Written by Luke Frye
Photo by Ahmet Sali
Tax filing and small biz accounting are complicated at the best of times. So, as a CPA for photographers and creative biz owners, I spend a lot of time busting tax myths for new clients.
Here are some of the most common tax myths that trip entrepreneurs up. Avoid them all and file a better tax return this year.
You can deduct clothing
Sorry, gotta bust this one... The IRS allows you to deduct safety gear and equipment, but not suits and dresses or cool shirts for a really important client meeting.
Some easy rules of thumb:
If the clothing has a business logo on it, it may be deductible as a marketing expense.
If you can ONLY wear the clothing for work purposes, it’s deductible, but it needs to be something you couldn’t wear personally in your non-work life (hard hats, safety gear).
Qualified performing artists
Anything else is generally not deductible.
It’s ok to NOT keep meal receipts
This is a big fat lie. Sure, you can prepare a return and not get audited if you don’t have receipts. But meal receipts should be kept and substantiated. That means, keep your receipt for every meal and write the following on it:
Who you were with
The business purpose of the meeting.
Keep in mind, the meal cost is 50% non-deductible.
If you get audited, you’ll probably need these receipts or you’ll likely lose the deduction. See the IRS website on the Burden of Proof. You’ll also want to be sure that receipts for food are shown separately from entertainment, which is no longer deductible.
It’s ok to make a mileage log at year-end
Wrong. The IRS requires a mileage log be kept “contemporaneously” (as you actual drive the miles) to be valid.
There are lots of ways to do this: an old-fashioned, reliable notebook, apps like MileIQ and QBSE, or even an excel sheet can be ok.
The key is, if the auditor thinks you wrote this on April 14th, the deduction could be disallowed.
Like meal receipts, an ongoing record book of miles isn’t mandatory to file a return, but you’re best to be in the habit of tracking throughout the year to avoid any disallowances if you’re audited. IRS Publication 463 talks more about what adequate records are.
You should form an S-Corp to save on taxes
Okay, this one’s a bit tricker. So the answer is… “Maybe.” While you may save on payroll taxes (FICA which is Social Security and Medicare) if you don’t plan your income distributions and salary properly, you may end up in a mess very quickly.
Most of the self-set-up S-corps I encounter are somehow goofed. Wrong election date, no salary, wrong election form used. Not to mention choosing and using the right bookkeeping tools and payroll software… but that’s an entirely separate article.
The point is, saving taxes is one reason to do something. Sound logic is another. Meaning: if you hate doing your taxes, do you really want to spend another 5 to 10 hours and another $1500 to $2000 minimum to get your S-Corp taxes done?
Also, with the new QBID 20% deduction, remaining a sole proprietor or Single Member LLC (which are both easily reported on Schedule C of your individual federal income tax return form 1040), you may actually end up paying LESS in total taxes and LESS in total tax compliance by NOT being an S-Corp.
An LLC will help you save on taxes
Maybe in the future. If you are a sole-prop thinking about how to scheme Uncle Sam out of what’s rightfully yours anyway, then you may have been told to form an LLC.
The short answer is: there are no tax savings if “becoming an LLC” is the only change you make.In this scenario, the only tax savings you’ll have is because your profit will be less by the amount you spent on the additional expense to the Secretary of State and potentially a lawyer (or dare-I-say) legalzoom.com to set up the LLC.
BUT, you may still want to form an LLC after you talk to your lawyer. An LLC may protect you from some business liability that otherwise may put your personal assets at risk.
In addition, if you form an LLC, there is also the entity planning opportunity for becoming an S-Corp later on. A sole prop cannot simply become an S-Corp the way an LLC can elect to be treated as an S-Corp can.
Confused? Ask your CPA for advice on this one.
LLC is a corporation
Nope. But this is an easy mistake to make. An LLC is the acronym for “Limited Liability Company.” COMPANY, not corporation.
A “corporation” is a different type of legal entity also formed with your Secretary of State. This can get confusing because many Secretary of State websites have a Corporation division where you go to form an LLC. So, it is possible to think of an LLC as a form of a Corporation, but best to just unlearn that and view them separately, because, well, they are.
Forming an LLC in Delaware or no-income-tax-state will help you avoid taxes
False. An LLC is what’s considered a “Disregarded Entity” or a “Pass-through Entity” if it is treated as an S-Corporation or Partnership for federal income tax purposes. This means the IRS “sees through” it to you, the owner, and you still report it on your personal income tax return subject to the income taxes of the state you reside. For federal income tax purposes, you might as well not have formed the LLC out of state (except for the planning opportunity above).
I filed my return myself or I filed with a friend last year and it was accepted so it’s right
False. Your return may be selected for audit for up to 7 years after the date it was filed. That means you have 7 years to find out if that “filing” is going to be revisited (if it is, this is when the IRS might start asking questions about those missing business meal receipts and mileage log).
Filing or submitting a tax return and not hearing back does not mean it was done correctly. Many erroneous returns are filed and never audited.
An S-Corporation is referred to like the Marines, “S-Corps” with the “p” being silent
Nope. Always say the “P,” please. The “corp” in S-Corp is short for corporation. CorPoration! A Corps is a different word that means “a main subdivision of an armed force in the field, consisting of two or more divisions.“
You don’t need to know these rules inside and out. But, given that taxes are one of your biggest cash outflows, it pays to be aware of them so you can stay on top of your obligations and file the an effective tax return with your accountant.
Luke Frye is the founder of Timber Tax, a tax filing service for creative professionals and small business owners. Got a question about tax filing? You can book a call with him here.