There are two things in life you don’t want to watch closely as they’re made: The first is sausages, the second is tax laws. While death and taxes are inevitable, death doesn’t get worse every time Congress meets. The constant push-pull of special interests, partisan and “pork barrel” politics left us with an income tax system that is convoluted and overly complex.
The system has one saving grace: It’s semi-voluntary. For example, everyone knows that if you own a home, you may deduct the property taxes and mortgage interest. But you are not required to. You could file form 1040A and forego deductions and “volunteer” to pay more taxes.
There are a great number of tax-saving opportunities available to small business owners like landscape contractors. Sad to say, many of these opportunities are not well known and are often ignored even by tax planners, CPAs and attorneys. By not using them, you will have “volunteered” to pay more taxes.
Let’s get one thing out in the open at the get-go: Everything this article covers is legal, audit-tested and rooted well within the IRC (Internal Revenue Code.) So let’s get started so you can keep more of that hard-earned money from your landscape business.
There are plenty of business tax savings in the system without resorting to illegal strategies that can come back to bite you. Stay away from tax evasion schemes such as foreign trusts, secret offshore bank accounts, claiming your house as a “church,” and other shady deals sold on the Internet.
Here are a few legitimate strategies you can implement now.
Rent part of your home to your business. Many business owners use part of their homes for business, second office, storage, etc., and yet those expenses are not deducted. Determine the portion of your home that is used for business and rent it to your corporation or LLC. Rent should be reasonable and average for your area. You must report the income on Schedule E of your personal tax return (1040) but you will apply a percentage of deductions against that income such as utilities, home insurance and maintenance, depreciation, etc. that you cannot use otherwise.
Don’t fear the home office deduction. If you operate as a sole proprietor, you cannot rent part of your home to yourself. However, you can use the home office deduction. A court ruling in the late 1980s resulted in that deduction being outlawed and denied to many businesses. Legislation two years later overturned this ruling and restored the deduction. However, many accountants to this day fear using this. Don’t listen to them. Home office deductions are legitimate and allowed by the IRC. As in all deductions, be sure to keep documentation to back it up.
Don’t neglect business use of your automobile. Simply because you don’t use your car often in your business, it doesn’t mean you shouldn’t deduct the amount that you do use. Keep a log of your business mileage, reimburse yourself by using the IRS mileage rate and deduct it on your business tax return. Do not include commute to and from your business, and make sure to document the business reason for auto usage.
Make your spouse part owner. A recent tax court ruling held that any money paid to sole shareholders of “S” corporations from the business must be taken as payroll. That’s because “S” distributions are not subject to payroll taxes and the IRS wants those taxes paid. The tax court backed it up by stating that a single shareholder-owner is rendering service to the corporation. By having a spouse part owner, you no longer have a sole shareholder and the spouse may receive distributions without payroll taxes. Caution: Be certain you have a good marital situation because your spouse will now own part of the business.
Consider LLC “Disregarded Entity Status.” Bad at record keeping? If you are a single member LLC owner, the IRS allows your status to be “disregarded’ for income tax purposes. You file a Schedule C (self employment) just like a sole proprietor, yet you are protected from liability. The advantage is simplification of record keeping. You can take money out of your business anytime, you can co-mingle money, avoid filing as a corporation and generally make business life easier. Caution: You must still document income and expenses and retain documentation to back it up.
Set up a retirement plan. Since it comes off the top, this will save 27.5 percent and 7.5 percent in the average brackets. Sure, you can’t spend it until you retire, but so what? You’re going to get older and need money for retirement; where will it come from if you don’t accumulate it? Caution: If you have employees you must contribute equally to their retirement plans. Consult with a pro for the details.
These are only a few business ideas. There are tons more in the IRC, so be proactive. Work with your accountant to develop safe, tax-saving strategies. But just as important as knowing how to take full advantage of tax-savings is how small business owners can audit-proof their tax returns.
There are differing degrees and levels of audits, yet they all have one thing in common: They are triggered by what people put in their business tax returns.
The IRS has something called Discriminate Function programmed into their computers. When the numbers on a return fall under certain criteria, the return is flagged for manual review. An agent will determine if that return should be audited.
Although the specific criteria are secret, we know that certain things will trigger audits: Ratios and unusually high deductions, and certain tax shelters and strategies. You should claim these deductions if you have incurred them, but retain documented proof such as receipts and cancelled checks.
Here are some audit triggers on corporate, partnership and other business returns that you can easily avoid.
- Round numbers. Deductions rounded off to the nearest hundred or thousand will lead the IRS to think the taxpayer is guessing rather then determining from accurate records. You didn’t spend $10,000 on advertising, it was $9,487.56.
- Answer all questions and boxes. Blank doesn’t mean “no.” Questions on various returns involving trusts, partnerships, foreign accounts, accounting methods, etc. should be answered. Don’t leave them blank.
- Categorize deductions. Large deductions headed “Miscellaneous” or with vague wording may lead the IRS to decide you’re not keeping good records, can’t prove the deduction, or are hiding false deductions within that general category.
- Distributions. Be careful about distributions on Schedule K of your corporation tax returns (1120 or 1120S) If you are a sole shareholder of a “sub S,” a recent tax court ruling holds that you may not take distributions, it must be structured as payroll.
If there are multiple owners, the amount of distributions on Schedule K must always be less than officers’ compensation on page one of your 1120S.
If your landscape company is a “C” corporation then most distributions will be considered a dividend and subject to double taxation.
Document net operating loss (NOL) carefully. If you have a year in which you sustain large losses in your landscape business, you may go back three years by filing for NOL and receive refunds of taxes paid previously.
NOLs are scrutinized very carefully and audited most of the time, so be warned. Be sure your documentation is near perfect before filing.
Skewed ratios losses. You can’t operate a landscape business for a decade and lose money each year.
A landscape contractor may have gross sales of $200,000 in one year and expenses of $190,000. A couple of years later the gross income rises to $600,000. Will the expenses also rise to $570,000? Usually not.
These are actual cases that were audited. As you may guess the results weren’t very good.
In recent years IRS audits have dropped for staffing reasons, but are now increasing.
Businesses and average-to-higher income individuals have greater chances for audits in coming years. This is just a small sample of the savings possible with good planning. There’s not enough room to list them all, but they’re out there waiting for you – just like the IRS. LL