I recently attended the national conference of the National Association of Tax Preparers. It was easy to get to as it was in St. Louis this year. As much as I enjoyed taking the classes and meeting new people, sometimes the best information you get at these things is not in the actual classes, but in the scuttlebutt that you hear about what’s going on across the country. One of the issues that people were talking about was that the IRS has really stepped up the audits on Employee Business Expenses (Form 2106).
Just because certain types of forms might be susceptible to an audit doesn’t mean you shouldn’t claim legitimate deductible expenses on your tax return. If you are entitled to a deduction, you should take it. (Let me tell you, Warren Buffet’s not skipping out on his legal deductions). Just make sure you can back up your claims.
If you plan on claiming Employee Business Expenses on your tax return this year, the one thing you’re going to want is a copy of your company’s policy on employee reimbursements. If you get audited for your Employee Business Expenses, the first thing the IRS will ask you for is your official company policy on official company letterhead. If your company has a full reimbursement policy—you will automatically lose the audit. You may not claim a deduction for expenses that could have been reimbursed by your company.
Major companies like GM or Citibank will definitely have a policy. Smaller companies often don’t. To be honest, on more than one occasion I’ve written the reimbursement policy for a small company so they could submit something to the IRS when an employee was being audited. (Now that I think about it, I guess I should write one for my own company).
If you are claiming business mileage, you want to have a mileage log. This is the big IRS “gotcha” because so many people just guess a number and it’s wrong. For some reason, people seem to think that they drive 20,000 miles a year for business. Some people actually do. Some drive even more. But if you say that you drive 20,000 miles for business, you had better be able to back it up with a mileage log. For one thing, “20,000” is like a guaranteed audit flag. If you keep a mileage log, all you have to do is just whip it out and show the IRS agent and you’re done, end of story.
People who claim 20,000 miles and don’t keep mileage logs have a tougher sell. You’ll need outside proof, like your oil change statements to show your overall mileage, plus some type of record to show where you’ve been. Like hotel receipts to prove you drove to various places on business. I charge $100 an hour to recreate those statements for you and it takes time to recreate 20,000 miles. You’ll save yourself a boatload of money and a big headache if you just keep the log.
Don’t make up mileage numbers. I’m serious about the 20,000 being an audit red flag. One audit I worked on the gentleman asked me why I thought he got pulled for an audit. It was obviously his miles. Everything about his tax return had looked pretty normal, except for his 20,000 business miles. Hint: round numbers in multiple thousands look suspicious. He had no mileage log so I had him get me his odometer readings from his oil change company. Well it turns out, not only did he not have 20,000 miles of business driving, he drove less than 5,000 miles during any given year for the past three years!
I’m good at what I do, but this guy wound up paying the IRS some money. I asked him, why did he claim so much in mileage when he only drove 5,000 miles altogether. He said that was what the other guys in his office claimed. Don’t do that! Use your own numbers.
The other thing that gets a lot of IRS attention is the meals and entertainment expense. This trick is so easy it’s ridiculous. Let’s say you take John Smith to lunch to talk about him buying your product. The waitress brings you the check and you get out your credit card. She brings the receipt back for you to sign and add the tip. You also write on the top copy: John Smith sales widgets. Or you may write Jane Doe, advertising; or Fred Bird IT consulting; or whatever. The bottom line is that this note tells you who you were with and what the meeting was about. The receipt itself gives the date, time and place. The waitress may wonder why you wrote about Jon Doe and the widgets on the receipt, but that’s fine, (she’s seen it before.) But by writing on the top copy of the sales receipt, you made the yellow copy a time recording stamp. As the yellow copy of your sales receipt ages it changes color. This shows that you wrote your note a long time ago – remember that an audit will be two or three years after the fact. This proves to the IRS that you were – time for the big word here—contemporaneously recording your business expenses. It gives you street cred with the IRS agent. You took care of business, back when you were supposed to instead of trying to make up stuff after it’s too late.
Bottom line, if you want to audit proof your employee business expenses, you want a copy of your company’s expense reimbursement plan, a solid mileage log, and notations made on the top copy of your meal receipts.
Because of my line of work, I spend more time on the phone with IRS agents than anybody else I know. When I used to work for a big tax company, my co-workers joked that my real reason for calling the IRS so much was because I liked their hold music and I should just buy a radio instead. But the truth is, the IRS is a scary organization for many people to deal with and not everyone can hire someone like me to do it for them. These are my tips for calling the IRS if you’re going to try it yourself:
- The most important rule in the book is to remember your good manners. No matter what you may be thinking, no matter how angry you are about the situation, you absolutely must remember your good manners that your mother taught you.
- You are most likely going to be on hold for a long time. Be someplace where you are comfortable and have something else to do while you’re waiting. Even with my special “Bat Phone” that I get to use for the IRS, I still have to wait on hold. You’re going on a regular civilian line and the wait can be very long.
- Make the call someplace where you won’t be disturbed. I have a home office and a work office. You would think that my home office is the perfect place for making IRS phone calls, except that my dog hates the IRS. I do not understand her problem—she’s a dog, she doesn’t pay taxes; but every time I’m on the phone with the IRS she begins barking like a crazy beast. In my line of work, this is not a good thing. I now make all my IRS calls from work. You probably don’t have the luxury of a designated IRS calling place, but just do your best to limit your distractions.
- You have to make the call yourself; you can’t have your daughter or neighbor call for you. If you can’t call for yourself, you need to be in the room. The IRS agent will want to talk to you personally, confirm your identity, and then you will have to give permission for the IRS to talk to the other person. Even after you give permission, you still have to be in the room.
- If you have a letter or notice from the IRS, have it with you when you call. Call the phone number on the notice that they provide. If you don’t have a phone number, the main IRS phone line is 1 (800) 829-1040—but only use that if you have no other phone number, you’ll wait on hold even longer.
- Be prepared to get transferred and put on hold again. (I find that dark chocolate M&Ms have a calming effect on the stress of being on hold. Just a suggestion.)
- Finally, the moment will come when a real live IRS agent will pick up the phone and will actually be able to assist you without sticking you on hold and forwarding the call again. Ta Da! By now, you could be really frustrated with the hold music and all, but you will remember your good manners and pleasant voice and say, “Hi, I’m ________________, and I’m calling about a notice that I’ve received from your office.”
And now the real conversation begins. The agent will need to identify you, she will ask you questions about your name, birthday, social security number, phone number, etc. Basically, she’s trying to make sure that you really are the person you say you are. Don’t be offended by that, it’s actually for your own protection.
The next part of the conversation will be about why you’re calling. Is the notice wrong? How do we fix it? Is the notice right and you want to find out how to pay the tax? Or maybe the notice is right but you don’t have the money to full pay and need to make arrangements. This is the nuts and bolts of the phone call where you find out what’s needed to end your problem.
I’d say that 95% of the IRS agents who man the phones are actually decent people and they really do want to help you. They might not be able to—they have rules and laws that they must stick to—but most of them genuinely want to be helpful.
So what if you get one of the other 5%, or what if the IRS agent just can’t solve your problem? You don’t have to settle the issue right that instant. Let’s say you get a notice that says you owe $20,000—you can’t pay and when you call the IRS you can’t come to a resolution on the phone. You very politely say, “I’m going to have my representative call you next week.”
If you can’t settle the issue on your own, then it’s time to hire someone like me (an enrolled agent), but at least you’ll know that you’re not wasting money on something you could have handled yourself.
I recently watched President Obama’s LinkedIn townhall meeting on Facebook. Talk about a double dose of social networking media!
I haven’t really blogged about the tax proposals because quite frankly, I prefer to wait until something is actually the law before I post about it. But I found the comments that people were making about the economy and their concerns were pretty relevant and important. If you’d like to read the comprehensive fact sheet, here’s a link to that right here: http://www.whitehouse.gov/the-press-office/2011/09/08/fact-sheet-and-overview
This certainly isn’t every Facebook post from the meeting, I couldn’t keep up with all of them and I did omit items that were off topic. But I found that these posts reflected issues that are certainly facing people today. And I felt they were worth sharing.
• Charles B
I agree that best way to keep Social Security is raise the salary cap. I would recommend a tax rebate, and reinstating the consumer loan interest tax deduction. This would be more effective than deducting the amount going into Social Security using the payroll tax cut.
• Morrie E
How about coming up with an export program that supports already successful small to medium US manufacturers ship their products to the international markets? This takes companies that are already having success and expands their market so they will have to hire more people to meet the increased demand.
• Daisy H
When we have 14 – 26 million Americans unemployed and only 3.5 million jobs available; as Jeff of LinkedIn previous stated, it is obvious, that we need to put lots and lots of resources into helping Americans to create small businesses and hire each other.
• Wendy D
Mr. President: I have been looking for a permanent job fo 15 months. I have found that employers are reluctant to hire the long term unemployed. Can an incentive be given to employers for hiring someone who has been searching for a long time as opposed to hiring someone who alreayd has a job? Thank you.
• Morrie E
Why can’t growing small businesses like mine access the SBA for small working capital loans. Without a good FICO score, the banks will not underwrite the loan. Of course, many small businesses are just recovering from 2008 and now the business owners personal FICO score is now being used instead of the D&B for just the business even if your business is a C corp.
• W Reynolds W
It is a known fact that employers discriminate the unemployed. Even if legislation is passed trying to ban discrimination, the legislation won’t be worth the paper it is written just as it has been ineffective to control discrimination based on race. We need a universal employment policy that is based on economic reality.
• Norman Wade P
When the times are tough, you take care of home first. America is our home, take care of schools, manufacturing, construction, medical invsestment, transportation, environment.
• W Reynolds W
The President has been pushing infrastructure repair as part of his American Jobs Act bill. He would be wise to focus on repairing employment legislative infrastructure to stimulate true jobs growth.
• Shashank M
The guy who has obviously made tons of money in Silicon Valley business stands up and wants his taxes to be raised. Fine – do that. Why wrap the rest of us in it. Not all of us have minted money so we can afford to be “unemployed out of choice”! And no – you did not invest in my education. I paid every dollar out of my earnings.
• Susan S
What is the point of all this discussion when we all know the rep are never going to allow your reforms. I have been out of work for 2 yrs due to medical issues and am still waiting for a hearing with SSD I will lose my home before I even get to Hearing after owning my home for 25+ yrs. whats fair about that after paying into SS all these years They are dragging their heels long enough to lose it after all these years
• Vickie T
Mr. President, I have been laid off for almost two years. Working in the IT world. I need the immediate training and now!!! Not next week! Now!
• Ben K
In the current economy, a lot of people, myself included are working as contract workers, and not employees and receive limited or in some cases no benefits, and are part of what has come to be called the Permanent Temporary Workforce and have been for a year or longer, as I have been. What is your plan to help companies hire contractors and other temporary workers as employees?
• Wendy D
Retraining will work for most. But there are many like me, 60 yrs +, who don’t have time to retrain. We need jobs now, in our areas of expertise, or we are domed to living in poverty as we age.
Mr. President , take the debt off the backs of the American not the big corporations and banks, have a good day!
•Joseph G Jr.
I don’t have problems finding work even though for the past 10 years it has come in the form of contract work but finding a permanent job or starting my own business is my motive though I can’t seem to make enough money to make my business grow and getting a small business loan is out of the question in this economy. I’m a contractor in the Information Technology field who badly wants to start my own business and I’m full of ideals and have a deep passion for technology and a desire to lead and help others, how can I get the funds I need to grow, hire employees and compete in today IT industry without going into financial ruins getting business loans?
Education is important but at this point and time it is secondary until we manage to keep jobs in the US. Also we can’t all be in management. We need the blue collar worker too.
Back to me again. Here’s a link to the White House Press Release about the event. http://www.whitehouse.gov/blog/2011/09/26/president-obamas-town-hall-linkedin-we-are-thing-together?utm_source=092711&utm_medium=blog&utm_campaign=daily It has the video and the written transcript if you’re interested. Thanks for reading.
I was talking with a small business owner the other day and she told me this story:
I have a friend who’s really hurting. She lost her job about six months ago and she just can’t make ends meet. She’s having a hard time even putting food on the table. I wanted to help her out so I had her come help me with a project at my business and I paid her under the table. The thing is, she really did a good job and I could really use some more help but I can’t afford to pay her under the table any more.
Let me make one thing perfectly clear: Never pay anybody under the table!
First, it will come back to bite you in the behind one way or another. Trust me, I do a lot of audit work. “Under the table” doesn’t help anybody. You don’t get a deduction for paying “under the table” and the person you paid can wind up getting audited and get stuck paying tax on that money anyway. It’s a lose/lose situation.
If you really want to help someone out, but you can’t officially give them a payroll job, hire them as a contractor. Do the whole thing, have them fill out a W-9 form, and explain that you’re hiring them as contract labor. Tell them they’ll have to pay taxes on the money: 13.3% for self employment tax plus any additional income tax for their tax bracket.
Hiring someone as a contractor gives you a “triple good” effect. First, by making your friend contract labor, you can write off the money you give her as a tax deductible expense. If you’re paying 40% on your self-employment income, that $100 you pay is really only costing you $60. Plus, you’re getting a benefit out of it too because you’re getting the benefit of her labor. And third, your friend has a job. It might not be a full time job, it might not pay all the bills, but it’s something to put on the resume to show that she’s working. News reports are saying that employers won’t hire someone who has been out of work for over six months. That contract labor job gives her a better chance at finding real work. Plus, it allows her to use you as a reference. (Okay, I guess that makes it four benefits, not three. That sort of makes me the accountant who can’t count. Maybe I should hire someone to help me with that.)
But what about all the reporting requirements? With contract labor, all you have to do is prepare a 1099, which is due in January. You can get the forms free from the IRS. It’s easy. You only have to submit 1099s if you pay someone over $600 so if you’re just helping someone a little, you don’t even have to worry about that. I’ll make a how-to post in late December, so you can do it yourself. (My fiendish plan to get people to come back to my blog.)
What about all the new tax incentives for hiring that the president has proposed? So what about them? Right now, that’s all they are—proposals. Congress may or may not pass some or all of them. We have to run our businesses and our lives in the present tense. I’ve tried waiting for Congress to pass bills before—it’s bad business. Hiring someone as contract labor is a good quick fix for your staffing problems and it’s a good quick fix for someone who may need to eat.
Who knows? Maybe that contract laborer you hire will be the key to you making big profits.
I love tax-free income. The great thing about tax-free municipal bonds is the tax-free part. The downside is that they usually pay a lower interest rate than taxable bonds. For many people, tax-free trumps taxable every time—but you have to be careful because they’re not always the best deal for everybody. This is what you need to know:
1. While municipal bonds are tax-free on your federal return, they may be taxable on your state return. Usually, if the municipal bond is for your own state, then it’s not taxable. For example, here in Missouri, if I buy a bond from St. Louis County—that’s not taxable on my Missouri return. But if I bought a tax-free bond from New Jersey, then I’d pay tax on that interest. Buying at home gives you better bang for your buck.
2. Even though your municipal bond interest isn’t taxable, it could make your Social Security income taxable instead. Say what? That sounds a little crazy, doesn’t it? Let’s say you’re a senior citizen with moderate income. You’ve got your social security check, a small pension, a little interest from a CD and a bank account, and most of your other cash tied up in tax-free municipal bonds. With social security income, you’ve got that funky formula where you take half of the social security and add it to the other income and if it crosses the threshold, then part of your social security benefits become taxable. Are you rolling your eyes yet? The computer does this all for you right? But – and this is the important part—your tax-free municipal bond interest gets added into that equation. If you’re one of those borderline seniors, that tax-free bond isn’t saving you as much money as you thought. You might want to look at other, higher return investments.
3. The dreaded AMT. If you’re a high income earner, tax-free income sounds like a great investment doesn’t it? But you’ve got to be careful if you’re dealing with the Alternative Minimum Tax. If you’re in the AMT zone, you want to stay away from what’s known as a “private activity bond.” A private activity bond is when a company like GM wants to raise money, but instead of GM issuing a bond itself, it has the local government issue a bond for it (for example for building a plant in the area). It’s still a tax-free municipal bond, but it’s actually for a private business so it’s called a private activity bond. If you’re an investor that doesn’t have to pay AMT taxes, you’re fine, you get all the benefits of tax-free income. If you’re paying AMT, then you’ve lost all the benefit of the tax-free income. Private activity bond income is taxable under AMT rules.
With the stock market going crazy and many people turning to bonds, it’s important to know the real tax effects of “tax-free” on your tax return.
Perhaps I should subtitle this: Who Are All These Rich People Who Don’t Pay Any Taxes and How Come I’m Not One of Them?
It’s frustrating isn’t it? You work hard for your money, you’re taxed at 28-35% federally, plus your state tax, real estate tax, sales tax, etc., and then you hear on the news about all these rich people who don’t pay enough in taxes. Makes you want to scream, doesn’t it? And I haven’t even mentioned AMT yet!
As a wage earner, you’re kind of stuck (The rich people with really low income tax rates aren’t wage earners like you, but I’m guessing you knew that anyway.) You’re going to receive a W-2 that reports your income and – let’s face it – it is what it is. But that’s a good thing, be glad you have a job that earns you good money. But the goal here is find ways to reduce that taxable income.
Easy one first: max out your 401(k) plan. This one is so basic I wouldn’t even think to say it, but I’m shocked and amazed by the number of high income wage earners who don’t do this. Those of you who work for companies where you get kicked out of the plan because not enough lower income employees participate are exempt from this scolding-that’s a whole other problem that I don’t have a cure for. But if you’re making enough money to be reading this post, then you need to maximize your 401(k) contributions. For 2013 and 2014, the maximum amount you can defer is $17,500. (If you’re in the 33% tax bracket, then that’s over $5,000 in tax savings!) If you’re over 50, you may defer $23,000.
Cafeteria plans: These are those other services that you can set aside money for—tax free, to be used later to pay for health care or child care expenses. Some companies have a huge selection of these benefits, but health and child care are the two most common ones. There’s a hitch with cafeteria plans though, it’s use it or lose it so don’t put aside more money than you intend to spend.
People often ask about the tax credit they can get from paying for day care service and don’t they lose the credit if they pay for day care through their work. That’s true. But look at the reality—at your income, the best you’re going to get in a tax credit is 20% of what you spent on daycare. By paying your child care expenses out of your cafeteria plan, you’re saving whatever your tax rate is so you’re better off. Any child care money that wouldn’t qualify for the child tax credit will be regular taxable income to you.
As a high income earner, you’ve probably already met my not-so-good friend Mr. Alternative Minimum Tax. The AMT winds up costing you many of the deductions that other taxpayers usually claim, but this is a tip that’s important for you to know. While the AMT may eat away many of the deductions that you could have claimed on your Schedule A form, it’s still a good idea to do the paperwork anyway. Depending upon what state you live in, you can often claim your itemized deductions in your state even though they were lost on your federal return. Not all states do this and you might need to play around to see what works best for you.
For example: here in Missouri, you can’t claim a deduction for your state income tax paid, but if you substitute state sales taxes paid on your schedule A then that’s still a deduction. For most people, state income taxes paid is a much bigger deduction than state sales tax. But if you’re dealing with AMT then claiming the lower state tax amount paid doesn’t change your federal taxes—you’ve still got the same tax liability either way. So, in Missouri you’ll want to claim the sales tax rate instead of income tax so that you get the larger deduction on your Missouri state taxes. Also, by doing this it makes your state refund not taxable for next year, and let’s face it, you don’t need any more taxable income.
Many of the tax programs give you updates on how an item on your tax return affects your federal taxes. If you’ve played around with this you’ve probably given up claiming certain deductions, (like state income tax and employee business expenses.) But make sure that you check the value that these deductions have on your state return, you don’t want to miss out on anything that you can possible claim.
I’m posting this in September of 2011—that means we have over three months before the year is even over. If you’re asking this question now, it means you’re expecting a refund—which is good—but the bad news is you’re not going to see it for quite a while.
Hopefully, here are some answers you’re looking for.
Although the IRS hasn’t posted any official dates yet, generally, the first day that you can e-file a return will be the day after Martin Luther King, Jr. Day—basically the middle of January. Please don’t hold me to that, Congress can always come in and mess things up, but that’s usually the earliest you can e-file.
Last year, because Congress had slowed up the e-filing for lots of people’s returns, folks asked, “Can I just mail my form in before the e-file date if I’ve got everything done?” The answer is “No, don’t.” The IRS will just toss your mailed return in a corner and not open it until they’re allowed to and your return will get processed slower than the e-filed returns so you really don’t want to do that.
What about those loans you can take against your refund? When do they start and who has them? That’s a really good question. Last year, the IRS changed its practice of providing something called a “debt indicator.” If you filed a tax return through a company that issued Refund Anticipation Loans, the IRS would send back information saying whether you had a federal tax levy against you or not. If there was no “debt indicator” then it was safe to assume that the bank issuing the Refund Anticipation Loan would get its money. If a taxpayer had a debt indicator flag, then they wouldn’t get the Refund Anticipation Loan.
The problem is that the IRS refuses to issue a debt indicator anymore so banks aren’t willing to take the risk. Refund Anticipation Loans have virtually dried up. Last year, only one tax business in my area offered a Refund Anticipation Loan but it was limited in scope.
The Advance Refund Anticipation Loans or Christmas Refund loans were pretty much based on the same principal. As of this writing, I know of no one who is issuing advanced money for the 2011 tax year. If anyone is, it’s doubtful they’ll offer that program anytime before Thanksgiving.
Is there anything I can do to get my hands on my tax money? In 2011, probably not: Congress repealed the advanced EITC law which used to allow you to claim your EITC in your paycheck. If you have federal income tax withholding taken from your pay (not Social Security and Medicare, but federal income tax) you can change your withholding so that you get more take home pay. There’s a calculator on the IRS website that can help you figure out how many exemptions to claim. http://www.irs.gov/individuals/article/0,,id=96196,00.html
You’ll want to have your most recent pay stubs and your last tax return handy as you fill in the answers. It’s a pretty good indicator of what your refund will look like come tax season and if changing your W4 could benefit you.
A word of caution: The IRS clamped down on Refund Anticipation Loans because it felt that those loans were harmful to consumers. They basically put the big tax companies out of the loan business because they have to follow the rules. Sometimes, shady guys slip through the cracks. So here’s the warning—if you find a tax business that does refund anticipation loans ask a lot of questions. How long have they been in business? What happens if there’s a problem with your return? How will you get your money? How long will you have to wait for your money? What are the charges for the loan, for the tax preparation, etc.? If you don’t feel safe, if your questions aren’t answered to your satisfaction, then walk away.
You can get free tax preparation from VITA or the IRS. If you have a bank account, you can have your refund direct deposited within two weeks of filing. You’re already going to have to wait for a few months anyway, if you can hold out for just a little bit longer you can save yourself hundreds of dollars—money that you can spend on you, your kids, your rent, etc. Good luck.
A question that I’ve heard a lot lately is, “How much damage will an IRS lien do to my credit score?” I recently heard that question again at an IRS panel about liens and they couldn’t answer the question either. I decided to do some research.
The term FICO score comes from a company called Fair Isaac and Company. They developed a computer software program that most of the credit bureaus use to determine your credit worthiness. Because the computer software is the Fair Isaac and Company’s business (and source of their income), they don’t release the mathematical formulas they use to determine the scores. If they did, no one would buy the software, people would just recreate the program and figure their FICO scores themselves. How any one event, such as an IRS tax lien, might affect your personal credit score is a pretty well guarded secret.
That said, there are a few things I can tell you.
- Although I can’t say by how much, I can tell you that an IRS tax lien will make your FICO score go down.
- Although many debts will come off of your credit report after 7 years, an IRS tax lien will never come off your credit report unless it’s paid.
- Once you have paid off your IRS debt, the IRS will automatically issue a lien release. Even with the lien release, the IRS tax lien will stay on your credit report for seven years.
Seven years! But there is something you can do about that. An IRS Lien Release is basically an automatic procedure that happens after you pay off your tax debt. You pay the bill, the release is issued and your credit still stinks. But you can take action.
What you want is an IRS Lien Withdrawal. An IRS Lien Withdrawal expunges the tax lien from your record as if it was never filed. This is what you want to do to bring your credit score up. In order to get an IRS Lien Withdrawal, you have to request it with a special form. Here’s a link to get it: http://www.irs.gov/pub/irs-pdf/f12277.pdf. It’s called form 12277. Remember, every IRS form has a name and number.
You can request an IRS Lien Withdrawal even if you haven’t paid your taxes in full, you just have to have a direct debit installment agreement set up and make a few payments. I have some more information about that in another post: http://robergtaxsolutions.com/2011/06/irs-liens/
An IRS tax lien can do some damage to your credit report, but you have the power to fix it.
I’ve gotten this question twice in the past week so I thought I’d post it on my blog:
I pay my estimated taxes out of my personal account, but really I’m paying estimated taxes for my small business, shouldn’t I take the money out of my business account?
That’s a really good question, and the answer is “It depends.” If you own a C corporation, then the answer is yes. But most of the small businesses I deal with are Sole Proprietors and Sub S Corporations; if you have one of those, the answer is NO!
Here’s why Sole Proprietors and Sub S Corporation Owners should not pay their estimated taxes out of their business accounts: All of the profits from these kinds of companies are taxable to the individual that owns them. The companies themselves pay no tax, the individual owner does. Because the owner, not the company, owes the tax, the owner must pay from his personal account.
Let’s do an example: Daisy Duke owns Daisy’s Delightful Doggie Daycare (D4). It’s basically a pet-sitting business she runs out of her home. Daisy’s pretty savvy about accounting, so she maintains a separate bank account for her business and she claims every legal deduction she’s entitled to. She runs all of her business expenses through her business account.
For the quarter, Daisy has $10,000 of income and $6,000 of business expenses. She wants to make an estimated payment on the remaining $4,000 of income. Daisy determined that she spends 40% of her net income on federal taxes so she’s going to send $1600 to the IRS. This check is not written on the D4 checking account, but instead on Daisy’s personal account.
Note that Daisy runs all of the business expenses through the business account, but because the taxes are not considered to be a business expense, they can’t go in there. If Daisy were to take her kids to Chuck E. Cheese’s for pizza, she would not pay for that out of her D4 account either. Now it’s sounds crazy equating estimated tax payments with Chuck E. Cheese’s Pizza but to the IRS’s eyes, they’re the same thing—a personal expense.
So here’s the next question that people always ask: What if Daisy doesn’t have enough money in her personal checking account to pay the taxes? That’s another good question. Remember, though, that the reason Daisy has to pay estimated taxes is because she’s making a profit. She’s got that $4,000 of profit sitting in her business bank account. She can make a payment to herself because she owns the company. She’s paying herself a draw (or maybe with an S Corp a salary), but when you own the business and you have a separate business account, you are allowed to pay yourself from the account.
Next question: But isn’t it a waste of time? Aren’t you writing two checks-one to Daisy and then one to the IRS, when writing one check directly to the IRS would solve the problem? No, it’s not a waste of time because it’s worth the extra five minutes to keep your books straight.
If you keep your business books strictly for business, with no personal expenses running through there at all, the IRS is going to think you’re pretty boring and not worth wasting much time on trying to audit you. This is one of those times where boring is good! Remember, paying your estimated taxes out of your business account is seen to be the same as taking your kids to Chuck E. Cheese’s Pizza. It’s a cheesy expense! (Sorry, that pun flew out of the keyboard, I couldn’t stop it.)
Many small business owners get into tax trouble because they wind up using their business accounts for personal spending. While your estimated tax payment seems like it would be a business expense, it’s not and you have to keep it separate.
You should never take cash out of the ATM using your business bank account. Never.
If you never have and never will take ATM cash out of your business account, you’re done here. Go read a different post, I’m not worried about you. If you still think it’s okay to make a cash ATM withdrawal from your business account, keep reading. Imagine you’re routinely getting whacked upside the head with a rolled up newspaper about every two minutes until you learn this lesson.
Why not use the business account for the ATM?
1. It’s a blazing red flag to the IRS that you’re doing something naughty. Even if everything you do related to your ATM withdrawals is 100% legitimate, to the IRS it says, “I’ve been a scumbag! Make me pay more taxes!” It’s really not a message you want to convey.
2. It’s bad bookkeeping practice. You have income and expenses. You take money in and you spend it. You need to account for how you spend it. An ATM cash withdrawal doesn’t give you the paper trail you need for your expenses. Even if you’re good about keeping those receipts (and believe me, you’d be the exception) you’re still stuck with issue number 1 – blazing red flag to the IRS.
But I own the business and it’s my money, why can’t I just make a withdrawal? Good question. Let’s say you’re just a plain sole proprietor, nothing fancy. You’re absolutely right; that’s your money and you’re entitled to use it as you see fit. If you’re keeping a separate bank account for your business, then you should write a check from your business to you for your “draw”. That’s legit and it gives you a paper trail. Whenever you take money from your ATM, it is considered as going to you and you’ll be taxed as that being your profit.
Here’s an example: Fred takes $200 a month out of his business account to pay some contract laborers. He occasionally hires some kids from the local football team to help him with his moving company. He pays the boys in cash and has never paid any one boy more than $600 so he hasn’t had to issue a 1099 (1099s must be issued if you pay $600 or more.) Fred gets audited by the IRS. He’s claimed $2400 in expenses for contract labor. That’s the $200 a month cash he’s paid to the boys on the football team to help him with some moving projects. What the IRS sees is $2400 in ATM cash paid directly to Fred and they charge him $1200 in taxes and penalties for under-reported income. Fred will have a very difficult time fighting this. It’s possible that he can fight and win, but why be in that position in the first place?
Let’s move it up a notch, what if Fred has an LLC-a limited liability company? Let’s say Fred takes an ATM withdrawal from his business account so he can take his wife out to dinner. Once again, its Fred’s money and he has that right. But now Fred is treating his business account as a personal account. This messes up his “limited liability” status. If you don’t keep a strict line between your business account and your personal account, you risk losing your limited liability protection. This makes it even more important for Fred not to use his business ATM card for cash if he has an LLC.
How’s your head? Been smacked enough times? Bottom line: never make an ATM cash withdrawal from your business bank account. If you want to pay yourself, write yourself a check. If your business needs to use cash, set up a petty cash account and fund it by writing a check for petty cash. A clean paper trail will keep the IRS off your back and that means money in your pocket.