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Small business tax tips
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April 12, 2000: 3:21 p.m. ET
For new or established businesses alike, it quite literally pays to be prepared
By Staff Writer Alexandra Twin
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NEW YORK (CNNfn) - As the filing deadline loomed nearer, Denise James realized that as well-managed as "Friends of Crown Heights," her home-based daycare center in Crown Heights, Brooklyn, was, she simply was not ready for her first year of filing her business taxes.
Denise knew of other small business owners who had found industry-specific tax advisers and knew that that was the best bet for her business.
That's where Gwendolyn Jackson came in. A Brooklyn, N.Y.-based CPA with more than 200 clients in the growing home-daycare industry, Jackson was able to advise the fledgling company on how best to take advantage of the special tax laws that distinguish home-based daycare from other home-based businesses, such as the ability to maintain non-exclusive home and work space using the time-space percentage.
But Jackson is no stranger to small business. She teaches one of the Internal Revenue Service's national monthly "Small Business Workshop and Tax Education" seminars that offer tips on everything from a detailed overview of federal taxes to unusual deductions that most owners don't realize they can include.
"Many owners are not accessing all their options and end up significantly overpaying," said James Pazderak, a tax partner with Deloitte and Touche. "Don't overlook all of the techniques for deferring income, the opportunities in terms of property taxes, sale and use taxes, estate planning, diversifying and reinvesting."
Louise Kaminskj, coordinator of the IRS public affairs office, said that approximately 45 million small business and self-employed workers will file statements with the IRS this year. Depending on the size of the business, and including both quarterly and annual statements, owners will make anywhere from four to 60 transactions each, generating 790 billion forms a year. Nearly 44 percent of the total taxes collected by the IRS come from this group.
The IRS estimates that 60 percent of small business owners prepare their own taxes (as opposed to a mere 20 percent of individuals). They are the most likely to have complications due to forms that are incorrectly filled out.
"This is one of the most complex group of filers there are," Kaminskj said. "With taxes on personal and corporate income, excise and employee withholding, they have one of the highest error ratios of any group. The more well-informed you are, the less likely you are to come into trouble." 
If you cannot hire a private accountant to advise you, "there are a wealth of available resources for accessing unique and cost-saving opportunities," said Pazderak, "from the online sites for the big five accounting firms to the business journals to the IRS's own Web site. The IRS won't tell you legal, available techniques for reducing taxes, but it will explain to you how exactly to fill out the forms, what they mean, and why you need them."
You may also want to consider some of the following suggestions: accounting firm Deloitte and Touche's key filing tips for business owners.
Consider establishing an employee stock ownership plan. If you own a business and need to diversify your investment portfolio, consider establishing an ESOP. A properly funded ESOP provides you with a mechanism for selling your shares with no current tax liability.
Consider the limited liability company (LLC) and limited liability partnership (LLP) forms of ownership. These entity forms should be considered for both tax and non-tax reasons.
One of the newer forms of doing business, the limited liability company (LLC), generally offers greater business, legal, and tax advantages than a regular corporation, S corporation, or general or limited partnership. A main advantage is that members can actively manage the LLC business without subjecting themselves to personal liability. Each LLC ownership interest may have various management, voting, and distribution characteristics similar to different classes of stock. Since an LLC is generally treated for tax purposes as a partnership, it also offers the use of special allocations for items of income and deduction and avoids tax at the entity level.
Use of the LLC form may present an opportunity for you to shift income to a child or family member, while retaining control and voting rights of the business.
There are many complex issues involved in the formation of an LLC. While existing partnerships may convert to the LLC form with no tax consequences, an existing C or S corporation may not convert to the LLC form unless the corporation goes through an actual or deemed taxable liquidation. It is not clear which members of an LLC may be subject to self-employment tax. Differences in the individual state statutes under which an LLC is formed may add complexity. You should contact your tax adviser to discuss the significant issues involved in setting up an LLC.
Avoid nondeductible compensation. Compensation can be deducted only if it is reasonable. Recent court decisions have allowed business owners to deduct compensation when (1) the corporation's success was due to the shareholder-employee, (2) the bonus policy was consistent, and (3) the corporation did not provide unusual corporate perquisites and fringe benefits.
Purchase Corporate Owned Life Insurance. COLI can be a tax-effective tool for funding deferred executive compensation, funding company redemption of stock as part of a succession plan and providing many employees with life insurance in a highly leveraged program. Consult your insurance and tax advisers when considering this technique.
Avoid dividend treatment when a corporation purchases stock from family members. In certain circumstances, the family member may be treated as receiving a dividend and have to pay tax at ordinary income rates on the entire amount of the redemption proceeds. If certain tests are met, the family member may instead report only capital gain equal to the difference between the proceeds and basis and pay tax at a maximum rate of 20 percent. Consult your tax adviser before the corporation purchases stock from family members.
Consider establishing a SIMPLE retirement plan. If you have no more than 100 employees and no other qualified plan, you may set up a Savings Incentive Match Plan for Employees (SIMPLE) into which an employee may contribute up to $6,000 in 1999. You, as employer, are required to make matching contributions. Talk with a benefits specialist to fully understand the rules and advantages and disadvantages of these accounts. 
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IRS
Deloitte & Touche
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