If you run a service-based business, you’ve probably noticed that the last couple of years have brought about major tax changes for your company.
With so many tax changes it can be difficult to determine what is true and what might be a myth when it comes to your small business taxes.
In this article, we will discuss 5 big time myths about taxes and how to avoid them.
Myth #1: All Business Expenses Are Deductible
One of the biggest benefits of running a small business is the ability to deduct business-related expenses from your tax bill. However, one of the biggest myths about taxes is that all business expenses are deductible. Only business expenses that are ordinary and necessary to your business operations are deductible.
For example: suppose you run a service-based business that provides skilled labor in home construction. You are considering expanding and deciding that adding a heavy truck can help obtain customers and improve business performance. Similar trucks are used by other construction businesses, and you are confident the truck will help your business generate revenue.
In this case, the cost of the truck is deductible as a business expense. The truck will help your company’s operations, and similar trucks are used in the industry by other construction companies. Therefore, the truck’s expense is ordinary and necessary.
Now suppose you decide to purchase a motorcycle instead of a heavy truck. Motorcycles cannot carry much equipment, and they are not used by many service-based construction businesses. You are also not confident the motorcycle will help your business operations.
You will have a much harder time convincing the IRS that the motorcycle’s cost is deductible as a business expense, as it appears neither ordinary nor necessary.
One of the best parts of using a tax advisor is scenarios just like this. If you are questioning whether a potential purchase will be beneficial to your tax filing, consult your tax advisor!
Myth #2: “Side Gig” Income Is Tax-Free
The “gig” economy has grown immensely over the past couple of years, and many workers have questions about the tax treatment of their income from their service-based businesses. This can be especially confusing as income from side gigs has no withholdings and is often made in cash.
This is another of the biggest myths about taxes. Gig or freelance workers are considered independent contractors for tax purposes and are responsible for sending in the appropriate amount of self-employment taxes.
For example: suppose you have a side job working as an Uber driver in addition to your normal employment. The income you earn from your normal employer has the necessary withholdings, but the income you earn as an Uber driver does not. Therefore, you are responsible for paying the appropriate taxes on the income you earn as an Uber driver. You (or your tax advisor) are also responsible for the tax filing!
Although independent contractors are responsible for paying their own taxes, they do qualify for business deductions that are unavailable to employees. In the above example, you can claim the mileage deduction for miles driven for Uber, but cannot claim the deduction for miles driven to your employer’s workplace.
Myth #3: A Filing Extension Delays Payments
This is another one of the biggest myths about taxes many taxpayers believe to be true. Tax extensions are a great tool granted by the IRS if you need time to get your documentation organized. Unfortunately, the IRS often does not make explicit that a tax filing extension does not mean an extension to pay your tax bill.
You are probably asking, “How can I pay my tax bill when I have not completed my return?”
This is a valid concern, and the IRS states that you should send in an estimated payment which can be adjusted later.
For example: suppose you are a small service-based business owner who is unsure of the amount of taxes you owe this year. Your salary has remained the same since the previous year. You can use last year’s tax return as a starting point to estimate this year’s tax liability. Making an estimated payment is vital to avoid IRS penalties.
Myth #4: Married Filing Separately Is Better Than Married Filing Jointly
Another of the biggest myths about taxes is that if you are married, choosing the married filing separately return status will save you money. The opposite is true.
The “married filing jointly” tax status gives couples a larger standard deduction, makes available tax credits such as the child tax credit, and can bring you into a lower tax bracket if you or your spouse makes significantly more money than the other.
Tax filing status is a personal decision, but it is a good idea to consult with your tax advisor if you and your spouse have questions about which filing status is more beneficial to reduce taxes.
Myth #5: You Don’t Need to File a Return If You Don’t Owe Taxes
This is one of the myths about taxes that can be the most confusing. While in most cases you probably need to file a tax return, there are certain exceptions to the rule. For example, if your income falls below a specified threshold or you are claimed as a dependent on someone else’s taxes, you may not need to file a tax return.
Luckily, the IRS has created a helpful tool to figure out the answer to, “Do I need to file a tax return?” Called their Interactive Tax Assistant, the step-by-step guide will ask you a series of questions to see if you are required to file a return. Click here to check it out.
Taxes can be complicated for owners of small service-based businesses, but hopefully, our discussion of 5 big time myths about taxes can help make the process easier.