As a CPA who has been preparing business taxes for over 30 years, I understand that dealing with taxes is probably one of the most difficult parts of owning your own business. However, once you realize the importance of taxes and really pay attention to them, you can turn that in to more money for you.
I have several clients who own recruiting firms. One of my new clients, who owns a recruiting business, was amazed when I showed him the tax money he could save. For every $1,000 of deductions, he saved $460 in cash. This was because he was in the 46% tax bracket (between federal, state, social security, and medicare taxes). He said 46% was much higher than his profit from his recruiting clients and suddenly, spending time on his taxes made a lot more sense.
The following are things you should think about as you are preparing your documents to bring to your accountant or if you do your own taxes.
The sales income you report is fixed by what you receive. Deductions are a little trickier. You must know exactly what qualifies as a legitimate tax deduction. The basic rule is that in order for an expense to be deductible, it has to be “ordinary and necessary”. Therefore, most of your office supplies, advertising, accounting fees, etc. fall under this rule.
The deduction for travel and entertainment has special rules. Entertainment is only 50% deductible under the tax law, so make sure to keep track of this separately from travel, which is not subject to this 50% limitation. You must have a business conversation for entertainment to be a deducible expense so make sure to document who, when, where and why. If you take your employees out for goodwill (birthday, holiday party, etc.) this is 100% entertainment, which is another separate category you should keep track of. For airfare to ever be considered deductible, at least 50% of the travel days must be for business purposes – so make sure to understand the travel rules if you mix business and personal travel.
Automobile expenses are deductions where understanding your options can generate additional money in your pocket. You have a choice of deducting either the standard mileage rate ($.50 per business mile in 2010) or you can multiply actual expenses for your auto by business miles/total miles (business percentage). Add business tolls and parking to both calculations. Taking the time to compute which option generates the highest deduction for your auto is worthwhile. If you are considering a new automobile and deducting actual expenses, using the luxury tables for deducting auto expenses may lead to a more generous deduction for leasing versus buying.
Recruiters working out of their homes should consider taking the home office deduction if they have a dedicated space or room used exclusively for business. Many clients have said to me that they do not want to take the home office deduction since they are nervous that it will increase their chances of being audited. Based on my 31 years of experience in this industry, I believe that this is not true. To calculate the allowable home office deduction, measure your dedicated home office space and divide that by the total square footage of your home to get the percentage of your home that you use as your home office. Your home office deduction is calculated by multiplying your rent, mortgage interest, real estate taxes, utilities, depreciation if you own, homeowners insurance, and other qualifying home expenses by the percentage on form 8829. This can produce a legitimate deduction for an expense you are already paying.
You should be aware that the deduction for gifts is limited to $25 per year per person.
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Do not forget to look into setting up a retirement plan for your business since most of us need to force ourselves to save for our golden years.
Deductions are a fun part of the law to write about. I would be remiss if I did not also inform you about some of the tax requirements that you might not be aware of:
- One tax requirement that recruiters constantly have to deal with is hiring people as employees versus independent contractors. This issue can not be ignored. The federal government and your state each have rules on what defines an employee. If you pay someone as an independent contractor and they are later construed as an employee, you can end up with a shocking tax bill. Do not take this lightly, as the government is auditing this issue more frequently.
- Another tax requirement is to pay sales and use tax to your state. Most states do not require you to charge sales tax on recruiting services but make sure you are certain you are not subject to sales or use tax in your state. Even if you do not collect sales tax, you probably owe use tax to your state. Use tax is a remittance of sales tax that you did not pay and should have. This liability can occur if you purchase an item in a different state that is shipped to you and no sales tax is charged. You can also owe use tax if a person in your state did not charge you sales tax and should have. Most states audit use tax so be aware of this liability.
- An important requirement to be aware of is paying estimated tax payments if you are set up as a sole proprietorship, partnership or LLC. The tax law states that you have to pay the lower of 90% of your final tax obligation during the year or 100/100% of last year’s tax depending on your income limit. It is important to make sure you understand your tax obligation and not fall behind. The government is not a bank and they do not take it lightly if you fall behind on your tax obligations.
- If you are the owner of a recruiting firm you should review how you set up your business for tax purposes. There are many choices including sole proprietorship, partnership, LLC, S-Corporation or C-Corporation. Choosing the correct entity can save you taxes and may limit your liability.
Taxes can seem overwhelming, but setting up your accounting system is a key component of getting it under control. Most of my clients use QuickBooks and are quite happy with the software, which is reasonably priced and user friendly.
It is very important to hire a good CPA as part of your team. Use your accountant to review whether your company is correctly set up, to help you understand your tax requirements, and to properly record all your valid tax deductions. You are required to prepare your tax return.
No matter how good your CPA is, you personally need to understand your tax obligations because the ultimate responsibility is yours!