Mistakes Small Business Owners Make That Can Cost Them…DOH!

I was recently the presenter at a small business roundtable discussion that was geared toward small business owners. The facilitator asked me to discuss some mistakes that small business owners make that can cost them money, and to come up with a title. I gave it about a half second of thought, and realized that he already gave me the title, but took out ‘money’ and replaced it with the play on words (dough, and Homer Simpson’s cry when he does stupid things). My presentation lasted about an hour, and I won’t bore you that long, but hopefully some of these items will help you prevent your own “DOH!” moment.

1-Former W-2 employees becoming business owners/independent contractors: When you’re an employee, it’s so easy to just fill out your W-4, claim single-0, married-1, or whatever withholding exemptions, and the employer deducts the taxes for you and pays them in to IRS and the state. All you have to do is file your tax return and get your refund. This all changes when you become a small business owner or independent contractor. There’s nobody to withhold tax and pay it in for you; you need to do it yourself! If you’re an unincorporated entity (sole proprietor, partnership, single or multi-member LLC), you need to pay your taxes in to IRS and state on a quarterly basis, via estimated tax payments. Not only do you have to pay income tax, but on the federal level you also have to pay in self-employment tax.

“DOH!” You can be subject to underpayment penalties if you don’t pay enough tax in during the year. The penalty is 3% of the underpayment, and a late payment penalty and interest can be assessed if you’re not paid in full by April 15th. This “DOH” moment can be avoided with proper planning (with help from your favorite CPA, of course)

2- Employee vs. independent contractor: In this case I’m talking about the people you pay, to do work for you. If you pay somebody as an independent contractor, you give her/him a check for whatever the fee is, and at the end of the year, if you’ve paid that person $600 or more, you give her/him a 1099-MISC. When you pay somebody as an employee, you have to withhold taxes, pay them in to IRS and state, file quarterly payroll tax returns, issue W-2s, pay state and federal unemployment insurance and other benefits. What an expensive headache…makes you want to just pay somebody as an independent contractor, right?

“DOH!” IRS and the states have stepped up their scrutiny of the misclassification of employees as independent contractors, and are coming down hard. The determination of employee vs. independent contractor is ‘facts and circumstances’ driven, and you need to understand this, before potentially owing all sorts of penalties and taxes. This one can cost you BIG time.

3-Not making payroll tax deposits: Sometimes a business owner will have cash flow problems, and will skip making payroll tax deposits, which can be a significant amount of money.

“DOH!” Taxes withheld from employees are not the employer’s money, but are considered ‘trust funds’, and must be deposited on a timely basis. The penalty for failing to do this is 100% of the amount that was supposed to be remitted. What’s more, the “responsible person” for making the tax deposits (generally the business owner) can be held personally liable for any tax not paid. Don’t even think of not making payroll tax deposits.

There are a bunch of other “DOH!” moments that I want to discuss, and now that I’ve gotten into this, I think I’ll continue this next week. If you’re not embarrassed, please leave a comment about a less than bright decision you’ve made while running your business, and please forward this article to anybody you know who could use some good advice. Stay tuned for part 2 next week.

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AMT…WTF?!

Once upon a time, high income taxpayers were able to pay little or no income tax, because they were able to take deductions and credits for things that the average taxpayer couldn’t. IRS created the Alternative Minimum Tax (AMT) in 1969, in attempt to eliminate some of the benefits of all the deductions that high income taxpayers were getting, and generate at least some amount of tax.

The major problem with the AMT (and IRS recognizes it) is that it’s not indexed for inflation, so over the years, more and more middle-income taxpayers are finding that they’re owing more tax based on the AMT. I’ve seen this countless times over the years with my clients, and have had the same conversation with many people, often with the conversation starting out with the title of this article!

The AMT is computed on Form 6251. Generally, the computation starts with your adjusted gross income (AGI) less your total itemized deductions (line 41 of Form 1040). From this number, “alternative minimum taxable income” (AMTI) is computed, generally by adding back certain deductions that are allowable for the regular tax computation. For most taxpayers, the ones that come up most often are the itemized deductions for taxes and the miscellaneous itemized deductions. There’s a long list of other deductions and “tax preference” items that need to be added back to arrive at AMTI, but they’re beyond the scope of this article.

After arriving at AMTI, taxpayers are allowed an exemption amount, and the remaining amount will generally be subject to a tax rate of 26 or 28% to come up with the tentative minimum tax. Once this tax is computed, the amount is compared to the regular tax on the Form 1040, and if the minimum tax is higher, than bingo, you lose, and wind up with the AMT.

The 2011 AMT exemption amounts are $74,450 for married filing joint taxpayers, $48,450 for single and ‘head of household’ taxpayers, and $37,225 for married filing separately taxpayers. If your taxable income for regular tax purposes is higher than these exemption amounts, the AMT may apply to you, and you need to fill out Form 6251 to see if you are in the AMT.

I’ve attempted to make this as understandable as possible. If you think you might be in the AMT, it would probably be a good idea to have a tax professional prepare your taxes. Please pass this article along to your fellow taxpayers, and leave a comment if you’ve had a ‘run-in’ with the AMT.