Part 2 of 2
TAX ISSUES CONCERNING SMALL BUSINESSES
FINDING THE RIGHT PROFESSIONAL
You need a good CPA (certified public accountant) to help you with the formation of your company, to set up the books and records and provide you with a roadmap of potential red-flag tax issues concerning your business. Also, a good CPA can prepare your returns and monitor your business changes, suggesting tax strategies to implement, based on his or her understanding of your business.
An attorney is important to structure your company and to deal with business operations, such as contracts and LLC or corporate resolutions. Your attorney should be familiar with business planning and the formation of companies, and should have at least a general understanding of the tax issues facing your company and you. Because the exit strategy is so important, you attorney should understand estate planning concepts and how estate taxes could impact you.
The best way to choose a CPA or an attorney is through personal recommendations and referrals. Ask those in your industry who they use. Ask CPAs to recommend an attorney and vice-versa. Always ask for the reasons why they think a certain CPA or attorney would be a good choice. Another method is to look in the Yellow Pages or on-line for CPA’s or attorneys with experience. Contact and interview at least 3 of them and choose the one you are most comfortable with. Never choose a professional if he/she is rude or seems too busy to handle you. If they act like they are doing you a favor by letting you become a client, walk away! You need access to your professionals when emergencies arise.
When you interview a CPA or attorney, ask them to describe their experience as it relates to your business. How many cases or clients have they handled? Have they represented them on audits and if so, what were the issues and the results. Your attorney should form new companies on a regular business and should be familiar with the legal issues facing your industry. What types of matters have the attorney handled and how were they resolved. If they do not address your specific concerns, go elsewhere.
What to Do If Your are Audited?
First rule: Don’t panic. Inform your CPA or attorney that you received an audit notice and fax the notice to them. Often an audit involves supplying information, such as proof of entertainment or car expenses, gross receipts or other accounting records. If the audit is focused on providing financial records to support items on your tax return, your CPA can handle the audit for you. You do not have to be personally present for an audit and the audit does not have to occur at your place of business.
TIP: The key to successfully defending a tax audit is to keep the auditor focused only on the issues raised and to provide evidence that addresses only those issues. Often, auditors will attempt to broaden the scope of the audit and ask for information not pertaining to the subject matter. These requests should be politely but firmly resisted.
An experienced taxpayer’s representative will strive to constantly take issues off the table and to limit the scope of the audit, while providing only the minimum amount of documentation necessary to win a particular point. It is extremely important that the taxpayer, if he or she is present at all, provide the most limited answers in any audit. An inadvertent statement or slip of the tongue can open the proverbial can of worms.
Also, taxpayers should not provide auditors with information the IRS already has, such as tax returns and other documents filed by the taxpayer. IRS has not right to subpoena such information and it should not be voluntarily provided. This will usually stop the auditor from conducting a fishing expedition. Unfortunately, many non-attorneys believe it is better to cooperate with the IRS than to resist these over-reaching requests. Such cooperation, however, can be detrimental to the client’s best interests in minimizing the potential tax liability.
The audit process starts with an examination by an IRS officer. At the conclusion of the audit, the auditor will issue a report. You then have 30 days to appeal the auditor’s report. If you appeal, the case is reviewed by an IRS appellate officer. Attorneys often get involved at the appeals stage. Appeals officers are instructed to try to settle as many cases as possible.
If the case cannot be settled, then IRS must send to you a “Notice of Deficiency” which gives you the right to take your case to Tax Court. IRS cannot assess you a deficiency (cannot increase your taxes beyond the amount you reported on your return) unless:
- You consent to the assessment in writing;
- You fail to timely petition the Tax Court for a hearing; or
- The Tax Court rules against you and the time to appeal its decision has expired.
TIP: There is a group of tax professionals called Enrolled Agents, who are licensed to practice before the IRS. Enrolled agents are usually ex-IRS employees or others with solid accounting backgrounds who are not CPAs. Enrolled agents may represent you before the IRS in audits are often the best choice of professional to use at the audit level.
If the issues involve a legal interpretation or potential fraud or criminal activity, you need to hire an attorney. Although enrolled agents and CPAs are not precluded from representing you when there is a legal issue, they don’t have the training in advocacy of an attorney. Legal tax issues include:
Most tax shelter matters;
- Personal expenses versus business or investment expenses;
- Controversies involving the proper tax year for income or deductions;
- Disputes involving the character of income, loss or expenses such as capital gains versus ordinary income, taxable income versus a non-taxable gift, and the classification of passive activities, portfolio interest and investment interest;
- Independent contractor vs. employee issues;
- Dividend vs. compensation or loan issues involved with a shareholder and a “C” corporation; and
- Issues involving the interpretation of contracts and agreements.
Fraud and criminal could be an issue when there is:
- Under-reporting income or over-reporting deductions;
- Failing to file returns or filing false returns;
- Under-the-table payments, payments of bribes and kickbacks that are deducted;
- Filing returns for a business engaged in illegal activity (drugs, prostitution – yes, you must file a tax return even if your earn income from illegal activities)
- Unreported foreign bank accounts or investments;
- Claims that your property or investments are held in the name of others;
- Use of trusts or other entities to hide or distort your income; and
- Situations where your bank deposits greatly exceed the income reported on your return or where you have a large cash hoard.
Attorneys know the rules of evidence and how to protect you from making incriminating statements or providing incriminating documents or evidence.
Special Tax Situations
Independent Contractors: The challenge you face is preserving your status as an independent contractor. Federal and state tax authorities will attempt to reclassify you as an employee. If this happens, you cannot have a retirement plan independent of your “employers” and your business expenses are not fully deductible, but are considered itemized miscellaneous expenses and subject to a floor of 2% of your adjusted gross income.
TIP: Become an LLC or “S” corporation and have the companies you work for pay your company. If you operate as a sole proprietor, then use a business name such as “Smith & Associates” or “Smith Consulting”). You should have business cards and stationery in your company name, brochures advertising your business and a Yellow Page listing (auditors check the yellow pages to verify that you are a business). If you have a home-office, you should have a separate telephone for your business with an answering machine or voice-mail identifying the business (“You’ve reached Smith & Associates” – auditors will call your phone as well). You should have a written contract with the company that clearly states you are an independent contractor and you should never do anything inconsistent with your status as an independent contractor, such as filing for unemployment benefits.
Mom and Pop Businesses and Franchises: These businesses should be minimizing taxes by making sure they are maximizing their deductions. Have your children work for the business during the summer and pay them reasonable wages (they should punch a time clock to document that work was performed and in every way they should be treated as an employee). Consider transferring part of the ownership to your children or family members at the inception of the business to save on estate taxes later. Remember, if you only own 60% of the business, then only 50% of its value will be part of your estate.
Start-ups: Sweat-equity owners vs. investors. A sound written agreement stating how income, profits and losses will be divided between the owners should be drafted by an experienced business or tax attorney. If it is contemplated that the business will be financed with venture capitalist money, then audited financials and maximizing taxable income (rather than maximizing tax deductions) are appropriate. The same holds true if you are planning to sell to a public company. Start-ups should consider providing their employees and key independent contractors with stock options, in lieu of monetary compensation to cut-down on the expenses and to give those working with the company an incentive to work very hard.
**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**