April 2010 Archives

April 19, 2010

What If You Don't Have Proper Tax Records?

Because you're human, you may not have kept all the records required to back up your tax deductions. Don't despair, all is not lost--you may be able to fall back on the so-called Cohan rule. This rule (named after the Broadway entertainer George M. Cohan involved in a tax case in the 1930s) is the taxpayer's best friend.

The Cohan rule recognizes that all business people must spend at least some money to stay in business, and so must have had at least some deductible expenses, even if they don't have adequate records to back them up. If you're audited and lack adequate records for a claimed deduction, the IRS can use the Cohan rule to make an estimate of how much you must have spent, and allow you to deduct that amount. However, you must provide at least some credible evidence on which to base this estimate, such as receipts, canceled checks, notes in your appointment book, or other records. Moreover, the IRS will only allow you to deduct the least amount you must have spent, based on the records you provide. In addition, the Cohan rule cannot be used for travel, meal, entertainment, or gift expenses; or for listed property.

If an auditor claims you lack sufficient records to back up a deduction, you should always bring up the Cohan rule and argue that you should still get the deduction based on the records you do have. At best, you'll probably get only part of your claimed deductions. If the IRS auditor disallows your deductions entirely or doesn't give you as much as you think you deserve, you can appeal in court and bring up the Cohan rule again there. You might have more success with a judge. However, you can't compel an IRS auditor or a court to apply the Cohan rule in your favor. Whether to apply the rule and how large a deduction to give you, is within their discretion.

For more information, see Deduct It! Lower Your Small Business Taxes, by Stephen Fishman.

April 14, 2010

How Long Should You Keep Records?

You should keep your business and tax records for as long as the IRS has to audit you after you file your returns for the year. These statutes of limitation range from three years to forever. To be on the safe side, keep your tax returns indefinitely. They don't take up much space, so this is not a big hardship. Your supporting documents probably take up more space. You should keep these for at least six years after you file your return. Keeping your records this long ensures that you'll have them available if the IRS decides to audit you.You might also need them for other purposes--for example, to get a loan, mortgage, or insurance. Keep your long-term asset records for three years after the depreciable life of the asset ends. For example, keep records for five-year property (such as computers) for eight years. You should keep your ledger sheets for as long as you're in business because a potential buyer of your business might want to see them. For more information, Deduct It! Lower Your Small Business Taxes, by Stephen Fishman.

April 12, 2010

Accrual or Cash Method of Accounting - Which Is Best?

There is no best accounting method. Each method has its advantages and disadvantages. The cash basis method is much simpler to use and easier to understand. You don't report income until it's actually received, so it's more advantageous than the accrual method if you're in a business in which you're paid slowly. The accrual method is more complicated than the cash basis method, but you get a truer picture of your net profits for any given time period because income earned in one period is accurately matched against the expenses for that period. So you see the ebb and flow of business income and debt. Moreover, the accrual method is more advantageous than the cash basis method if you are paid promptly by your clients because you are allowed to deduct expenses when you incur them, not when you actually pay for them.

When you are paid promptly, the cash method's actual receipt rule is not important; and, using the accrual method, you may prepay business expenses in advance to offset the income you received for the year -- something you can't do with the cash method. Any business can choose to use the accrual method but some businesses (mostly larger-sized ones) are required to use it. For more information, see Deduct It! Lower Your Small Business Taxes, by Stephen Fishman.

April 7, 2010

New IRS Form Available for Special Payroll Tax Exemption

The IRS has released and posted on its website a new form, Form W-11, Hiring Incentives to Restore Employment (HIRE) Act Employee AffidavitThis form can be used by employers who want to claim the new special payroll tax exemption created under the HIRE Act (the Hiring Incentives to Restore Employment Act). To claim the exemption, employers must obtain a statement from new hires certifying that they were unemployed for 60 days or worked fewer than 40 hours during the 60-day period prior to being hired. The new Form W-11 can be used for this purpose. In order to claim the payroll tax exemption for new hires and the related new hire retention credit, employers must have this certification in their records--but they don't file the form with the IRS. The IRS also has FAQs about the payroll tax exemption and new hire retention credit posted on its website at www.irs.gov.

April 6, 2010

Asking the IRS for a Tax Filing Extension

As anyone -- especially a busy small business owner -- knows, that annual IRS tax filing date can come up quickly. If you need more time to pull together all your tax records and documentation to send to your accountant or tackle on your own, consider filing for an extension with the IRS. 

Unlike with an amended return which may trigger greater IRS scrutiny of your tax return, filing for an extension should not increase your chances of an audit, according to "Business Owners Look to Extend Tax Time," a recent article in the Wall Street Journal. 

You must file for an extension by your tax filing deadline, which is April 15 for flow-through entities like sole proprietorships, partnerships, and S corporations. For corporations, the filing deadline is two and a half months after the end of the company's fiscal year. 

Just because the IRS automatically grants you the extra time to file doesn't mean you are off the hook for paying what you owe. You'll get extra time to gather your paperwork and make sure you haven't missed any deductions or credits but you still have to estimate your tax liability for the year and pay that amount when you file for the extension. If you underestimate, the IRS will charge 3% to 6% interest on the amount you underestimated by. And if the IRS thinks you didn't act in good faith, it can add a .5% penalty per month until the liability is paid. Nevertheless, in the end, it is more important that you spend the time to do your taxes accurately. If it means filing for an extension, then take advantage of this automatic reprieve the IRS grants to all taxpayers.

For help in developing the best tax plan for your small business, see Tax Savvy for Small Business, by Frederick Daily (Nolo).