In the middle of a property tax audit, a restaurant owner was suffering from a number of issues, especially the stress of what could have been an incredibly costly tax season.
The local tax authority was making a concerted effort to ensure accurate property tax payments from businesses, and this company was the subject of an audit looking into the previous five years of its filing and payment history.
If it weren’t for the owner reaching out to a local small business tax partner, he would have paid thousands in tax expenses he didn’t truly owe, among other issues.
Addressing The Big Tax Problem At Hand
With the state auditing his business’s property taxes, the owner’s current small business tax accountant recommended what most accountants recommend in these situations: Just pay the tax bill.
But because of the way the IRS and state determine tax bills, this is rarely your best option.
The IRS uses industry averages to assess tax bills, and then adds penalties and interest based on the issues at hand. In this owner’s case, the state used the average equipment (property) value for restaurants to determine how much property tax the small business owed. The state concluded that the owner owed $12,000 in unpaid property taxes, penalties and interest.
The restaurant owner already had paid $8,000 toward that tax bill when his new tax advisor looked into the situation. After reviewing his financials, his partner found that the business should only have owed $2,000.
After filing the proper documents and reaching out to the state, his advisor got the state to acknowledge the $10,000 difference, and that the owner did not owe so much. Unfortunately, it is incredibly difficult to get money back from the state after it’s been paid, but the tax professional is optimistic that he can recoup the additional $6,000 that the owner paid.
Discovering Other Significant Tax Issues
Upon reviewing the restaurant’s financials, the owner’s tax partner started to uncover other issues, some of which were incredibly costly.
Overstating Revenues, Overstating Income Tax Dues
The previous accountant had prepared the business’s income tax return and determined that the company owed far more than it had it any other year: $28,000. To the new small business tax specialist, something was clearly off. It took some hard work, but he discovered that the business’s sales tax transactions were incorrectly applied in QuickBooks.
Despite making timely and accurate sales tax payments to the state, their accounting system was overstating their revenue by adding the sales tax portion of a sale as revenue. This money was then deducted as an expense in the system. But sales tax is not revenue and it is not an expense. It is simply money you collect on behalf of the state. It’s never your “possession.”
This error led the owner to overstate his revenue by $65,000, hence the abnormally large income tax calculation.
His tax partner prepared a new return, which determined the accurate (and far less expensive) income tax bill.
Identifying Another Huge Audit Risk
Especially with the changes brought on by the Affordable Care Act, understating your personal income is a red flag to the IRS. In an S Corp, like this restaurant, the owner saves money by taking a reasonable salary from the company’s revenue, paying income taxes on this money and less taxes on the company’s income.
This restaurant was taking home $120,000, but its owner took only $20,000 in salary, which was far from reasonable.
Every situation is different, but a good rule of thumb to determine a reasonable owner’s salary would be to determine how much someone else would need to be paid to perform the same work you do for your business.
To be perfectly safe, consult a small business tax advisor to choose the salary that maximizes your tax benefits and ensures your compliance. Remember, your salary may be different from year to year.
With new, more experienced eyes on his financials, the restaurant owner is close to minimizing his property tax bill and saved a minimum of $4,000, but his tax partner also was able to identify many other costly issues.
Like most small business owners who meet with their accountant just once a year, he had many problems that put his profit at risk. But once he established a relationship with a partner who met with him on a monthly basis, he finally had the support he needed to streamline his business and start maximizing his tax savings.