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• Is there a contract or defned ben- efts, such as a pension, insurance, vacation time, etc., and is the work relationship considered an ongoing, key aspect of the overall business? Misidentifying a person who should be considered an employee can lead to penalties and interest for non-payment of the employer share of employment taxes. Also, the busi- ness needs to make sure that every employee receives a W-2, and every contractor that was paid more than $600 receives a Form 1099-Misc. For self-employed individuals, nonpayment of the employer share, aka "self-employment taxes," can also get the person in trouble with the IRS. These should be included with quarterly estimated tax payments throughout the year, Hamilton noted. 3. Not paying S-Corp shareholders "reasonable" wages. For the employee-shareholder in busi- nesses organized as an S corporation, the IRS requires reasonable wages be paid to them as taxable income. This is before non-wage distributions can be made, because the non-wage distri- butions are taxed differently. The offcial instructions for the 1120S income tax return state, "Dis- tributions and other payments by an S corporation to a corporate off- cer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation." In short, if the shareholder plays an active, day-to-day role in the operations and management of the business, they are an employee and should be paid a salary that is appro- priate to that position. 4. Overstating business expenses or missing out on valid deductions. A fast way to get the attention of the IRS is to have expenses that either exceed the business' income over sev- eral years, or to have certain types of expenses that are outside of common percentage thresholds. Whether it's for business travel, meals and enter- tainment, printing supplies, or other usually legitimate deductions, the IRS' computers are good at looking at what similar small businesses in an indus- try type spend on similar expenses. Hamilton noted that Schedule C small businesses often have the most challenge when it comes to business expenses, since many items may be partially used for business purposes and personal use (mixed-use assets). For home offce use, however, the IRS has strict rules that the room is not supposed to be used for any other purposes than the business. And if an audit happens, the business owner had better be able to convince them of that. (No, the corner desk in a bed- room does not pass this test.) On the other hand, there are many deductible expenses that, as the IRS defnes them, are "ordinary and necessary" as a part of running a business- just make sure you keep the receipts. Unfortunately, many Sch. C flers can miss some legitimate expenses when they prepare their taxes and, therefore, miss the deduc- tions. Hamilton says this is especially likely to happen to those who do not strictly manage their business and personal fnances independently (see mistake No. 1). For most small businesses, oper- ating expenses are deductible in the year they are incurred. However, capital expenses, such as the cost of purchasing vehicles, buildings, long-life manufacturing equipment, etc., can be depreciated over several years. The IRS has an online resource center for determining how certain business expenses should be treated. 5. Not planning ahead. Taxes are complex and not everything that a do-it- yourself tax program says you can do is necessarily the correct thing to do. The best advice is to be proac- tive! Seek the advice of a qualifed tax professional such as a CPA or Enrolled Agent, to plan ahead before tax season. These professionals can help identify credits that you may not be aware of, and can often save the business much more than the cost of their professional services. Additionally, they can help the business better manage their account- ing and business processes overall, helping the entity and its sharehold- ers to be more fnancially secure. And if the IRS initiates an audit or sends a scary letter, a CPA, EA or licensed tax attorney can represent the person or business on their behalf. Tax tips The best way to avoid taxophobia is to follow a few simple suggestions: • Keep the business' money and expenses separate. • Make sure employees are not being paid as contractors. • Pay reasonable wages to the employee-shareholders of S-Corps. • Keep very good track of expenses. • Seek professional help! ABOUT THE AUTHOR Isaac M. O'Bannon is the managing editor and digital content manager for CPA Practice Advisor (www.CPAPracticeAd- visor.com), drawing on nearly two decades of experience covering the areas of profes- sional accounting, taxation, business productivity and consumer technologies. He is also a U.S. Navy veteran. February 2014 VendingMarketWatch.com Automatic Merchandiser 15 B U S I N E S S B A S I C S autm_14_15_0214TopTax_F.indd 15 2/4/14 8:23 AM