting your own business — from choosing a name to building a business plan and filing the official paperwork to doing what you need to do to promote and move your business forward. You are already the proud wearer of many hats, and that may include also being the doer of your own taxes. But handling taxes also means interacting with the IRS, and that can seem like the beginning of a scary story.
No one likes dealing with taxes. The founding fathers were so disturbed by taxation that they opted to caffeinate the Boston Harbor instead of paying up. Part of the negative connotation with taxes has to do with the IRS. Sadly, the Internal Revenue Service is often imagined somewhere on the villain scale between Mr. Smith in “The Matrix” and Maleficent from “Sleeping Beauty.” The trick to keeping the dreaded audit at bay is to ensure that your business and you are adhering to IRS business guidelines.
Numbers, Numbers, Numbers
The first (and main) step for keeping your business in the good graces of the IRS is to pay attention to your numbers. As a small business owner, you really cannot be too careful about checking and double checking your books.
One of the top reasons that small businesses are audited is simply because the numbers on the tax returns are not correct. Most of the time, there is no occurrence of wrongdoing, but rather, the business owner has not been careful in his/her record keeping.
If you work for a person/company as an independent contractor and receive a 1099 form, your income total needs to match what the client has listed. Same goes if the situation is reversed and you are the client who has hired contractors — all of your bottom lines need to add up.
Record This and Write Off That
The next few crucial steps in remaining compliant with the IRS have to do with keeping accurate records and knowing what to expense. Do not ever assume that any expense related to your business is too insignificant to not document. Additionally, be very careful with the expenses you attribute to your company.
Types of records to keep for your business:
- Gross receipts — provide evidence of any money that comes into your business. If a buyer wants to pay cash, make sure that you can track those payments.
- Purchases — anything you buy and resell for a profit
- Expenses — if it is something that is used for your business, keep the receipt or documentation
- Assets — not just real estate, but also vehicles, furniture, and electronic equipment qualify
Part of keeping accurate records for your business is knowing how to classify purchases from expenses and assets. This will be especially helpful when filing your taxes. Every expense and deduction listed on the tax return must have proof to back it up.
Another way to keep yourself away from the Audit Zone is to only deduct what you actually spend on your business. The extra bedroom that is sometimes your office, but also your sewing room and yoga studio probably will not count. If you purchase a Keurig machine for your business, then it should mostly be used for the business.
Tax laws give some breaks to businesses by allowing certain deductions to offset the taxes that the business owner has to pay. But too many deductions can be a red flag to the IRS. The best bet is to keep your records as accurate as possible and check with the IRS or a tax professional for additional help.
Among the fine lines that business owners walk is how they classify their workers — either independent contractors or permanent employees. The primary difference between the contractor versus the employee may appear to be a tax and benefits issue, but there is more to it than just taxes.
The most obvious difference is that employers pay taxes on employees but not independent contractors. There are some business owners who may be reticent to hire “employees” because of the taxes; classifying a worker as an independent contractor saves the business money. Other employers are just naive in how the IRS determines a worker’s classification.
The legal system uses a series of “factors” known as the Economic Realities Test to determine if a worker should be considered an employee or an independent contractor.
Employees versus Independent Contractors are evaluated based on the following factors:
- The degree of control that the employer exhibits over the worker
- The permanent status of the worker
- The necessity of the worker’s role to the business
- The worker’s skill and initiative level
- The level of independent business judgment by the worker
If your independent contractor’s work is integral to the ongoing function of your business and/or does not have control over his/her schedule and pace of work, then you have likely misclassified that worker. Even if the worker does not complain, the IRS will not be okay with your business not paying the proper amount of taxes. This seemingly minor mistake can be quite costly, from IRS fines to potential lawsuits.
Keeping Compliance a Priority
Unlike the horror stories you may have read or heard about regarding the IRS and audits, your tale does not have to be a tragedy if you make the “crossing and dotting” as much a priority as all the other parts of your business. Having an idea of what kind of taxes you need to pay when starting the business is also important.
If you have any concerns about whether you might miss something when checking your records and doing your taxes, you may consider using a professional service like 1-800-Accountants to handle all of the tedious tax issues for you.