This year’s tax-filing deadline of April 17 will arrive whether or not your business is ready. What’s at stake? Comstock’s spoke with experts in the Capital Region to learn how your business can avoid tax audit triggers and abide by the rules.
Be On Time — Or File for an Extension
If your business is unable to file its taxes with the Internal Revenue Service by deadline, it’s crucial to say so immediately. Procrastinating is not an option. “It’s incredibly important for filers to file — or extend — on time and pay tax due on time,” says Dawn Rhea, director of Moss Adams, a large accounting firm with an office in Rancho Cordova. “Otherwise this will very likely draw additional scrutiny and assessment of financial penalties to their tax return.
Maybe you have never filed for an extension. Then make this year your maiden voyage. Why? Bottom line: It’s a red flag to file late and fail to give advance notice.
Watch Out for Personal Expenses
“Small business audit triggers are any business expenses that might be viewed by the Internal Revenue Service as being personal in nature,” says Dave Du Val, the chief customer advocacy officer at TaxAudit.com, a Folsom-based firm. “These include excessive mileage, meals, entertainment and travel.”
Firms — especially those with high-volume spending — should keep close tabs of their activities. “Avoiding an audit may not be easy to do for those who have legitimately high expenses,” Du Val says. “However, taxpayers can avoid the assessment of additional taxes and penalties in an audit by keeping contemporaneous records with all of the required information, including the business purpose of the expense and names of business associates or clients involved.”
Classify Workers Appropriately
How employers classify their workers can present problems in today’s gig economy. A gig is temporary wage income for self-employed independent contractor workers. They file W-9 (1099) forms instead of the W-2 forms that company employees use. The distinctions loom large for businesses, according to Dr. Andrey Mikhailitchenko, director of Sacramento State’s Center for Small Business.
“If a small business uses a lot of 1099s, especially 1099-MISC for small amounts, but doesn’t have W-2 employees, it often raises a red flag and causes audits from the state Employment Development Department and federal Internal Revenue Service,” Mikhailitchenko says.
The Tax Cuts and Jobs Act, signed into law this past December by President Trump, contains potential minefields for businesses filing tax returns. “The new section 199A may potentially lead to an increase in employee misclassification, which may trigger more audits in that area,” says Elizabeth Lyon, an assistant professor of accountancy at Sacramento State. “This may become an even more significant area of concern now that new section 199A potentially allows independent contractors a 20 percent tax deduction that is not available to employees, increasing the possible motivation for workers to seek classification as independent contractors.”
Lyon says the IRS has been cracking down on employee misclassification for the past several years. That’s because, “when employees are misclassified as independent contractors, no income taxes are withheld and no employment taxes are paid or withheld,” she says. Therefore, businesses should document the nature of the relationship — for example, why the worker is an independent contractor.
Du Val concurs with Lyon: “It would be safe to say that the IRS will be looking harder at businesses that take advantage of the new change … [but] some business owners who claim the deduction may not qualify for it.” If you are in doubt, inform yourself before filing.
Whether your business is large, small or somewhere in the middle, be diligent when it comes to your record keeping and taxes. Because you never know if your business will — or won’t — be audited. Mikhailitchenko says the firms that the Center for Small Business works with “believe that tax auditing in California is more intensive and aggressive than on the federal level and most of the other states, especially in the small business sector,” he says.
But that’s not actually the case, he says. “In California the chance of getting audited for a small business is approximately the same as for a large one, and related to hobby businesses, mom and pop businesses, and micro-businesses.”