With tax season upon us, we sat down with Todd Zgoda, CPA, and asked what he considers the top five accounting mistakes clients experience.
Filing Tax Returns Late
Paychex: Filing late tax returns is a common problem year after year. Can you explain the potential penalties associated with filing late and how business owners can avoid it?
Todd: The Internal Revenue Service (IRS) and/or state agencies can and will impose penalties and interest for failing to file a tax return or form by the mandated due date. Even one day over constitutes being late. In addition, there are several types of penalties that can be imposed for the same offense—the penalties can be significant.
For any return or form that allows for filing an extension of time to file, make sure that you either file that form/return electronically or mail it by certified mail. Without documented proof that it was filed, the government does not have to accept the extension as timely filed.
Even if you don’t have the money to pay your taxes by the due date, you should at least file on time to minimize any additional penalties and interest. Paying your taxes late will certainly get you assessed some significant penalties and interest. However, you don’t want to tack on additional penalty and interest for filing the form/return late.
Paychex: Can you give an example?
Todd: Sure. If you fail to pay your New York State Sales Tax on time, you will be assessed a 10 percent penalty based on the tax due with the return. In addition, you will lose the privilege of claiming the vendor tax collection credit if you were entitled to claim it. Furthermore, the first-time offense for filing the return late carries a $50 penalty. Many taxpayers make the mistake of not filing their New York State Sales Tax return because they did not have a tax due. A return must always be filed until you file a final return with New York State in which you surrender your Certificate of Authority to collect sales tax.
A good rule of thumb is to always file your return. The IRS is quite willing to let you pay your taxes in installments. By entering the installment agreement, it will keep the IRS from placing liens on your assets and/or levying your bank accounts.
The good news is that if you are assessed penalty and/or interest and it is your first offense, the IRS and state agency will typically abate the assessed penalty and interest—if the taxpayer or the taxpayer’s accountant writes a letter asking for forgiveness and provides reasonable cause as to why the return was filed late. Once you have used up your one free pass, you will likely be out of luck if it happens again.
Paychex: Business owners tend not to maintain a good record of expenses. Can you outline common recordkeeping mistakes and how to avoid them?
Todd: Yes, taxpayers often fail to keep good records of their deductions for both personal returns and business expenses.
First and foremost, keep a mileage log. This must contain the date, where you went for business, who you met with, the business purpose, and the number of miles driven. In addition, the taxpayer must keep proof of their total miles driven during the year. This could be from oil change receipts, car registration, or any other document from a third party that shows your mileage at a given date.
Failing to keep copies of both canceled checks and letters from charitable organizations where you made donations is also a common mistake. It’s worth noting that there are different rules depending on whether the donation is above or below $250.
It’s also important to keep copies of meal receipts. According to the IRS, you must document on the meal receipt who attended the meal and the business purpose of the meal.
Finally, failing to keep receipts in general is a common mistake. Many taxpayers believe that providing a credit card statement will be sufficient under audit and throw out their receipts. While some charges on a credit card may be clear as to what was purchased and the auditor may accept it as sufficient proof, the auditor has the discretion to disallow the expenses if the actual receipt is not produced, per IRS guidelines.
Business Owners of Sole Proprietorship
Paychex: Business owners often forget to summarize their business activity. What is the importance of producing a balance sheet and a profit and loss statement and how can a business owner easily do this?
Todd: Although it isn’t required, I recommend that the business owner summarize their business activity in accounting software, with something like Paychex Accounting Online. This should reduce many errors because the software package will do the adding and subtracting for you. If you fully utilize the software package, it will allow you to produce a balance sheet and profit and loss statement for the year. It also has the capability to reconcile your annual cash activity. If you perform this function correctly, it will reduce the chances of adding expenses incorrectly, duplicating expenses, or omitting expenses.
Too many times, a sole proprietor walks into his accountant’s office at tax time with a sheet of paper with subtotals of expenses by category. Fast forward a year or two when the IRS or State sends the taxpayer a letter that they would like to review all the records that support the deductions claimed on Schedule C of Form 1040. As the taxpayer begins to scramble looking for the records and begins reviewing the total provided to the accountant, they realize that they added incorrectly, duplicated an expense, or failed to claim an expense. If a client doesn’t keep well-organized records, this process can be quite burdensome to locate all the receipts for the expenses claimed. On the other hand, if the taxpayer had entered all of his records into an accounting software program, a report could be run to show the detail of the expenses claimed by category.
Again, by using a software program correctly, it will most likely minimize the mistakes I just mentioned, but it will also likely save the taxpayer a great deal of time figuring out what documents need to be located since the reports will provide the date of expense and how it was paid.
Paychex: A lot of business owners don’t know they can save thousands of dollars on common tax deductions. What are some of the deductions you see small business owners failing to take?
Todd: Here’s a common example: a business owner is out of the office and about to make a company purchase—only to discover that he forgot the company checkbook and credit card. What does he do? The next best option is generally to pay for the purchase with cash in their pocket or to use a personal credit card. To make matters worse, the owner forgets to turn in the receipt or mention the purchase to the accounting department (if he has one) or his accountant at the end of the year. This could be a huge lost deduction for the owner—and the owner will end up paying more taxes.
Many business owners make several small purchases throughout the year and think it’s no big deal; it was just a few bucks here and there. Most people fail to realize how quickly little things can add up over the year, not to mention over multiple years.
Another common missed deduction for business owners is failing to keep track of any business miles they drive with their personal vehicle. Again, a few miles here and there, several times a year, can really add up. At $.56/mile, the overall deduction can be significant.
The final point of the two missed deductions I just mentioned is that not only is the owner paying more taxes for failing to claim these expenses, the owner is out the money personally. With proper documentation, the owner is entitled to be reimbursed by the company.
Paychex: Understating and overstating expenses can potentially cost you more in income tax and leave you in the dark with your business’ financial position. What are some common expenses that your clients misclassify?
Todd: One of the most common misclassifications is with mortgage and loan payments. Failure to properly break out principal and interest—and in some mortgage payments, escrow as well—can lead you down the wrong road. Some taxpayers will classify the entire payment to either the loan balance or interest expense. Without matching the monthly loan statement—where you’ll find the remaining mortgage/loan balance—to the accounting records, the taxpayer may not realize that he has understated or overstated his interest expense.
Another common misclassification is paying workers as independent contractors rather than employees. You can refer to 1099 Employee vs. Independent Contractor to learn more about the differences between the two.
Finally, company meals are another commonly misclassified expense. Many taxpayers believe that businesses only get a 50 percent deduction for company-related meals. While this is true when a company takes out another person—for example, a prospective customer or colleague—and discusses business, there are times when meal-related expenses are 100 percent deductible.
Paychex: Can you give some examples?
Todd: Of course. Sometimes a company will purchase breakfast, lunch, or dinner for the whole staff. Or, as a thank you, a company owner may spring for lunch. Other times, a meal purchase is used not as a thank-you, but as a convenience to the employer. This happens when an owner provides lunch or dinner so that the staff can remain on the work site and produce more for the company.