06/30/2023 in Accountant

Common Tax Mistakes for New Business Owners: Cautionary Guidelines to Avoid Costly Errors

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New business owners often fall into a common misconception that owning a business grants them the freedom to deduct personal expenses on their tax returns, which were previously not deductible. While there may be some gray areas regarding certain scenarios such as business-owned autos or meals involving both spouses working in the business, it is advisable to avoid risky tax positions that are unlikely to hold up under closer scrutiny. The following list outlines activities that should be either entirely avoided or approached with caution:

Business Credit Card for Personal Expenses

It is important to note that there are no tax regulations prohibiting business owners from using a business credit card for personal expenditures, as long as those expenses are not claimed as deductions on the tax return. While using a single credit card may seem convenient and could even allow for earning credit card points by combining business and personal purchases, it is generally unwise to mix business and personal activities. From a tax perspective, this practice can lead to complications. In small businesses particularly, the absence of established processes or personnel to differentiate personal and business expenses increases the likelihood of deducting personal expenses.

Full Deduction of Automobile Expenses in Office-based Businesses

For owners of office-based businesses where business-related travel is minimal, deducting the entire cost of the car for business purposes is not permitted. Instead, it is necessary to maintain records of business and personal use and only deduct the portion relevant to business activities. Furthermore, commuting from your home to the office is considered personal mileage and is not deductible. Unless the car is used for business purposes for at least 50% of the time, the recordkeeping does not justify the deduction. In such cases, it is more beneficial to have the business reimburse you for business mileage at the IRS standard mileage rate. It is crucial to maintain accurate documentation of business travel, including dates, business purpose, and mileage.

Employment of Children and Reasonable Compensation

While there are no specific rules against hiring your children in your business, it is recommended to do so under certain conditions: (1) Your child must genuinely provide services to the business, and (2) you should pay them a reasonable amount for their services. If you would not pay a non-family member the same wage for equivalent services, it is likely that the amount you are paying your child is not reasonable.

Misuse of the “Augusta Rule”

The “Augusta rule” allows taxpayers to rent out their residences for up to 15 days without reporting that rental income on their personal tax returns. Business owners often run into trouble with this rule when the business pays rents to the owner without actually utilizing the property, or when the rent paid exceeds the market rate. Utilizing your home for staff meetings or holiday gatherings can be a valid use of the Augusta rule. However, it is essential to understand that this rule is not an IRS loophole or a means to evade taxes – the rental deduction must reflect a genuine transaction between the business and its owner.

These examples represent only a few situations where caution is advised, and there are many others to consider. The key takeaway is that, in most cases, business ownership does not change the nature of an expense as either business or personal. Common sense should guide you in making the correct decisions. When uncertainty arises, it is advisable to consult with a tax advisor before taking any action.