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6 Tax Problems To Avoid This Season
January 26, 2020
6 Tax Problems To Not Fall Victim Of This Tax Season

6 Tax Problems To Avoid This Season

Tax season is never a fun time. Business owners must spend time preparing their taxes, which takes them away from managing their businesses. Worse, several tax problems will cause headaches for them when the tax authorities discover discrepancies.

Tax Problems Are Common

Taxes are complicated enough for individuals, but even more so for business owners. There are too many rules for anyone to keep up with them. Business owners can’t afford to spend the time needed to learn all the rules.

These complications cause people to do the wrong things on their taxes. Some people don’t want to deal with the problems, so they make guesses. This tactic may work for a while, but the IRS eventually learns of the mistakes. 

Penalties are steep, and business owners can find themselves paying interest and back taxes. This could cause tax debt problems. Learning the mistakes can help you avoid the problems and keep the IRS away.

Tax professionals are trained to recognize problems. Some business owners feel these professionals charge too much money. However, the amount they charge will be small compared to an audit by the IRS.  Some business owners may be cleared during an audit, but there’s no guarantee.

Using a tax professional who advocates on your behalf goes a long way in managing any audits that arise. It’s even possible that the IRS will bypass companies that use qualified professionals.

Learning about the most common tax problems can help you avoid them. If you decide to skip using a tax professional, avoiding the tax problems may help reduce the risk of an audit.

Six Tax Problems To Avoid

The government wants its tax revenues, and it empowers tax authorities to get it. These authorities search for discrepancies in taxes and will audit any business owners or individuals when they find them.

Software is helping tax authorities to discover problems quicker. The problems listed in this article are by no means extensive. However, knowing them can help you lower your risk of an audit.

The information provided for the following tax problems can help you understand their impact and why you should avoid them.

1. Tax Avoidance and Tax Evasion: Know the Difference

Are you aware of the differences between tax avoidance and tax evasion? They seem like they should be similar, but are quite different. 

Tax avoidance is a legitimate means to keep your taxes as low as possible. When you find deductions you’re entitled to, you won’t have to pay as much tax due to them. You effectively avoided the tax, and it’s entirely legal.

Conversely, tax evasion will likely wind you up in jail. When tax authorities learn that you evaded paying taxes, they’ll start the process to get you to pay the full amount of unpaid taxes. If the offense is blatant, they may have you arrested and brought up on charges.

Tax evasion can also occur if you try to hide information from the IRS or other tax authorities. For instance, if you don’t report large sums of income, this can be used against you.

 Tax Avoidance and Tax Evasion: Know the Difference

2. Over-Reporting Business Expenses

Business owners have some leeway in what they consider business expenses. When companies report expenses, this helps to offset the income they declare that is subject to tax. It’s natural for business owners to want to enhance this number.

The allocation of expenses is somewhat subjective. However, some business owners take it too far and inflate the costs. Other tricks are to expense items that wouldn’t be legitimate business expenses.

It may be acceptable to use terms like miscellaneous for your business expense labels. However, if you have too many of these, it could raise red flags.

The method of accounting can cause problems. Companies using accrual accounting must match expenses to revenues. Some business owners try to report expenses earlier than they should. Luckily, most small business owners are permitted to use cash accounting, which is simpler.

3. Under-Reporting Business Income

The more income a company reports, the more taxes it will have to pay. Therefore, it’s tempting for companies to under-report business income. 

In this age of electronic payments, it’s becoming more difficult for businesses to hide income. When payments were made in cash, it was easier to work out deals with customers to keep income down. 

The customers could find ways to shift the payments on their books. Companies would reward customers willing to do this with discounts or incentives. Today, though, many transactions are made through payment processors, such as PayPal. This provides an electronic audit trail of transactions.

It’s possible to forget to report a few small income items. This is usually an oversight and may not even appear on the radar of the IRS. However, the tax authorities may not look favorably at a history of these small mistakes.

4. Lifestyle Creep and Tax Fraud

If you aren’t familiar with the term lifestyle creep, it refers to people who have increased their discretionary income. They feel entitled to purchase nonessential items. It’s also a concept that can get them into trouble with tax authorities.

People get caught up in living a heightened status and start to show off. They continue buying luxury items to give the appearance of wealth and entitlement. However, when it is tax season, they risk being taxed at a higher bracket. This causes them to try and shelter their income and purchases.

Business owners fall into the trap by purchasing expensive items to show off to clients. They buy expensive cars to take clients out to lunch, or purchase paintings and other items that most would find extravagant. In most cases, this behavior alerts the tax authorities to problems.

5. Failing To Report Employee And Sales Taxes

Do you pay any employees under-the-table or off-the-books? It’s not easy for the IRS to detect this. However, employees get sloppy and cause the IRS to question information on their tax returns. When this happens, the employees may be forced to report your business as their source of income.

If your business gets caught, you can be responsible for penalties and back taxes. It’s also considered fraud, and it could lead to criminal processing.

Sales tax is another tricky area for business owners. It’s more complicated with selling on the internet. The government has been trying to define jurisdictions in ways that online sellers can be held liable for taxes due. 

For instance, many sellers use Amazon for product fulfillment. Amazon has warehouses in many states. California has recently gone after several online sellers for back sales taxes. Their reason is that the products may have been shipped from Amazon warehouses located in California.

6. More Penalties And Frauds To Avoid

The home office deduction is often a red flag for tax authorities. People working from home in a designated office space, often over-inflate the value they apply to their home office. Some tax advisors suggest bypassing this deduction as it practically invites IRS tax problems.

To understand the problem, think about how much heating oil a small office uses? The business owner cannot deduct the entire heating bill. When you make lunch for yourself, can you write off the kitchen utensils and appliances? Are you certain that your business needs a brand new television?

Another situation that business owners should avoid is mixing business expenses with personal ones. This problem is more pronounced with corporations, but it can cause issues with sole proprietors, too. 

It is possible to buy something for your business using your personal credit card, but this should be limited to emergencies only. You’ll start to have problems when you buy items for personal use, but expense them to your business.

6 Tax Problems To Not Fall Victim Of This Tax Season Infographic

Our Final Thoughts

The job of tax authorities is to collect taxes on businesses and citizens. It has several tools in its arsenal to collect on those taxes. Some business owners can escape being audited, but it isn’t worth the risk.

When the tax authorities initiate an audit, they have reasons to believe that a problem exists. They have likely already made their case against you. The audit will cause you to lose time, and if they rule against you, you’ll pay penalties and back taxes. Most business owners discover it’s not worth the trouble.

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Frequently Asked Questions

How can business choose tax professionals?

If you decide to use a tax professional, consider choosing a Certified Accounting Professional (CPA). In many states, these specialists are required to accompany you during an audit to represent you. They also sign with their CPA designation on your tax returns which could help avoid audits.

Fora Financial

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.

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Fora Financial is a working capital provider to small business owners nationwide. In addition, the Fora Financial team provides educational information to the small business community through their blog, which covers topics such as business financing, marketing, technology, and much more. If you’d like to see a topic covered on the Fora Financial blog, or want to submit a guest post, please email us at [email protected].