Although the chances of an audit are rare, the fact is tax audits are a fairly routine business for the IRS. That said, audits can be especially scary for small business owners. After all, there are certainly horror stories in which IRS audits have resulted in company closures.
Fundamentally, an IRS audit is an evaluation of your business’s financial accounts and information. As such, you’ll find most audits are a result of discrepancies on tax returns. The IRS is simply reviewing your entries to ensure everything is in order. Sometimes an audit is random, and other times it can be based on suspected suspicious activity.
So, here are some red flags that could trigger an IRS audit of your business.
1. Data Entry Errors
The more manual your accounting and expense management functions are, the more likely you are to make errors when filing your taxes. Your accounting system is crucial to understanding business performance and is also vital to tax preparation.
While most accounting functions are digitized nowadays, data entry blunders like treating expenses as income or duplicating an entry could trigger a letter from the IRS. An audit can be triggered by something as simple as misspelling your business name. This is where e-filing comes in handy because you can load vital information from past tax returns.
If your math is a little shaky, soliciting the services of a tax preparer near you could save you the headache of an IRS audit.
2. Failing to Report Some Income
Underreporting your income on your tax return is a top audit trigger. The IRS compares your income from one tax year to the next. A noticeable discrepancy without supporting information can make Uncle Sam sit up and take notice.
The IRS wants what it’s owed and will go to great lengths to verify the reported amount of tax is correct according to tax laws. So, it’s only a question of when before it spots your omission. This is especially true for cash-heavy businesses like barbershops and nail salons.
3. Questionable Business Deductions
It’s not uncommon for small business owners to have itemized deductions on their returns, like home office deductions. While these tax deductions can reduce your taxable income, they can also raise red flags when they don’t measure up to your income. Same case if you’ve made significant contributions to charity.
The IRS also compares your tax returns to those of other businesses in your industry – anything that’s out of the ordinary may subject you to further scrutiny.
4. Excessive Business Expenses
The IRS stipulates that a business expense has to be both ordinary and necessary to qualify as a deduction. For instance, a professional painter could claim paint and paintbrushes as business expenses, but a software engineer who paints as a hobby cannot.
If you have large expenses, it’s pertinent to keep all your receipts in case you are asked for verification. However, matters get a little more complicated when it comes to entertainment, travel, and meal expenses, as they may blur the lines between personal and business expenses.
5. Earning Substantial Income
One in 100 businesses get audited each year, and usually the ones that earn more than $1 million per year, especially if they report a significant change in income. It’s not unheard of for companies to start raking in millions in revenue seemingly “out of the blue”, particularly in the age of social media when branding has a direct impact on your bottom line.
Don’t be surprised if you hear from an IRS agent when you start showing a substantial increase from year to year. That’s also a great time to bring in a business advisor to develop a growth strategy.
6. Reporting Too Many Losses on a Schedule C
If you claim a business loss each time you file a tax return, you may be due for a tax audit. While it’s not uncommon for small businesses to have losses, having many years of Schedule C losses could have the IRS questioning the legitimacy of your business. If you don’t turn a profit, the IRS may consider your business a hobby which could limit your tax deductions.
Keep all your business documentation that shows your company’s revenue and expenses throughout the year to cover all your bases.
7. Being Self-Employed
Unfortunately, the IRS tends to scrutinize self-employed individuals, especially if they fail to report a profit for at least three out of five years. This applies to freelancers and anyone working in the gig economy as well. Yet again, the IRS could claim your business to be a hobby, which would disqualify you from claiming certain business deductions.
As a small business owner, you should consider forming an LLC to lower your audit risk. Consult a tax professional near you to determine which entity would work best for you.
8. Misclassification of Employees
Some businesses intentionally misclassify employees as part-time workers or independent contractors for several reasons:
To lower labor costs
To avoid paying certain small business taxes
To reduce business insurance expenses
It’s important to classify your employees appropriately and keep documentation of any independent contractors you hire.
Avoid the Dreaded IRS Tax Audit with FMA CPA
Talk to FMA CPA about your accounting practices, income, or deductions to determine what could trigger an IRS audit. We’re a CPA firm in Clearwater offering business advisory services designed to help you understand your business better and keep you on Uncle Sam’s good side.
Contact us for comprehensive tax preparation services and any questions you might have.
The I.R.S. recently announced a new tax rule for small business owners related to the 2021 American Rescue Plan Act. And as a result, any payment your business receives from a digital service or third party that accepts credit cards will appear on your income tax return if it exceeds $600. Between this rule and the coronavirus-related tax changes, you might wonder what the small business tax rate will look like in 2022.
Here’s everything you need to know.
Business Tax Changes Related to the COVID-19 Crisis
The U.S government brought in tax breaks and made specific changes to help businesses hold out during the pandemic.
Coronavirus Aid, Relief, and Economic Security (CARES) Act. This act encompasses the Paycheck Protection Program (P.P.P.), a loan meant for utility, employee payrolls, and mortgage payments. Your business may apply for loan forgiveness. If granted, this P.P.P. loan will not appear on your taxable income.
Economic Injury Disaster Loan (EIDL). The S.B.A. increased the borrowing limit for this low-interest loan.
Employee Retention Tax Credit (ERTC). Small businesses whose gross receipts decreased by at least 50% due to the pandemic qualify. If eligible, companies receive a tax credit, that is 50% of staff wages.
Families First Coronavirus Response Act (FFCRA). This act mandated particular businesses to offer sick pay and family leave arising from COVID-19. These companies would then receive 100% tax credits.
Small Business Tax Rates for 2022
Small business tax rates aren’t straightforward. This complexity is because of the non-existence of a uniform tax rate for all of them. Below are the small business tax rates by business structure.
C corporations’ small business tax rate is perhaps the simplest form, courtesy of the 2017 Tax Cuts and Jobs Act. If you qualify, you will pay a flat tax rate of 21%. Moreover, there’s no need to worry about the alternative minimum tax (A.M.T.) as the TCJA got rid of this requirement. Note that C-corporations comprise approximately 5% of small businesses.
As for dividends, your business must pay shareholder dividends. Your shareholders must then include the dividends tax on their individual income tax returns, hence the term “double taxation.” The shareholders’ tax rate varies based on whether it’s a qualified or ordinary dividend. While C-corp experiences double taxation, their corporate tax rate is less than several personal tax bracket returns.
Pass-through businesses include partnerships, S corporations, sole proprietorships, and Limited Liability Companies(L.L.C.s).
These entity types make up about 95% of small businesses in the U.S. and don’t pay federal income tax. Instead, an employer includes business income on their individual income tax returns. Therefore, your income in a tax year will determine your federal income tax rate.
If you are a business owner and receive secondary income from a different job or investment, your tax rate will reflect the total income.
Also, the more your taxable income is, the steeper your tax rate.
Two primary factors determine your small business tax rates.
1. Tax credits
Tax credits are precise reductions. For businesses, these may include work opportunities and alternative car credit. Individuals also receive federal tax credits such as the adoption credit and the earned income tax credit.
Deductions reduce your taxable income. Examples of business deductions include rent expenses and legal fees. Individual deductions include medical expenses and charity donations.
Other Small Business Taxes
Small businesses must pay other taxes besides federal income taxes.
State income tax. Tax rules differ by state. The only states without a state tax are Florida, Wyoming, Alaska, South Dakota, Washington, Nevada, and Texas. As for the other states, businesses are subject to a corporate income tax within the 2.5 and 11.5 percent range.
Gross receipts tax. This tax typically applies to states that don’t levy a state income tax.
Payroll tax. Payroll taxes are a requirement for any business that has employees. These taxes include federal and state unemployment taxes and Federal Insurance Contributions Act taxes ( Social Security and Medicaid).
Excise tax. Businesses that sell specific goods and services like gasoline and indoor tanning must pay the excise tax.
Sales tax. Sales tax is a requirement in 45 states. Rules differ for each state. And in some cases, you may need to remit taxes for more than one local jurisdiction.
We, therefore, recommend working with a C.P.A. firm to help you navigate these tax rules.
Property tax. You must pay property tax if you own vehicles and real estate.
Here are several ways to make tax filing more successful in the 2022 tax year.
Make use of accountable plans
Monitor your adjusted gross income as it affects your deductions
Track all business transactions
Avoid late payments
Consider business restructuring
Take advantage of technology by installing a tax preparation software
Knowing which entity type will offer better tax rates can be confusing. For instance, L.L.C.s have several options available and may pay taxes as S corps or sole proprietors. A business advisor can break down the rates to help you choose the most beneficial option.
F.M.A. C.P.A. is a C.P.A. firm in Clearwater with a team of professionals who understand state tax rules. Our business advisory services include tax planning and accounting. Tax season doesn’t need to be stressful. Contact us at 727-530-0036 to learn how our team can make your small business tax planning stress-free.
Income Tax Brackets—How is Your Income Tax Calculated?
The United States operates under a progressive tax system that imposes a higher tax rate on taxpayers who have higher incomes. Generally, you’ll pay more tax as you move up the pay scale, which is accomplished by creating income tax brackets that group taxpayers based on income ranges.
Seven tax brackets exist for the 2021 tax year or taxes due in April 2022 or October 2022, with an extension. These are 10pc, 12pc, 22pc, 24pc, 32pc, 35pc and 37pc. The bracket you fall under depends on several factors such as your taxable income, credits, deductions, and your filing status: single taxpayer, married couples filing jointly, or married filing separately.
Upcoming Tax Brackets & Tax Rates for 2021-2022
The IRS tends to adjust tax rates, allowances, and thresholds every year based on inflation.
Here’s a look at the brackets and tax rates for taxes due in April 2022.
Income Tax Rate
Married Filing Jointly and Qualifying Widow(er)s
Head of Household
$0 – $9,950
$0 – $19,900
$0 to $14,200
$9,951 – $40,525
$19,901 – $81,05
$14,201 – $54,200
$40,526 – $86,375
$81,051 – $172,750
$54,201 – $86,350
$86,376 – $164,925
$172,751 – $329,850
$86,351 – $164,900
$164,926 – $209,425
$329,851 – $418,850
$164,901 – $209,400
$209,426 – $523,600
$418,851 – $628,300
$209,401 – $523,600
$523,601 and above
$628,300 and above
$523,601 and above
For married couples filing separately, the tax brackets are similar to single filers, with deviations coming in for incomes above $209,425. The tax rates for married couples filing separately become:
35%, for incomes between $209,425 and $314,150
37% for incomes over $314,150
In November 2021, the IRS provides tax inflation adjustments for tax year 2022. As such, here are the tax brackets for taxes due April 2023 or October 2023, with an extension.
Income Tax Rate 2022
Heads of Households
$0 to $10,275
$0 to $20,550
$0 to $14,650
$10,275 to $41,775
$20,550 to $83,550
$14,650 to $55,900
$41,775 to $89,075
$83,550 to $178,150
$55,900 to $89,050
$89,075 to $170,050
$178,150 to $340,100
$89,050 to $170,050
$170,050 to $215,950
$340,100 to $431,900
$170,050 to $215,950
$215,950 to $539,900
$431,900 to $647,850
$215,950 to $539,900
$539,900 and above
$647,850 and above
$539,900 and above
How Federal Income Tax Brackets Work
Almost everyone agrees that the current tax system is too complicated. Tax brackets are not as intuitive as they seem at first glance because odds are you’ll have to look at more than one tax bracket to figure out your effective tax rate. That’s why most people opt to work with a CPA firm for tax planning and business advisory services.
The tax bracket your top dollar falls into is your marginal tax rate. However, not all your income is levied at this rate across the board. Let’s say you’re a single taxpayer with a taxable income of $80,000 in tax year 2021. Your marginal tax rate is 22%, but here’s how your taxes will be broken down.
The first $10,275 will be taxed at 10% resulting in a tax of $1,027.50.
The next $31,500 ($41,775-$10,275) will be taxed at 12% resulting in a tax of $3,780.
The last $38,225 ($80,000-41,775) will be taxed at your marginal tax rate of 22% resulting in a tax of $8,409.50.
Therefore, your total tax returns will amount to $13,217, or the sum of $1,027.50 +$3,780 + $8,409.50. As you can see, the last dollar you earn is taxed more than the first dollar you earn – this is technically the principle of a progressive tax system.
How To Get Into a Lower Tax Bracket
No one wants to pay higher taxes than they need to. Fortunately, you can lower your tax bill through tax credits and tax deductions.
Several tax credits exist to help low-income and middle-income households reduce the amount of taxes they owe. Some examples include:
Earned income tax credits to offset the burden of Social Security taxes
Child tax credit to defray the costs for childcare for dependents under age 13
Lifetime learning credit to offset the costs of post-secondary education
You can also lower your income using tax deductions. For instance, you can deduct property taxes and the mortgage interest paid on a home loan. Additionally, there’s a defined dollar amount that lowers your taxable income.
Let’s look at the 2021 and 2022 tax years, where the standard deduction is as follows:
2021 tax year
2022 tax year
Married, filing jointly
Married, filing separately
Head of household
The IRS allows you to take the standard deduction on a no-questions-asked basis. But taking the standard deduction means you cannot deduct home mortgage interest, medical expenses, plus charitable donations from your tax bill. If your standard deduction is less than your other deductions combined, it’s best to itemize your deductions and save money.
The Bottom Line for Income Tax Brackets
FMA CPA is a CPA firm in Clearwater, specializing in helping individuals and small business owners with all matters of tax preparation and tax planning. As business advisors, we can help you get your house in order when filing taxes to ensure you don’t have to pay Uncle Sam more than what’s necessary.
IRS Announces Inflation-adjusted Rates for 2022 Tax Returns
The IRS announced new rates for 2022 tax returns. These rates have increased due to inflation, which was higher in 2021. The new rates will become effective starting January 2022. So, you’ll need to take the changes into account for the first time in 2023—when filing your 2022 tax returns.
Below are some of the main changes you should expect in your 2022 tax returns.
Tax Brackets to Have Higher Limits
While tax rates remain the same, limits under each bracket have increased by at least 3%. Meaning, your income could increase by 3% and still leave you in the same tax bracket. These rates depend on whether one is single or married. For married couples, your rates depend on two things: whether you’re filing separately or jointly.
Increase in Standard Deductions
Taxpayers usually must choose between standard deductions and itemized deductions. These are expenses that the IRS allows taxpayers to deduct from their taxable income. Since you can’t have both the standard and the itemized deductions, it makes sense to go with the highest.
For married couples filing jointly, standard deductions increased from $25,100 to $25,900. For single taxpayers and married couples filing separately, deductions increased from $12,550 to $12,950. Lastly, for those filing as heads of households, standard deductions rose from $18,800 to $19,400.
Earned Income Tax Credit (EITC)
EITC is a federal tax provision that allows tax refunds to taxpayers who qualify. If you have children and your income is low, you may be eligible for the child tax credit. In 2022 taxes, those with three or more qualifying children will get a tax credit of $6,935. And those with one qualifying child will get $3,733. Since the income phase-out limits have increased as well, your income could increase and still qualify for EITC.
Increase in 401K Contributions
The 401K contributions increased from $19,500 in 2021 tax returns to $20,500. So if your employer provides for social security, you’ll have to contribute more to this fund. But since the contribution is tax-deductible, this means your taxable income will decrease.
Annual Exclusion for Gifts
When you give someone a gift, you may be required to pay taxes if the gift’s value exceeds certain amounts. In tax year 2021, the limit was $15,000, but this amount will be $16,000 for 2022 tax returns. That means you can give a person a gift valued at up to $16,000 annually without paying taxes on it.
Foreign Earned Income Exclusion
If you live abroad and earn money from different countries, you can qualify for the foreign earned income exclusion. Tax laws allow for a deduction of a certain amount of your income earned abroad. In 2021, the limit was $108,700. But in the new tax season, the limit will be $112,000.
Standard Mileage Rates
These are tax-free reimbursements that employers give employees who use personal cars for business. It applies to cars, vans, panel trucks, and pickups. These rates fall into three categories: business, charitable purposes, and medical/military moving.
In 2022 tax filings, the applicable rates will be:
58.5 cents per mile for business
14 cents per mile for charitable uses
18 cents per mile for military and medical moving expenses
Capital Gains Tax
These are taxes paid when you sell real estate, stocks, or other investments at a profit. These rates haven’t changed for the 2022 tax year. They remain at 0%, 15%, and 20% respectively. However, the taxable limits under each rate have increased from 2021 to 2022.
For single taxpayers, capital gains taxes (at 0%) have increased from $40,400 to $41,675. The same limit applies to married couples filing separate returns. For married couples filing jointly, the amount increased from $80,800 to 83,350. For heads of households, the amount rose from $54,100 to $55,800.
These are a few examples of tax rates applicable to 2022 tax returns. All the adjustments show an upward increase in both payments and deductions. So, you must keep up to date for you to file accurate returns and avoid cases of owed taxes. For a simple transaction, you can use a tax calculator. But for detailed calculations, you must be careful with each item in the tax law.
A business advisor can help you lower your taxes without violating any tax laws. If you’re under pressure to file returns for the year ending December 31, 2021, reach out to our CPA firm in Clearwater. We can help you file your returns. Our tax experts can also help you apply for an automatic extension to give you more time.
Independent Contractor Taxes: A Guide on How to Pay Your Taxes
With an evergreen tax code that measures thousands of pages long, it’s understandable if you’re unsure of what’s expected of you regarding independent contractor taxes. Being an independent contractor offers several tax advantages, but it requires excellent record keeping.
For instance, if you’re a physician, you might be able to deduct professional membership dues. All self-employed individuals’ circumstances are different, which is why it’s crucial to work with a business advisor to understand what you can and cannot deduct.
Things get a little more complicated when you’re filing and paying independent contractor taxes. You’ll have additional forms to file, and you’ll need to pay quarterly estimated taxes. To calculate and make estimated tax payments, you must fill out Form 1040-ES.
Are you thinking of being your own boss? Here’s what that means for your taxes.
Understanding Independent Contractor Taxes
As an independent contractor, you have some unique responsibilities where taxes are concerned. Working with a CPA can help you optimize your tax strategy so you can reduce your tax bill and avoid issues with the IRS.
Here’s a breakdown of what you stand to benefit from:
Report self-employment income and pay self-employment tax
An independent contractor is any person running a one-person business. As such, you’re required to provide details of your profit and loss like other business owners. To do this, you’ll have to file a Schedule C along with your personal tax return, filed with Form 1040.
In addition to paying income taxes, you’re also required to cover the full portion of Social Security and Medicare taxes yourself. The current self-employment tax rate is 15.3% – 12.4% for Social Security and 2.9% for Medicare – which you’ll report by filing Schedule SE.
A self-employment tax of 15.3% is high, but there’s an upside – you qualify for certain business deductions as an independent contractor. These deductions can include health insurance, home office deductions, and business expenses like credit cards, phone, internet, and mileage expenses.
The IRS allows you to deduct direct and indirect taxes on your business. If travel is part of your business, keeping track of mileage and hotel receipts can help reduce your tax bills. Other possible deductions that can reduce your taxable income include retirement savings and costs for professional service fees like lawyers and accountants.
Quarterly Estimated Tax Payments
The U.S. tax system is a pay-as-you-go system that requires you to pay taxes as you earn income during the year. As an independent contractor, you must pay taxes on a quarterly basis – April, June, September, and January. Estimated tax is used to pay both income tax and self-employment tax. Even if you don’t know how much tax you owe until you file your taxes, you may be charged a penalty if you don’t pay enough estimated taxes or if you pay them late.
To calculate and make estimated tax payments, you must fill out Form 1040-ES. You can estimate how much you need to pay by saving a portion of each payment you make.
Additionally, you can also check what you paid in previous tax years to estimate your tax payment. It can be difficult to estimate how much to pay as you must consider both federal and state taxes. Your best bet is to work with a CPA with an extensive understanding of the tax code to ensure you’re not subject to penalties.
Set up a legal structure for your business
Once you’re earning a level of income, you may want to consider setting up a legal entity for your business, like a Sole Proprietorship or a Limited Liability Company. Doing so can help you reduce your tax liability. For instance, as a sole proprietor, you might qualify for the Qualified Business Income deduction. QBI deductions allow you to minus up to 20% of your business income on your individual tax return.
FMA CPA can help you determine whether you qualify for the deduction as the threshold of qualification differs depending on the type of business.
If you think you might be paying too much to the IRS, talk to us about strategic tax planning. We provide information for people who want to establish, sustain, and grow their businesses as independent contractors. Here’s the best part: a portion of our fees may even be deductible as a business expense. Contact us today to schedule a consultation and ease any fears you may have regarding independent contractor taxes.
Personal Tax Deductions: Tax Planning Tips to Avoid Tax Audits
One of the most common problems small business owners make when they’re first starting out is commingling their personal and business accounts. That’s how so many businesses find themselves within an IRS audit.
Business expenses are the cost of carrying on trade or business. As such, personal tax deductions, like living or family expenses, are not eligible to be deducted as business expenses. The IRS doesn’t allow expenses that qualify as personal tax deductions as business deductions. Doing so skews the information on your financial reports and obscures the true financial picture of your business.
Writing-off personal tax deductions through your company also means you’ll be unable to check the financial health of your small business. You may find yourself unable to make sound decisions for your company’s future because you lack accurate financial information.
So, what expenses are deductible through your business?
Personal Tax Deductions Versus Business Expenses
You cannot deduct personal, living, or family expenses from your taxable business income. If you were to buy personal items through a company account, these expenses would be considered fringe benefits, and as a result, they’d be subject to payroll taxes.
There are two ways you can view deductions on your federal tax return: itemized deductions or standard deduction. If you have no qualifying personal tax deductions or tax credits, the IRS allows you to take a standard deduction. A specific dollar amount that reduces your taxable income – on a no-questions-asked basis.
Allowable itemized deductions include mortgage interest, charitable gifts, unreimbursed medical and dental expenses, casualty and theft losses, and state and local taxes. Tax returns can range from simple to complex. A tax preparer can help you file your individual and business tax returns so you can get the best tax refund for your situation.
It’s crucial to draw the line between what’s personal and what’s business. This isn’t always possible, especially when you incur costs for something that’s used for both business and personal expenses. These include home office expenses or car expenses incurred while traveling for business.
Deductible Business Expenses
A tax deduction is an expense you can write off your taxable income. The expense has to fit the IRS criteria of a tax deduction to be eligible. Deducting business expenses reduces your company’s taxable income and the amount of tax you’ll have to pay. Section 162 of the tax code dictates that only ordinary and necessary expenses are deductible.
Unfortunately, the tax code doesn’t go into detail about what makes-up ordinary or necessary expenses. For this reason, it’s important to work with a tax professional when filing your tax returns.
Any tax expert will tell you that ordinary expenses are those you incur as the cost of owning a business. These are the expenses that are common and accepted in your trade. Ordinary expenses are considered deductible in the tax year they occurred.
Necessary expenses are those that are helpful and appropriate for your business. It’s important to note that an expense doesn’t have to be indispensable to be considered a necessary expense. Startup costs may also be tax deductible but have to be spread out over several years since they do not qualify as ordinary or necessary expenses. Instead, the costs of setting up a new business are deductible as capital expenses.
To be deductible, an expense must meet the following conditions:
It was incurred in the production of income
The expenses must be incurred, in that they’re not dependent on an event that may or may not occur in future.
The expense impacts revenue, and not capital, in nature
Non-deductible business expenses do not fulfill the above conditions. These include personal and capital expenditures. Prominent examples of “ordinary and necessary” business expenses include:
Wages or salaries paid to employees for their services.
Retirement plans such as 401(k), 403(b), and SIMPLE (Savings Incentive Match Plan for Employees).
Any type of insurance acquired for professional business
Interest expenses on money borrowed for business activities
Various federal, state, local, and foreign because your business. Income tax does not qualify.
Other common tax-deductible business expenses include work-related travel expenses, business meals, office supplies, phone and internet fees, plus depreciation. You may also be able to deduct work-related educational expenses if you’re self-employed.
Still, this is not an exhaustive list of available business deductions. Seeking the help of a business advisor could support you make the most of both business and personal tax deductions. This way, you get to keep more of your business income.
In Search of the Best Tax Preparation Services?
It’s always best to start to file your taxes early enough. Planning ahead can help you file an accurate return and avoid processing delays. FMA CPA is a CPA firm in Clearwater providing business advisory servicesand is your best pick when it comes to tax preparation services.
Let us help you prepare for the upcoming tax season. Contact us today to schedule a free consultation.
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