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Protecting Your Business
Defending your business against
an audit
- If you own or operate a small business, it's important to note that
all the rights and remedies to avoid tax collection abuse discussed in
this web-site also apply to small businesses. The only difference is, businesses
are audited and penalized approximately six times as much as individual
taxpayers.
- In the eyes of the IRS, businesses -- especially small businesses --
are the source of most of the tax cheating. They are suspected of doing
most of the overstating of expenses and underreporting of income. If there
is one thing a small business owner does not need, it is hassles beyond
that of just struggling to make a living.
- The IRS is so intent on auditing and penalizing small business, they
have developed special audit task forces to audit various business segments.
For example, waitresses and waiters are prime targets for audit. Contractors
and subcontractors (like plumbers and electricians) are also another favorite
target. One of the most favorite audit targets of all is multi-level marketers
like Amway and Shaklee distributors.
- The good news is, the audit-proofing and penalty-proofing techniques
discussed in this web-site offer great protection to small businesses against
unnecessary IRS invasiveness.
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When to use independent contractors
- Independent contractors can be a great resource for small businesses
who need help on a part-time basis. Independent Contractors can provide
that help. However, in recent years, the IRS has cracked down tremendously
on the use of independent contractors.
- In all, there are twenty guidelines governing the use of an IC. Three
of the most critical ones are as follows:
- No. 1 - An IC may not work exclusively for you full time.
- For example, an artist may work for an advertising agency upon demand.
If at any time that artist begins to work exclusively for the agency on
a full time basis, that artist must be made an employee.
- If the artist works exclusively for the agency even on an part-time
basis over an extended period of time, a requirement to make the artist
an employee may develop in this case as well.
- No. 2 - An IC must be allowed to work on his or her own
clock.
- Once you set time and place requirements on an IC, you may run the
risk of converting that IC to an employee in the eyes of the IRS. One of
the nation's largest home builders found that job supervisors, once treated
as ICs, were in fact employees because of a contractual arrangement to
be on the job at specific times. In this case, the supervisors were also
prohibited by contract to work for other home-builders. The home-builder
lost the IC status on all its supervisors and was forced to pay back withholding
taxes, penalties and interest.
- No. 3 - An IC must provide his or her own tools of employment.
- Carpenters, plumbers, electricians and mechanics may fall into this
category. To be a true independent contractor, one must provide his or
her own tools of the trade. The plumber must use his own pipe wrench, the
electrician must use his own wire-stripper and a mechanic must use his
own spark plug wrench. If an IC must use the tools owned by the general
contractor, it's pretty hard to claim that IC is independent.
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- Other guidelines apply, and one should not use an IC or classify someone
as an IC if these guidelines cannot be kept. The consequences of losing
all the benefits of IC status are staggering. For all the rules on using
independent contractors, see my book the Taxpayers'
Ultimate Defense Manual and Double
Your Tax Refund..
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Turn your hobby into a business
- One should be shocked to learn that 20% of all small business audits
involve disallowing deductions because the IRS recategorizes the small
business as a hobby. The rule for being categorized as a hobby and not
a small business is one of the most misunderstood rules by small businesses
and tax professionals alike.
- It is a common misconception that a small business must show a profit
in three of five years or it is not entitled to claim expenses deductions.
That rule simply does not exist. What the rule does say is that there must
be the intent to make a profit and the potential to make a profit.
- In the case of Amway distributors, the potential to make a profit is
obviously real. Many people make big money in that business, yet the IRS
has made a system wide determination that all Amway Distributors are nothing
more than hobbyists looking for a way to get out of paying taxes.
- In the case of most small businesses, there is the potential to make
a profit if the IRS would just leave them to tend their business instead
of bogging them down with tons of compliance requirements.
- A good tip for anyone who intends to start a small business is to first
write a business plan that lays out your plan of attack for success. It
should include sales goals, projected expenses and projected revenues.
If it looks like the business may operate for a period of time on a break-even
basis, say so in your business plan. Once again, planning and attention
to the prevention of IRS abuse can go a long way toward the success of
your business.
- By the same token, many people operate a small business and intentionally
don't claim income or expenses or file tax returns. They truly operate
their small business without keeping records and taking advantage of tax
breaks because they don't want trouble with the IRS. There are two problems
associated with this way of thinking.
- First, you may be operating a small business that, if afforded the
ability to write off legitimate expenses, could become very profitable.
The tax benefits of being a small business could be just what is needed
to make that happen. Many would-be entrepreneurs end up cheating themselves
out of an opportunity to rise above the level of hobby by not treating
their small business properly.
- When you know the rules concerning business vs. hobby, you may be surprised
to learn you have the potential to start something very profitable. There
are many companies today that began in someone's garage. Apple Computers
and 3M. Even Bill Gates, the richest man in the world and chairman of Microsoft
Corporation, was nothing more than a hobbyist playing with computer knowledge.
Look at him and his company now.
- The second problem a hobbyist may face is that the IRS may someday
get wind of the fact that you are making things and selling them on occasion.
This is true even though they get paid very little for their time and likely
make no profit when expenses are considered. But, the IRS has been known
to look at a hobby and accuse the hobbyist of making a profit without paying
taxes. When this happens, the IRS is well-known for their propensity to
add income to a tax return and then try to collect tax and penalties for
underreporting and underpayment.
- If you make an occasional profit through your hobby, you are best advised
to treat your hobby like a business claiming income and expenses. You never
know when your hobby may turn into a full-time profit center. You also
never know when you will be called on to disclose the nature of your activities
and subject yourself to undue IRS scrutiny. Double
Your Tax Refund. shows you how to legally convert a hobby
to a legitimate business.
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