Taxes are a fact of life, even for business. But while everyone focuses attention on how businesses pay little to no income tax, there are other areas where taxes can represent a minefield for business, no matter how big or small. Here’s three quick ways that taxes can cause your business headaches.
- Buying things without paying sales tax. Now, you might think that this is the sole province of the Ebay buyer, but if you did, you’d be wrong. Large companies get burned by this, too. One popular area for case law here is the purchase of an airplane. Here’s how it happens: Company X buys a plane in the name of Entity Y in State Z, and hangers it in State A (Entity Y’s HQ), where it does little business, and whose tax law is either lax or absent on the topic.
State B, where Company X does business, comes along and assesses use tax. “Use tax?†cries Company X, “we don’t owe use tax…the plane is owned by Entity Y, headquartered in State A, and the plane rarely comes here! Even if we did owe tax, you can only charge us based upon use in your state, not on the full value! Anything else violates the Commerce Clause and interstate business!â€
State B challenges, saying no apportionment is needed and no Commerce Clause violation exists. The two wind up in court. The case law here is pretty extensive, but facts in these cases typically follow the pattern above. Occasionally, Company X has won in lower courts by challenging the assessment under Commerce Clause rules (See), getting the tax lowered to an apportioned amount, but in each case, that’s been overturned upon appeal (and you knew that would happen, right?).
The only solution is to pay SOMEBODY the tax, because the courts have tended to find that where the tax has been paid at purchase, another state cannot come along and tax it again.
- Failing to properly document cash payments. It’s not only the IRS that likes cash-based businesses; states do too. Often, it’s because the business fails to properly collect and remit sales tax (see above), but another good reason is the obvious – underreporting of income.
Whenever cash is involved, a good document trail is important. A comedy club client of mine held ‘open mike’ nights, where a small cash prize was awarded. If the contestant was particularly good, they’d be invited to stick around and perform later in the evening, earning them another payout. Fortunately, the owner was smart enough to copy the winner’s driver’s license, and get their addresses and SSNs, because while most performers earned under $600 (the IRS threshold for issuing a 1099-MISC), the aggregate total for the year was large enough to catch the IRS’ attention in audit. Although the Service initially denied the deduction for such payments, they relented after the client showed them his records. Without the records, he would have been assessed over $20,000.00 in taxes and penalties.
A second scenario involves the short-timer. Every business has had one – the person who shows up to work on Monday, and never again. No call, no e-mail – they just drop off the end of the earth. This is particularly true for small businesses, such as restaurants, but it happens across the board. Often, the business decides that running this person through payroll is a pain, and just cuts them a check, or in the case where the employee actually does give notice, pays them out of the cash drawer. Again, record keeping is important. The IRS will look to deny the deduction unless you can show that the person was 1) real, 2) not related and 3) owed the money. Particularly with small businesses, the IRS looks to checks to individuals and cash payments as attempts by the owners to take cash out of the business tax-free. Sounds odd (particularly where the person being paid has no relationship with or to the owner), but again, I’ve had these discussions with auditors enough to know that that’s their M.O. Besides, if they deny and assess, the burden of proof shifts to you. Keep good records, and save yourself a headache.
- Not doing your homework. Depending on what you do, and where you’re located, you can face a number of different taxes. Trying to start your own business – or run a business – without good tax advice is a recipe for trouble.
For example, picking the wrong entity can mean a bigger tax bill. You might have heard that an LLC is the way to go, but is it? It depends. Where are you doing business? What kind of business? And do you plan on expanding to other states? For example, in California, LLCs are hit with a gross receipts tax that applies no matter the business’ performance, while S Corps pay a flat $800 tax until profits get up around $40,000.00. You’d probably want to know that tidbit before you signed up to be an LLC in California.
A good tax advisor can also warn you of pending changes, such as the proposed FICA tax on S-Corps, or the very real excise tax on tanning salons. Thus, it’s important to do your homework and pick a good tax advisor who will keep you abreast of important changes. As part of your ‘homework’, you should also schedule a time to sit down with your advisor before the end of the year to review your financial position and discuss strategy. More importantly, you should check in with them often throughout the year, not just at year end. Even if an appointment costs you $200.00, it’s better than owing $5,000.00 in March because you weren’t aware of a change in the law. And if your tax advisor is not communicating regularly with you, you need a new advisor.
