6 common tax and bookkeeping mistakes

Congress doesn’t make it easy to keep up with the tax code. In November 2007, for example, Washington, D.C., was still working on tax bills that would affect income tax returns for that year. No wonder many individuals and small businesses err in their bookkeeping habits or tax preparation.

Forewarned is forearmed. Here are six of the most common mistakes that startups and other small businesses can easily avoid.

1. Missing out on the startup expense deduction.   Generally, business owners must write off the expenses they incurred prior to starting the business over a 15-year period. However, a change in the tax code a few years ago allows new small businesses to write off up to $5,000 of those expenses on their initial tax return. This is a good deal for the many sole proprietors and other small businesses that have less than $5,000 in startup costs and want to get the full tax benefit of the write-off up-front.

   To do this, you’ll want to keep track of all the ordinary business expenses, such as supplies, postage, printing, and so on, that you incur prior to your first official day of business. Maintain a separate file of those expenses so that they don't get mixed up with expenses that occur after your first day in operation.

2. Not saving receipts of less than $75.   People sometimes get excited when they hear that the IRS doesn't require receipts for meal and entertainment expenses of less than $75. That’s true, but avoid the trap of confusing "no receipts required" with "no records required."

   You may not need the receipt, but you will still need to have some sort of record documenting where you went, when you went there, who you were with, the business purpose of the meal or entertainment, and the business relationship between you and the rest of your party.

   Having the actual credit-card receipt or cash receipt makes this record-keeping a lot easier, since the receipt will typically have most of the information you need except for who you met with and what you discussed. If you don’t have the receipt, you can still record the relevant information in an electronic calendar or daily log.

3. Forgetting to track reimbursable expenses.   Many small-business owners initially pay for some business expenses with cash out of their own pocket or through a personal credit card. Nothing wrong with that. The mistake is if you don't track those costs and yet still expect your company to reimburse them.

   Most companies have written policies in which expenses must be tracked and approved in order for employees to be reimbursed for necessary business expenses. The costs are then deductible to the company and the reimbursements are nontaxable to the employees. If you don’t have such a policy, you need one—and you need to have everyone (including the owner) follow it.

4. Lumping equipment with supplies.   Equipment is a capital expenditure, and capital expenditures have to be depreciated, which means they get written off over several years.

   Special rules do allow most small businesses to write off up to $125,000 in capital expenditures for tangible personal property (such as computers and office furnishings) in the year of purchase. However, you still have to report these purchases as capital expenditures and elect to use this special method of expensing the costs.

   What if you don't report the purchases properly and instead just deduct your computers and other capital items as supplies? The IRS could rule that you improperly characterized the expense and are not entitled to the deduction you claimed.

   In general, items that are going to last for more than a year, such as computer equipment and other machinery, office furniture, photocopiers, filing cabinets, stand-alone lighting, and appliances are considered equipment. Smaller items with short-term lives, such as pens and paper, printer cartridges, postage, magazine subscriptions, and other desk items are considered supplies.

5. Miscalculating automobile deductions.   The many options for calculating deductions when a car is used for business help contribute to confusion in this area. Here are a few brief guidelines:
   
   
   • You can take a standard mileage deduction of 48.5 cents per mile for business use of a car in 2007.
   • You can take a deduction for those actual mileage expenses, which can include depreciation of the automobile.
   • You cannot take both actual mileage expenses and standard mileage deductions in the same year.
   • If the vehicle is owned by the corporation, the corporation deducts all the costs. However, you must add the value of any personal use of the car to your taxable income. You’ll probably want to turn to your tax professional or to IRS Publication 917, “Business Use of a Car,” for help in figuring out how to track and determine the value of personal use.
6. Giving without getting tax benefits.   It’s not uncommon to see a small business claiming it had $2,000 or more in deductible business gifts the previous year.

   There’s nothing wrong with giving gifts to clients and business associates. However, the IRS allows us to deduct no more than $25 worth of gifts to any one individual per year. Give a $25 gift and you get a $25 deductible business expense on your return. Give a $100 gift, and the deduction is still $25.

   So the company that claims $2,000 in deductible business gifts must be able to prove that it gave gifts to at least 80 clients (80 times $25 equals $2,000).

   For small-business owners, the message is clear. Be generous—but not too generous.

About the author   Joseph Anthony is a business-finance writer who has a tax practice in Portland, Ore., specializing in tax preparation and planning for individuals and small businesses. As an Enrolled Agent, he also represents taxpayers in their dealings with the Internal Revenue Service, and regularly speaks on current tax topics and controversies.