If you’re like most exceptionally busy small-business owners, all the noise building up to tax time—TV commercials, tax documents flooding your mailbox—is proportionate to your sense of dread. Tax Day never comes at a good time, but to paraphrase Benjamin Franklin, “Nothing is certain but death and taxes.” So in the first installment of our two-part tax series, here are four small-business tax tips to make preparing your return more palatable.
1. Business or Hobby? Many small-business owners worry about the ramifications of repeatedly showing a loss. That doesn’t mean you should avoid reporting justifiable expenses. “You should never downplay your situation just to look like you’re showing more of a profit,” says Lead Tax Analyst at The Tax Institute at H&R Block, Lindsey Buchholz. “Always prepare a return that accurately reflects your income and expenses for the year. People get nervous about the safe-harbor rule—which lets businesses remain classified as a business—because they think, ‘If I have a loss for more than three years, I’m automatically going to be reclassified as a hobby.’ That’s not necessarily the case.”
There are a handful of factors the IRS uses to determine if an entrepreneur is running a legitimate business. The big indication: motivation to make a profit. “If you’re running your company like a business, maintaining your records like a business, spend most of your time on it, make most of your money from it, and you’re taking advice from professionals that can ensure that you’re successful, those things will weigh in your favor,” Buchholz says.
2. S Corp or C Corp? If you are classified as a proprietorship, partnership, or LLC: Considering new tax laws, S Corporations or C Corporations are worth a look for 2013. “The biggest drawback with C Corps is that they’re subject to double taxation, which means that the corporation is subject to taxation, and the individual is subject to taxation on any dividends that they receive from the corporation,” Buchholz says. “However, corporations also are subject to a lower tax rate at the high end than individuals are now. With the Bush tax cuts put in place in 2001 and 2002, individual tax rates were reduced to top out at 36 percent.”
That changed with the American Tax-Payer Relief Act, which passed in January 2013. “It didn’t prevent all of the tax increases from coming back, so higher-income tax payers could be subjected to the highest rate of 39.6 percent, which is higher than the corporate tax rate,” Buchholz says. “So if you make over $400,000—or $450,000 if you’re married, filing jointly—it could benefit you to flip to a C Corp. In that case, you’d be subject to a lower tax rate than if you remained an S and it goes through on your individual return.”
Read more in Forbes’ C or S Corporation article , and check out The Money Alert’s four-classification comparison chart.
3. Organization: Dig Out of Your Hole. Some business owners maintain pristine, color-coded files and religiously track cash flow, and others have a pile of papers sitting on top of a bursting file cabinet.
“The biggest trap for many small-business owners is that they’re so busy, they leave things until the last minute,” Buchholz says. “If they get all their invoices together, know all the expenses they’ve had, and set it up in a way that’s easy to go through and understand, it’ll make filing much easier down the road.”
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“It could be as something as easy as Excel where you’re setting up a tab every month and mapping out income and expenses,” Buchholz says. “For receipts and corresponding documentation, set aside a file folder for each month, separate out receipts for expenses and income, and net it all together.”
4. Many Happy Returns. Buchholz suggests that small-business owners with investment income and a higher taxable income regularly take a bird’s eye view of their business.
“If you’re in that higher-income realm, look at what you are earning from your business and where you’re putting that money and sit down with a financial advisor to figure out ways that you can reduce the amount that’s flowing back as taxable income,” Buchholz says. “Also, look at where you’ve been over the past few years and compare it—if you continue growing at that rate—to where you could be in the next few years. It would be great to know where your money’s going for 2013 and future years.”
Learn more about the extended 179 deduction, health-care tax credit, estimated payments, and retirement contributions.