High Risk Tax Areas for Small Businesses

It’s scary keeping an eye on Washington and tax-related legislation that has been introduced in Congress these days. Because of  large and growing annual federal budget deficits, it seems bill after bill has been introduced this year to attack what are perceived to be major tax gap components. And many of these bills are directed at subject areas that are of particular interest to smaller businesses.

The latest rumblings that are cause for concern and awareness involve legislation that has been introduced to take aim at the mis-classification of employees as independent contractors, and the curtailment of the long-standing “safe harbor” provisions of  Section 530 of the Revenue Act of 1978, which provided some objective guidance and protection for businesses in this area.

The back taxes and penalties that could be assessed upon reclassification of independent contractors as employees by the IRS could be expensive, and in some cases catastrophic, to a small business. And with the knowledge that President Obama’s budget for the 2011 fiscal year includes $25 million for the hiring of 100 new “enforcement personnel” focused on misclassification, it reinforces the fact that well run small businesses  should take at least the following initial steps to reduce the risk in this area if they use independent contractors:

  • Review with your CPA and/or attorney the IRS 20-factor common-law test, which the IRS utilizes for classification purposes. Determine that you are comfortable with your classifications based on the test. Where you have the ability to “tweek”  relationships (as per the 20- factor test) to more clearly reflect the fact that you have independent contractors versus employees, do so.
  • Execute a written independent contractor agreement with all contractors. The agreement can be very simple, should mention the treatment of the individual or entity as an independent contractor, not an employee, and all language should be consistent with the independent contractor relationship.
  • Obtain a Form W-9 from all independent contractors, and file timely Form 1099′s on an annual basis.
  • Finally, if  you have individuals you are treating as independent contractors who should clearly be employees, then change your relationship accordingly. That will be the best and cheapest decision in the long run.

Small Businesses – Conserve Your Cash

This is just a short post to remind small business owners that Wednesday, September 15th is the deadline for another estimated income tax payment. For those of you who are making payments based on 2009 income taxes, remember that your estimated payments can also be based on 2010 actual income. So, if you project 2010 profit levels in your business will be down significantly compared to 2009,  it would be worth preparing a quick projection of anticipated 2010 taxes, and base your estimated payment on the lower expected level of taxes.

Other areas that should be looked at by small businesses to conserve a little cash as we move toward year end:

  • If you have hired any new employees since the first quarter, make sure you are taking advantage of one of the significant benefits of the HIRE Act, whereby employers are exempt from paying the 6.2% OASDI portion of  FICA taxes on wages paid, for certain formerly unemployed workers.  If you missed taking advantage of this exemption until now, you will be able to obtain a refund for any OASDI taxes paid for employees who should have been exempt.
  • Finally, if you are an owner of a Subchapter S company, are having trouble funding your salary and/or the related payroll taxes at their current level, and can fund your personal living expenses from sources outside the company, then don’t hesitate to cut or discontinue your salary for a period of time.  Although there is a need to take reasonable compensation, it appears that inability to pay is strong evidence that what you’re currently paying yourself is unreasonably high.

Small Contractors – Don’t Miss This Deduction

When we are fortunate to obtain a new construction industry client, the tax deduction which we find has been missed most often by their prior tax preparer is the Domestic Production Activities Deduction (DPAD). The DPAD began in 2005, as a deduction equal to 3% of qualifying income. It increased to 6% for years 2007 through 2009, and will increase to 9% in 2010.

Qualifying income is essentially that portion of taxable income earned in the US attributable to certain manufacturing and domestic production activities. The good news for those involved in construction as a general contractor, builder or trade (for example, a mechanical contractor, electrician, mason, etc.), is that construction of new buildings and structures, as well as substantial renovation of existing structures and facilities, are qualified activities for purposes of the DPAD.

The form of tax entity we work with most often are S corporations. As it relates to S corporations, each owner is allocated his or her portion of qualified production activities income and W-2 wages (note that the DPAD is limited to 50% of W-2 wages paid by the company). Each individual owner then calculates his or her DPAD on their Form 1040.

Admittedly, the past several years have not been good ones for those involved in the construction industry. However, we still see our share of companies who have achieved significant profits during this period. In the last month alone, we have amended returns for two new construction industry clients, owners of S corporations, whose collective refund for years 2006 thru 2008 is in the $5,000-$10,000 range.

If you are an owner of a profitable construction company, you should check to make sure the DPAD has been taken on your Form 1040.