Accountants will tell you that missed deductions, overlooked opportunities and outright blunders plague business clients’ taxes. Financial advisors, through familiarity with the most common mistakes and their root causes, can bring value to relationships by spotting planning and compliance gaps, and then educating clients and prospects about the right questions to ask their accountant.
Tax gaffes occur for varied reasons. Some folks rush headlong into creating a business without seeking advice. On their own, they may not choose the most tax-friendly entity for their company.
Other owners outgrow their first accountant and fail to move on. “The client may have started with an accounting firm when their business was small. Then the business got large, the accounting firm is no longer a fit, and opportunities are missed. There is a spectrum of expertise,” says tax attorney Adam Sweet, a principal in the national tax office of Eide Bailly LLP in Spokane, Wash.
In still other cases—and this illustrates the importance of helping entrepreneurs voice tax concerns—the accountant may not fully champion the client’s cause.
“Some tax preparers are great at preparing returns 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,” says CPA and financial planner Bruce Primeau, president of Summit Wealth Advocates LLC in Prior Lake, Minn. In these situations, financial advisors can help provide the initial impetus to make this happen.
Deductions Not Taken
The combined federal and state marginal tax rate on a successful client’s business income can approach 50%, or even exceed it in some cases. So the tax savings from deductions build rapidly, which works to the detriment of lax entrepreneurs who can’t seem to keep thorough and accurate records.
Consider mileage. At 56 cents per business mile for 2021, a few 30-mile round-trips each week would produce enough deductions to reduce 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 capture that deduction.
“Probably the most missed deduction for self-employed individuals is the home office,” says V. Peter Traphagen, Jr., managing director and wealth advisor at 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.
One downside he highlights to homeowners 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%, Traphagen’s says. Deducting a chunk of rent, which is otherwise non-deductible, is a boon for these self-employed individuals.
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.”