When it comes to tax rules, there are many misconceptions among small business owners. While their CPAs likely will get things right when they complete tax returns, it’s up to business owners to know the rules so understand the tax consequences of their actions throughout the year.
Take this quiz to see how you score.
(Note to tax practitioners: if you disagree with my answers, please email me.)
- Which type of business entity produces the best tax results?
- Sole proprietorship
- Partnership
- Limited liability company
- S corporation
- C corporation
- A small business owner takes a new employee out to lunch so they can get to know each other. The subject of business never comes up. How much of the cost of the meal is deductible?
- Zero
- 50%
- 100%
- Something else
- A business has offices downtown. The owner always brings work home and does it in an office in her home that is dedicated to this use. She can claim a home office deduction?
- True
- False
- Which of the following is tax deductible?
- Traffic ticket received on the way to work
- Under-the-table payment to obtain a contract
- An antique to decorate the office
- Federal income taxes on business income
- A business is owner is in the 25% personal income tax bracket. The business has a $1,000 expense. If the expense can be claimed as a deduction or tax credit, which is worth more:
- A deduction
- A tax credit
ANSWERS:
- There is no correct answer. Each type of entity has some special rules that impact tax results. The answer for a particular business owner must be deduced by looking at federal and state income taxes, employment taxes/self-employment tax, and other taxes that may apply to his/her situation.
- For a meal in town to be deductible, there must be substantial business discussion before, during, or after the meal. If the owner and employee had discussed business, then 50% of the cost would have been deductible.
- Because she has a fixed location for business (the downtown office), her home is not the principal place of business so no home office deduction is permissible. This is so even though she uses space regularly and exclusively for work and does a considerable amount of it at home.
- None of the options are tax deductible. Fines and penalties aren’t deductible. Nor are bribes. Antiques can’t be depreciated because they have no determinable recovery period. And federal income taxes are nondeductible.
- The credit, which is a dollar for dollar offset to tax liability, would save $1,000 in taxes; the deduction would save only $250 ($1,000 x 25% tax bracket).
Bottom line
Small business owners should become fluent in tax parlance so they can make savvy business decisions. Working with a good CPA or other tax advisor is a good move, but is no substitute for having first-hand knowledge of tax rules impacting the business. Resources to help:
- My book: J. K. Lasser’s Small Business Taxes 2017. The 2018 edition due out in October 2017 is in production now.
- IRS’ Small Business/Self-Employed Tax Center
