November 01, 2016
Plan. Execute. Record. 3 Ways to Make Taxes a Business Owner’s Friend
by John T. Hewitt
I am a businessman who loves taxes, but most of the businesspeople I meet do not share my enthusiasm for the subject. Where I think about taxes every day, they don’t like to think about taxes unless they absolutely must.
I understand independent business owners’ reluctance to deal with taxes. Over the years, I’ve dealt with many who fear the taxman and who try to avoid tax issues at all costs. They’d rather be building their businesses and exciting their customers, they tell me. They don’t want to “waste” time thinking about taxes or they are afraid of making mistakes because the tax code is so complex.
They are right about the complexities of the tax code. That is why it is important for executives to encourage IBOs to consult tax professionals who can assist them with tax planning and tax preparation. Fear of making mistakes leads every year to business owners leaving millions in tax breaks on the table. Internal data from ADP, for example, shows that at least 3,000 federal and state incentives exist for business owners, but about 50 percent of those breaks go unclaimed. In other words, many business owners are paying more in taxes than they should.
For direct selling companies who have IBOs struggling with this, I suggest this: In your annual message to consultants, emphasize the value and importance of proper tax planning. Make it clear to your consultants that taxes—actually tax deductions and tax credits—are available to them to help build their business, and tax breaks can materially affect their business’s bottom line.
IBOs can effectively engage with the tax system. What it requires is a little discipline, some planning, and execution. Of course, assistance from a tax professional who understands the consultant’s business and who has a clear understanding of the tax code and how it applies to a direct selling business is essential, too. That last part truly matters because business expense deductions are among the Top 10 most litigated tax issues. And, when it comes to litigation, the IRS often is victorious. According to the 2015 report by the National Taxpayer Advocate, “business taxpayers had a much lower success rate (against the IRS) compared to individual taxpayers. Individual taxpayers received full or partial relief in approximately 69 percent of cases. Meanwhile, business taxpayers received full or partial relief in only 37 percent of cases.”
That reality should not give corporate executives pause. Instead it should encourage them to impress upon their consultants the importance of bringing in a tax professional to help them pay their taxes when due and anticipate and properly utilize tax deductions and credits.
Here are a few examples of how tax planning can help your consultants.
Consider Potential Tax Breaks in Business Plan
When consultants sit down to contemplate their business and the direction in which they want to take it in the coming year, there’s more to consider than products.
Let’s say for example a consultant has aging equipment that needs to be replaced. Knowing this at the start of the year is good. Incorporating it into the business plan is better. Understanding what tax breaks may be available to make it happen is even better.
For the consultant who needs to replace equipment, Section 179 of the tax code could be of assistance. Section 179 allows a business to write off, within limits, qualifying property placed into service in the tax year. So, that computer could be purchased and the purchase price may be a deduction.
Know What Is Available, Then Execute
A tax professional can introduce consultants to business tax deductions they should consider for their type of business, but I thought it necessary to give a glimpse of some deductions that often apply to direct sellers. When considering business expenses, the IRS requires that they be ordinary and necessary.
The first place to start might be the consultant’s home. If their workspace at home meets IRS requirements they may be able to deduct a percentage of the expenses that benefit the business part of the home, including mortgage interest, real estate taxes, utilities, repair and maintenance of the home, homeowners insurance, depreciation, and rent, if they do not own the home.
Home office deduction. IBOs may want to ask themselves the following questions when considering whether their business is eligible for this deduction:
- Do I use my home office “exclusively and regularly” as my principal place of business?
- Do I use my home office “exclusively and regularly” to meet with customers and fellow consultants?
- Am I in a direct sales position and use my home office or a closet or certain area to store my inventory?
If the answers are yes, the IRS will allow for deduction of the home office area or inventory storage area of a home, and a portion of utilities paid as business expenses.
A good place to consider next is business equipment or property. As I mentioned above, Section 179 allows direct sellers to deduct the cost—up to certain limits—of certain qualifying property as an expense rather than as a capital expenditure. Direct sellers who choose this option might be able to deduct the cost of qualifying property purchased and placed into service in the tax year.
Finally IBOs need to consider the everyday expenses they incur and how they might reduce those expenses by applying tax deductions or credits. Below are a few such deductions:
- Health insurance. The self-employment health insurance deduction is 100 percent of the amount paid for medical and qualified long-term care insurance for the self-employed person and family members, as long as the business has a profit.
- Cash and credit expenses. IBOs shouldn’t overlook expenses that were paid with cash or credit, including telephone and internet expenses, related to the business. These expenses should be accounted for in the business bookkeeping. Credit card interest and processing fees are also deductible. Theft and bad debt. It happens; a customer does not pay for goods. Fortunately, a business owner can write off such things. Interest. If a business owner lends money to the business, the loan should be recorded as a liability with interest expensed. Promissory notes should be on file to cover owner loans to the business. Meals and entertainment. Businesses may deduct up to 50 percent of business-related meals and entertainment expenses, such as entertaining customers at a restaurant or other location. Travel. Travel away from home on business, perhaps to attend a business convention or business meeting, is deductible. Advertising and promotion. Product samples, business cards, signage or even greeting cards to send to customers can be deductible business expenses. Business use of car. The standard mileage rate for 2016 is 54 cents per mile, but given how much traveling a consultant does, he or she may want to include actual expenses, such as gas, licenses, registration, insurance, tires, repairs and more. Keep a mileage log, receipts, toll slips and more.
Keep Good Records or Lose Deductions
As I said, IBOs have many tax deductions and credits available to them. However, without good recordkeeping, they will be unable to access these tax breaks for their business. The item below from the 2015 National Taxpayer Advocate’s report to Congress provides a perfect example of why good records are essential.
The most prevalent issue was the substantiation of claimed trade or business expense deductions. For example, in Garza v. Commissioner, the Tax Court denied a travel expense deduction for failure to substantiate. The taxpayer, a direct sales representative for Time Warner Cable, used his personal vehicle to make service calls and maintained a calendar planner in which he recorded his vehicle’s odometer readings at the beginning and end of each month, sometimes, also including intermediate readings and personal notes. Although the taxpayer’s calendar planner was contemporaneous, it lacked information detailing the amount, date, and business purpose of each use of his vehicle. As a result, the Court denied the taxpayer a deduction for these claimed travel expenses.
A tax professional can help independent business owners establish a plan and structure for keeping business records. Many tax professionals have tax organizers to help individuals stay on track throughout the year. They will encourage consultants not to mix business and personal financial records and to establish a separate business bank account or bank card. One of the first things the IRS will look at in a business audit is bank records, so it’s important not to have muddied waters. Separate accounts will also help during tax time. A tax professional will be able to review the business account and help consultants properly classify expenses and income on their tax return.
Your consultants have a great deal on their minds. One burden they should hand off to the experts is tax preparation. Some of your consultants may reject the idea because of cost, but in the long run, knowing the tax code and how it can positively affect their business may lead to great cost savings.
I know these tips won’t make consultants fall in love with taxes, but, when put in place, they can help your field grow their businesses. So talk with your consultants and encourage them to speak with their tax professional to start building their plan today. It will pay off in the long run.
John T. Hewitt is CEO of Liberty Tax Service, a leading tax preparation franchise with locations in the U.S. and Canada. He is also the author of iCompete: How My Extraordinary Strategy for Winning Can Be Yours.