Research from the Internal Revenue Service (IRS) found small businesses pack a punch in the U.S. economy. Of individual income tax returns filed in 2014 (the last time data was available), 46 million – or one-third of tax returns – reported income from a sole proprietorship, a corporation, partnership, LLC, rents/royalties, or farms. That means one in three individual taxpayers reported business-related income on their tax return.
But as your business grows, taxes become much more complex. You may wonder why I’m writing about taxes, when the deadline has already come and gone. But as your taxes (and you’re your tax prep experiences) are fresh in your mind, there may have been details you forgot or wish you’d done better. When you run a small business, there is always room for improvement, and you don’t want to experience mistakes or oversights, especially when it comes to the IRS.
Did you procastinate?
Sure you could wait until the end of the year to complete the tasks necessary for your taxes, such as tallying business expenses or reviewing financial records. But this will likely bring on more stress for yourself and cause unnecessary mistakes because you’re rushed. To keep your sanity intact, be sure to keep careful records of all business expenses and record them into the accounting system in a timely manner. Business-related expenses like meals, entertainment, and gas mileage should be tracked. It’s even a best practice to keep daily diaries so you’ll know the exact information about each expense and how it related to your business. This information will be critical if you are audited by the IRS later.
You might be thinking that this is easier said than done because of your hectic schedule. As a small business owner, you probably wear a lot of hats in the day-today business. But, keeping daily records take only five to 10 minutes a day. Not to mention, there are now several helpful apps available to make this process simpler, too.
Did you miss someone?
Before you get into the nitty-gritty of your taxes, you need to figure out who you owe taxes to and what jurisdictions cover your business.
Most small businesses owe taxes to a few different authorities, which likely means preparing multiple tax returns. These include federal and state taxes as well as the localities where you might owe taxes for employees. And of course don’t forget property taxes, sales taxes, and taxes related to payroll. It’s important to remember IRS taxes requirements like unemployment. Each state, county, locality and district has its own filing and paying requirements. So it’s common that a small business with three employees could file 10 to 30 tax returns for federal and state agencies.
Your accountant can help determine which jurisdictions you’re accountable to. Since these can often be influenced by your line of business, working with an accountant, who specializes in your industry, is most beneficial.
Were you haunted by ghost assets?
Do you know what a ghost asset is? If you don’t, you’re not alone. Over 70 percent of small business leaders said they either didn’t know what ghost assets were or didn’t know how they impacted their taxes, according to the Small Business Accounting Report. Simply put, a ghost asset is inventory or an asset that “cannot be accounted for because it is physically missing or rendered unusable.”
Related Article: SMALL BUSINESS REPORT, WHAT SMB’S NEED TO KNOW ABOUT TAXES
Ghost assets can be easily avoided by implementing an automated inventory management or asset management system. So if you are one of the 43 percent of small businesses who track inventory manually or one of the 55 percent who track assets manually – then investing in an automated tracking system is a must this year. With an automated system in place, reporting is simple, with real-time accurate data. Both tracing systems can prepare inventory and assets for tax season and any potential IRS audits thereafter.
Did YOU MAKE the most of your inventory deductions?
When you start your tax process, here are some factors to keep in mind when it comes to inventory:
- Inventory should be valued at your purchase cost.
- Items that cannot be sold or are “worthless” can be taken out of inventory, and the loss is reflected as a higher cost of goods sold on your tax return. (You have the cost of the item, but no revenue for the sale).
- Higher cost of goods sold means more deductions against your total income from sales, lowering your profit subject to taxation.
The IRS accepts these three ways:
- Cost, which is the value of your items, plus the cost of shipping, etc.
- Lower of cost or market, or comparing the cost of items with the market value, dependent on the date and year.
- Retail, adding the retail value (or selling price) and then subtracting a set mark-up percentage to determine the cost.
Which is better for you? Most entrepreneurs and small businesses owners use the cost method, because it’s the easiest to track if you have a small inventory.
What if you can’t identify the cost of items in your inventory?
It’s good practice to use the First in First out Method (FIFO) or the Last in First out Method (LIFO).
- Use FIFO If you sell products (that you purchase or manufacture), and the cost of your products tends to increase over time. FIFO normally gives you a lower taxable income.
- Use LIFO if you are a retailer or manufacturer that sells items and find the cost of those items have increased. The use of LIFO will result in less taxable income and less income tax payments than FIFO. In the long run, and especially when costs increase even more, the lower income tax payments will definitely help.
Did you have too large or too small an inventory?
If you had a full warehouse or maintained the status quo, you’ll find there’s no tax advantage either way. Inventory items are not a tax deduction until they are sold or deemed “worthless” and taken off the warehouse shelves. In turn, you may want to coincide the purchase of inventory items with the production process (a.k.a. “Just in Time Inventory”). This practice can save small businesses a lot of cash, particularly by avoiding borrowing costs and not accruing extra facility costs due to excess item storage.
Did you beat yourself up over a loss?
Take your losses in stride. Most small businesses experience a Net Operating Loss (NOL) during the first three years of business. An NOL simply means your company’s tax deductions were greater than the taxable income. Though this seems like bad news, NOLs can be used to recover past tax payments and reduce future tax payments. Believe it or not, NOLs can also create tax relief. This is accomplished by applying loss to past payments and receiving a credit through applying the net loss to future income taxes.
What tax prep tips can you offer other small businesses?