10 Tax Myths To Remember When You’re Tax Planning

When it comes to the ever-changing tax code, it can be hard for a small business owner to keep up. You’ve got to wear a number of hats, and tax accountant is just one of many that can soak up a huge amount of time and energy. Unfortunately, there are a number of myths out there about small businesses, taxes, and tax planning that can leave you spinning your wheels, or worse: making bad decisions for your business based on tax misinformation. One common area of confusion is understanding what qualifies as business expenses under IRS regulations, which is crucial for claiming tax deductions.

Here are some of the most common myths about taxes and tax planning for small businesses.

Myth #1: Purchasing equipment is the best way to decrease business expenses.

You need to understand from the beginning that spending isn’t the best way to go about reducing your tax liability. If you spend $250,000 on equipment that saves you $75,000 in tax liability, you’ve still spent $175,000. If you borrow money to buy that equipment, you’re going to be spending even more in interest on the debt. So while that purchase might save you a few dollars on this year’s tax bear, it might just cost you more in the long run.

Purchase the equipment you need, but don’t over-purchase thinking that it will save you money at tax time, as understanding your overall business taxes is crucial. Make strategic decisions that will positively impact your business throughout the year (not just at tax time).

Myth #2: It’s always better to have an independent contractor than an employee.

If you’re hiring someone on a legitimately contractual basis, that’s one thing. You can escape some tax burden by treating them as a contractor and issuing a 1099. However, if that contractor is filling the role of employee, you need to treat them as such. If you tell them when and where to work every day and you are their only client, there’s a good chance the IRS is going to see that person as an employee rather than a contractor.

Correctly classify your employees or you’ll wind up facing stiff penalties.

Myth #3: Startup costs aren’t tax deductible.

The costs that you incur before your business actually opens its doors are considered startup costs. These costs can include things like advertising, training, and other capital expenses. Some of those costs can be immediately deductible; other startup costs can be depreciated over time, reducing your taxable income by a smaller amount for several years in a row.

There is a limit to how much of your startup costs can be deducted immediately, so consult with your tax advisor about how best to approach this area.

Myth #4: Having a home office deduction will get you audited.

There was a time when home offices were a rarity, and that claiming a home office deduction would create a red flag that would get you audited (seemingly by default). Today, however, that’s not necessarily the case. While the home office deduction can increase the scrutiny that’s applied to your tax return, it doesn’t guarantee you’ll get audited.

The home office deduction actually has two different calculations. The simpler option is to take a $5 deduction per square foot of office space that you have in your home. Taking this version of the deduction is pretty low-risk when it comes to getting audited.

Alternatively, you can break out your calculator and use the actual expense method to deduct a more detailed list of business expenses your home office incurs. This calculation is partly based on the percentage of your home that your office occupies. For example, if your home office took up 25% of your home, you could deduct 25% of your internet bill as a business expense. You’d take a similar approach for any other applicable expenses.

If you do take this more complicated deduction, you’ll need to keep detailed records of the expenses you’re deducting so you can back up the deductions you claim.

Myth #5: Incorporating your business always provides tax benefits.

For some small businesses, incorporation makes sense. It can protect your personal and private assets from liability in the event that there are troubles with your business. On the other hand, incorporating can also be a costly proposition. For example, you might spend $1,000 in fees and legal help getting your corporation set up, and find that you haven’t reduced your tax burden. In fact, given the fact that most small businesses don’t show a profit in the first couple of years of business, you could wind up facing a minimum corporate tax without any income.

Myth #6: An extension to file your taxes is an extension to pay taxes owed.

Under the terms of the federal tax code, the IRS is entitled to collect income taxes on the day they’re due, even if you file an extension to submit your forms later in the tax year. It’s one thing if you know you’re getting a tax refund and you request an extension; you’ll just delay your refund.

But what if you have a tax bill and you request an extension for filing taxes? It’s still your responsibility to pay income tax on time anyway. If you did owe taxes on your gross income for the year and didn’t pay an estimated payment on the due date, you’d start to owe interest and penalties. These can add up quickly, especially if you owe a lot.

The best approach is to file your taxes on time, but if you can’t, make sure you pay on time and protect yourself from penalties.

Myth #7: If your accountant makes a mistake on your taxes, you’re not liable for penalties.

No matter what kind of help you get during the tax process (and chances are, you’re going to want and need some help), the accuracy of your tax returns is your responsibility. You’re the one who’s going to be paying fees and penalties if your return has inaccuracies, not your accountant. Make sure you choose an experienced and reliable accountant, and educate yourself on the basics of the tax system so you can be sure you understand what deductions you’re taking and why.

The business tax landscape can be difficult to navigate. It doesn’t help that tax laws are constantly in flux; what’s true today may not necessarily be true tomorrow. Learn how to recognize tax myths, and plan your tax strategy accordingly. If you have any questions about something your accountant did, ask them about it. And if something feels off, don’t be afraid to get a second opinion.

Myth #8: Self-employed individuals have the same tax obligations as employees.

Contrary to popular belief, self-employed individuals face different tax obligations compared to employees. One significant difference is the requirement to pay self-employment taxes (Social Security and Medicare taxes), which cover both the employee and employer portions of payroll taxes. This can be a substantial tax burden, as it effectively doubles the payroll tax rate for self-employed individuals. In an “ordinary” employment scenario, this tax burden is shared equally between the employer and employee.

That said, being self-employed also comes with certain tax benefits. For instance, self-employed individuals can take advantage of the home office deduction, which allows them to deduct expenses related to maintaining a home office. Additionally, they may qualify for the earned income tax credit, which can provide significant tax savings. It’s crucial for self-employed individuals to understand these differences and plan accordingly when filing their tax return.

Myth #9: All income is taxed the same way.

Not all income is created equal in the eyes of the tax code. Different types of income are taxed at varying rates and in different manners, depending on the nature of the income and the individual’s tax filing status. For example, ordinary income, such as wages and salaries, is taxed at a different rate than capital gains income, which comes from the sale of assets like stocks or real estate.

Moreover, some types of income are not subject to federal income taxes at all. Tax-free interest income from municipal bonds is a prime example. Another example can be members of the military; these individuals and their families may also have reimbursements and allowances that aren’t taxable. Understanding how different types of income are taxed can help you make more informed financial decisions and optimize your tax strategy to minimize your overall tax liability.

Myth #10: The IRS will always contact you by phone or email.

One of the most persistent myths is that the IRS will contact you by phone or email. In reality, the IRS typically communicates with taxpayers through official correspondence sent by mail. They will never request payment or personal information via email or text message. If you receive a phone call or email claiming to be from the IRS, it’s likely a scam. Do not respond or provide any information.

The IRS will never demand immediate payment or threaten to arrest you if you don’t pay right away. They absolutely want you to pay the money they owe, but contrary to popular belief, they can actually be quite reasonable to arrange a payment plan instead of threatening you. Always be cautious and verify the authenticity of any communication claiming to be from the IRS by checking their official website or contacting them directly through verified channels.

Conclusion

Navigating taxes as a small business owner can be challenging, especially with so many myths and misconceptions out there. Understanding the truth behind these common tax myths is crucial for making informed decisions and optimizing your tax strategy. Whether it’s knowing how to classify employees, deducting startup costs, or understanding self-employment taxes, educating yourself can save time, money, and potential headaches. Partner with a trusted tax advisor and stay proactive about tax planning to help ensure your business stays on track.

With the right knowledge and resources, you can confidently tackle your tax responsibilities and focus on growing your business.

Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.