Missed deductions. Overlooked opportunities. Outright blunders. These things plague the taxes of business clients’ taxes, say accountants. And that’s where financial advisors come in—adding value by spotting planning and compliance gaps and being familiar with the most common tax mistakes and their root causes—and then educating clients and business owners about the right questions to ask their accountants.
Tax gaffes occur for varied reasons. Some folks rush headlong into a new business without seeking advice. On their own, they may not choose the most tax-friendly entity.
Sometimes they outgrow their first accountant but then fail to move on.
“The client may have started with an accounting firm when their business was small,” says tax attorney Adam Sweet, a principal in the National Tax Office of Eide Bailly LLP in Spokane, Wash. “Then the business got large, the accounting firm is no longer a fit, and opportunities are missed.”
Other times, an accountant might not champion a client’s cause, says Bruce Primeau, a CPA and the president of Summit Wealth Advocates in Prior Lake, Minn. “Some tax preparers are great at preparing returns,” he says, “but not so great at taking the time to advise clients as to how they can save taxes via their small business. Clients may need to push their preparer for opportunities.” Advisors can be the ones encouraging their clients to do the pushing.
Deductions Not Taken
The combined federal and state tax rate on a successful client’s business income can approach 50% or even exceed it in some cases. So the tax savings build rapidly with the right deductions, and conversely, lax entrepreneurs who don’t keep records will just as quickly lose out.
Consider mileage. At 56 cents per business mile for 2021, a few 30-mile round trips each week would cut a high-bracket client’s taxes for the year by $1,200. Low-cost, well-rated mileage-tracking apps such as MileIQ, QuickBooks Online, Everlance and Hurdlr can capture these deductions.
“Probably the most missed deduction for self-employed individuals is the home office,” says V. Peter Traphagen Jr., the managing director of Traphagen CPAs & Wealth Advisors in Oradell, N.J. Some self-employed clients don’t realize they can deduct a portion of expenses such as rent, utilities and homeowner’s insurance based on the percentage of the residence used exclusively for business, or claim $5 per square foot on up to 300 square feet under the simplified method. Others are not aware that the office can be a designated section of a room. “The space does not need to be marked off by a permanent partition,” reads the 2020 edition of IRS Publication 587.
Quite a few business owners shy away from the home office deduction because they fear it’s an audit trigger. “I have to convince them that is not the case,” Traphagen says, noting his 30-plus years in practice.
A downside for homeowners, however, is that when they sell their residence at some future time, tax will be due on the depreciation for the business space. This rule won’t apply if the client always uses the simplified method to claim the home-office deduction.
Renters fare particularly well because they tend to have a smaller residence, so their office is a larger portion of it—often 15% to 20%, in Traphagen’s experience. Deducting a chunk of rent, which is otherwise non-deductible, is a boon for the self-employed.
It’s also a prime example of an entrepreneur “living their financial life through their business,” says Primeau. “As a business owner myself, I recommend doing that as much as possible.”