Every tax filing season, many small businesses end up paying the government more than they need to. Some don't take advantage of all the deductions to which they're entitled. Some haven't kept up with changes in the tax law.
Tax professionals say there are two main reasons why small businesses get tripped up while preparing tax returns: fear of an audit and ignorance.
Stephen Fishman, a lawyer and author of Deduct It! Lower Your Small Business Taxes, says the specter of an audit stops many small business owners from claiming a home office deduction, even when they qualify for this break and could save a substantial amount on their tax bills.
Fishman noted that years ago, claiming you worked out of your home was one of those red flags that caught the eye of the IRS. But now, he said of small business owners, "they may not be aware the law is more liberal" since changes were made in 1999, Fishman said.
What does tend to trigger an audit, or, more commonly, questions about an individual item on a return, are deductions that seem abnormally high. Accountants and tax lawyers say as long as you have the paperwork to back up the claims you make on your tax forms, you shouldn't run into problems. You'll be on safest ground if you have your return prepared by a professional or reviewed by one.
Ignorance can cost a small business plenty of money - many small business owners just don't know what the law is. Fishman said owners tend to overlook a deduction tailored for them, known as the Section 179 deduction. This allows small businesses to deduct up-front rather than depreciate the cost of certain equipment bought and put into service during the tax year. There's a change in the deduction for the 2005 tax year - it rose to $105,000 from $102,000 in 2004.
There are other adjustments to the tax law each year, and business owners need to keep up with them. You can get a quick overview of them in IRS Publication 334, Tax Guide for Small Business. You can download a copy of it and other IRS publications and forms from the agency's Web site, www.irs.gov.
Another change for the 2005 tax year is an adjustment in the standard mileage rate used to deduct the cost of using a vehicle for business purposes. Because the price of gasoline soared in the last few months of the year, the IRS has set up a two-tier deduction for 2005 - businesses can deduct 40.5 cents for each business mile driven before Sept. 1, and 48.5 cents for business miles driven after Aug. 31 and before Jan. 1 of this year. (But beware - the deduction was lowered to 44.5 cents for 2006.)
There have been changes to some business tax credits, and some new credits created, such as the Hurricane Katrina employee retention credit, which gave employers whose businesses were inoperable after the storm an incentive to keep paying workers. A list of the credits can be found in Publication 334.
Many small businesses will be able to take advantage of a new deduction, the domestic production activities deduction that grew out of the American Jobs Creation Act of 2004. The deduction gives a tax break to a variety of companies with at least one employee - on its Web site, the IRS defines qualifying production activities as including "manufacturing, producing, growing, and extracting tangible personal property, computer software, and sound recordings, and the construction and substantial renovation of real property including infrastructure."
"They don't necessarily have to be a manufacturer. It can even apply to engineering firms - it's that broad of a definition," said Jeffrey Berdahl, a certified public accountant with Berdahl & Co. in Center Valley, Pa.
But tax professionals describe the regulations governing the domestic production activities deduction as complicated, and suggest small businesses hoping to take advantage of it consult with a tax adviser.
"It's going to be relatively difficult form to go through," Berdahl said.
Accountants and tax lawyers say some planning the previous year can help a small business avoid mistakes and oversights that end up in overpaying the government. Ask a financial expert about the biggest pitfalls that small businesses encounter at tax time, and they'll probably talk about a lack of planning.
"People don't spend enough time consulting their professionals and making sure it's done," said Bob Howard, a lawyer with Hofheimer Gartlir & Gross in New York.
Joyce Rosenberg writes for the Associated Press.