The 7 Most Expensive Errors CPAs Make

on Taxes for Small Business Owners

7. Not using the best depreciation method for long-term savings

Sure, taking a Section 179 deduction (purchase of assets written off as an expense in the year of purchase) may seem like an easy way to reduce your taxable income this year. But if you purchase a lot of assets in early years of your business or in expanding years, you may find yourself in a much higher bracket next year or a few years down the road. If so, you'll have fewer deductions in the future years. So you may be saving taxes at the 15% rate this year, but you would be better off saving taxes when you are suddenly in the 35% bracket. Also, if you are going to get rid of certain assets in a short time frame, you may get hit with a recapture tax when you sell or trade in the asset you have completely written off. So your big deduction in one year ends up adding to your income when you least want it.

6. Failure to take legitimate Office-In-Home deduction

A lot of accountants still tell their clients to avoid the Office In Home deduction entirely. Many years back, the IRS focused on home offices. But not anymore. The IRS lost several cases, and has backed off on auditing legitimate, reasonable home offices. In addition the IRS has actually made it easier to take depreciation on your home office because when you sell your home, you no longer have to allocate a portion of the profit to the business portion of the house. You still have depreciation “recapture” which has a maximum tax rate of 25%, but never have to pay back the savings on the self-employment (15.3%) tax you saved.

If you meet the basic tests of an allowable home office deduction (see below), consider taking this deduction!

A. The home office must be for the convenience of the employer OR there must be no other place to conduct business OR it must be the place where you regularly meet with clients and prospects.

B. The home office must be for the exclusive and regular use of business or for the storage of business goods or inventory. The home office may be a whole room, garage, or just a portion of those areas.

5. Incorrectly assuming that the S-Corporation format is the best for your business

Again, old habits die slowly. In the ever-evolving world of taxes, the one thing that is for sure is change. While S-Corps used to be one of the most efficient entities for small business, it probably has taken a back seat to Limited Liability Companies or LLCs. In fact, due to some abuses, the IRS has been taking a closer look at many S-Corporations in recent years. One of the most common abuses (intentional or otherwise) of S-Corps is that the owner typically does not claim to draw a salary, thereby avoiding self-employment taxes (Social Security and Medicare taxes). The IRS has taken a hard stance on S-Corp owners who don't pay themselves a salary. Likewise, it's also possible to subject oneself to too much self-employment tax (see Item 4). A high-earner running an S-Corp also may be paying too much in total income tax versus some other entity options. It's a good idea to periodically review your entity with your tax professional.

4. Causing too much income to be subject to Self-Employment Taxes

Sometimes worse than not paying enough S/E tax is paying too much. By arranging your business affairs in the best possible way, it's quite easy to save thousands and even tens-of-thousands of dollars annually in S/E taxes. Will you ever get the benefit of paying in all those extra dollars? High earners and young taxpayers may not ever see the benefits they are paying for!

3. Not carrying losses and other credits from prior years

It's amazing to us how many tax returns we see where the taxpayer's accountant didn't require the client to give him the prior tax returns. There's so much information on a tax return and more often than not, there's information carrying from one year to the next. In the late 1990's and early 2000's, plenty of folks lost tons of money on investments and cashed out. With a $3,000 annual loss limit, it's easy to forget how much of that $50,000 or $100,000 loss you have left carrying into 2006, seven years after the loss. But believe it or not, that loss may be very important in saving big bucks in some future year due to a huge capital gain you may have. And who wants to pay tax on that gain if you don't have to?

Perhaps you had to pay the Alternate Minimum Tax (AMT) one or more years. Most people don't even know what it is, let alone do they remember if they were subject to the AMT. Even if you didn't pay it last year, you may have a credit that can be used this or next year that was caused by paying the AMT. Without checking prior tax returns, there's no way to know if you are eligible for the AMT credit.

2. Not creating an overall Tax Savings Plan

Even though we can't predict with absolute certainty all of the tax laws affecting us into the future, we know that, for the most part, tax rules stay the same year after year. Without a plan looking into the future, most CPAs are stuck reporting nothing but history on your tax return. You did it, so now he reports it. But there are hundreds of ways for you to legally arrange your business affairs so you can pay less tax. But most of these arrangements require you to think ahead.

For example, if you are a sole-proprietor and know that your business is going to be low on cash to your pay your own salary, why would you want to borrow money to pay your salary? Sure it looks good when you go to the bank to get a loan, but did you realize that you are borrowing money, paying interest, and then paying up to 45% or more to the government for the privilege of getting that paycheck? And if you borrow from yourself did you know that are subject to getting taxed on the interest you are supposed to be paying yourself?

1. Not asking enough (or the right) Questions.

This is the one that stumps us day in and day out. Many deductions and savings we find for clients are the direct result of just asking lots of questions and probing deeper. We're not talking about wasting hours, as most of our interviews are only 15 minutes or so, but we've found that many CPAs don't even do that. They take your papers and review them and put the data on a tax return and hand you the result and the bill.

A thorough and proper interview is what your doctor does in order to find the root of your problem. Asking questions is just as important, if not more important, than the physical exam. With taxes, it should be the same way. Good questions yield better answers.

When was the last time your accountant gave you a forward-looking tax-savings idea?

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