[0:01] Welcome to Tax Problems Explained from the perspective of an attorney, a CPA, and a former IRS agent.
[0:08] Welcome to Tax Problems Explained from the perspective of an attorney, CPA, and former IRS agent with Lawrence T. Ullmann.
[0:18] With decades of experience inside the IRS and in private practice, Lawrence helps individuals and businesses understand
[0:27] how the tax system really works and how to resolve serious tax issues.
[0:33] I'm Leann Lyon and today we are talking about tax issues that can arise for small business owners
[0:42] often without them realizing there's a problem until too late.
[0:48] Hello Lawrence, great to see you.
[0:51] Lawrence, can you explain how do small business tax issues usually begin?
[0:58] Normally when someone's running a business, unlike an employee who's just going to a job and getting a W2 and wages,
[1:06] someone running a business has a lot of things they're doing.
[1:09] They're trying to have a good, well keeping system that tracks all of their activities.
[1:18] They're trying to make sure that they comply with payroll tax responsibilities for their employees.
[1:28] They're trying to make sure that they take care of estimated tax payments because unlike an employee that has withholding coming out of his or her salary,
[1:40] normally a business is making estimated tax payments four times a year.
[1:46] These are things that can result in problems coming up if the individual business owner is an on top of everything
[1:59] or another problem is if the business owner basically lets someone else take care of some of these activities
[2:07] and that someone else is incompetent to do so.
[2:10] So there's a lot of different things in a small business or a large business for that matter.
[2:15] They can result in problems with the tax filing responsibilities of that business owner.
[2:23] So what tends to happen when business and personal finances are not clearly separated, maybe especially for a startup business, but could be any business?
[2:34] Well first of all if you're mixing business with personal expenses and what have you and an internal revenue age it like myself comes in and sees that obviously we're going to look much more carefully at the books and records than we might have had that not been a problem.
[2:56] So that's one thing one reason you certainly don't want to mix business with pleasure.
[3:02] Secondly, if you are, let's say for example a corporation, normally the corporation is only going to pay corporate deductions.
[3:16] If the corporation pays personal expenses of a taxpayer, two things will happen. First of all the corporation will lose that deduction because it's not the corporation's deduction.
[3:30] But what's even more concerning is that since the taxpayer may very well be a shareholder with the corporation in turn revenue service will determine that this payment was basically like a distribution from the corporation over to the taxpayer who then use the money to pay the expense.
[3:51] Now that didn't happen but constructively that is what took place and there's a provision that provides for constructive dividends.
[4:02] So in other words this expense that's paid on behalf of the taxpayer personally can result as a loss of a deduction to the corporation and then a dividend income item to the individual shareholder.
[4:20] So these are just some of the problems that can result when you sloppy and you're mixing up business with personal expenses.
[4:30] How does the IRS respond when deductions are claimed but are not properly documented?
[4:36] Well the first response is going to be usually to think about disallowing the deductions.
[4:46] Now there may be other ways that you can reconstruct or explain that a deduction did take place but it basically sends a message to the revenue agent that this particular taxpayer isn't careful.
[5:04] It isn't being responsible in running this business and it's going to result in the IRS looking more carefully and more exhaustively into the tax return than may have been what the intention was in the first place.
[5:25] So what happens when income is under reported even if it isn't intentional?
[5:31] If income doesn't get reported it's a serious matter because even though it's not intentional it may be because of sloppy books and records.
[5:44] It may be because of sloppy behavior by the taxpayer.
[5:49] It may be because there's cash involved.
[5:52] It may be many many reasons why income is understated but if it is it's serious and it will normally result in the revenue agent either going more deeply into the books and records or it could even wind up if it was serious enough for the revenue agent to refer the case over to criminal investigation
[6:20] and social agents then would get involved on a criminal tax fraud.
[6:25] So you want to be very very careful and make sure that all income including cash is reported because normally during the ordering process this weighs the revenue agent through a bank deposit analysis cost of living analysis can tell what's going on.
[6:44] The taxpayer is living like someone who makes a million dollars a year but only reporting $50,000 a year.
[6:52] There may be reasons maybe that taxpayer is getting money as gifts or whatever but I mean it's certainly going to result in a revenue agent looking more carefully at the return.
[7:04] Why do payroll and employment tax issues tend to create the problems for small business owners?
[7:10] Payroll tax problems are a huge problem and the reason is because payroll taxes are so complicated. First of all, you normally have weekly or buy weekly requirements to deposit funds with the IRS that are withheld from the tax pay the employees wages or what have you.
[7:37] There's four quarterly tax returns that have to be prepared and filed timely. There's a 940 tax return at the end of the year that has to be applied and a filed for few to tax.
[7:55] Then there's reporting requirements for W2s to the Social Security Administration.
[8:01] The reason this becomes even more of a problem though is if these payments are not made timely there are penalties.
[8:11] Failure to file failure to pay that can get up into the 50% range and then what's even worse is these are trust funds that the taxpayer business owner is holding.
[8:23] It's not their money. It's money they withheld on behalf of the taxpayer to pay over to the government. These trust funds are such that the internal revenue service which normally could let's say only go after the corporation for payroll tax delinquencies can now go on what's called the trust fund recovery penalty and go directly after a responsible person.
[8:52] That person could be the president it could be a book keeper it could be anyone who had the requirement to pay these monies over and for whatever reason didn't and by the way the normal reason these payments don't get paid is because it's the end of the month.
[9:10] The taxpayer says oh my god I've got to pay this expense this expense so he uses that money for this this improper purpose and then one thing leads to another and pretty soon the taxpayer is in very bad situation.
[9:28] So basically as I say payroll tax problems are really really expensive.
[9:34] They're fraught with penalties and they're fraught with all kinds of problems.
[9:39] So let's talk about since we are talking about small business owners at what point does a small business owner need to start paying those quarterly estimated taxes.
[9:49] What if they're not profitable in a particular year?
[9:53] Well the estimated tax payments are normally computed on what you think your taxable liability is going to be.
[10:06] Now if you realistically and somewhat accurately compute that this is my first year or my second year or there have been problems it's COVID I'm not getting the income I once have.
[10:21] Then you may the tax pay may very well take the position that he doesn't have any estimated tax payments for that particular quarter but you have to be careful because if you're wrong not only are you going to have a big tax bill at the end of the year but you may very well also get hit with what's full a failure to pay estimated tax payments.
[10:48] And some other penalties under payment that sort of thing and what type of penalties could that be.
[10:54] I mean how much can that mean for a small business?
[10:57] Well if we started this situation with failure to pay failure to file if a taxpayer let's say gets way behind and says oh my god I've got to get caught up somehow and I'll file a return when I get called.
[11:16] By the way normally doesn't happen you can have 25% penalties for failure to file 25% for failure to pay you can have accuracy related or negligence penalties at 20% I deal with cases sometimes where penalties are two three times what the taxes.
[11:42] Especially if they're older and then of course all these penalties have interest built in if they go back a certain amount of time right we haven't even talked about the interest part of this yet so that's another.
[11:54] Another form of penalty so can you walk us through a general example of a small business owner who thought things were being handled correctly maybe a real estate agent within later ran into tax problems well let's say you're a real estate agent.
[12:10] You have responsibilities for your sub agents that work for you and you obviously not only have professional reporting requirements as a real estate agent but for tax purposes you've got to make sure that the income and the expenses are being properly courted and filed with the tax return.
[12:38] And if this doesn't happen it becomes it starts a spiral and what happens is you get behind on one thing and then you get behind on another and then a third thing happens and now you're afraid to even file a tax return one thing leads to another it just becomes a real problem.
[12:59] Absolutely so what patterns do you tend to see when smaller tax issues turn into a more serious issue.
[13:07] The first is failure to really apply or to notices things of that nature in other words turning your head and pretending the problem doesn't exist as we said earlier in this discussion.
[13:25] There are some taxpayers that think if I don't do anything it'll go away it doesn't go away sometimes it may take a year or so for the IRS to really get involved especially in today's world where the IRS is overworked and underfunded but it doesn't matter sooner or later they will get caught up and when they do.
[13:50] The problems will be a lot worse because they're going to take the position that we sent you notices we asked you to try to respond to this and you just basically blew us off and you're not going to get a whole lot of sympathy in a situation like that.
[14:06] So as we wrap up today when a business owner does realize that there may be a problem they're getting a notice what should they take into account before deciding how to respond.
[14:19] If the taxpayer knows what the problem is that's a start but many times taxpayers know they have a problem but don't know why it may require what I would call forensic accounting times there are times where taxpayer has no idea why they're behind in this or why they're behind in that.
[14:47] The bookkeeper maybe didn't do a good job of reporting everything and the taxpayer was out busy performing his business activities and it's like anything else the longer you get the more time and the longer it takes for you to figure out there's a problem normally the problem is going to be bigger.
[15:11] So it normally pays to get a professional in whether it be an accountant to forensically go through the books and records and see what's going on someone who is knowledgeable in payroll tax responsibilities and filings to go through and see if everything was filed.
[15:32] It really pays because again these penalties can get so huge that the money you save by not getting someone who knows what they're doing involved is very short-sighted.
[15:44] Well that is it for today's episode of tax problems explained from the perspective of an attorney a CPA and a former IRS agent all in one.
[15:55] If you are a business owner and have questions about your tax situation you can visit Lawrence T. Ullmann.com.
[16:04] Thanks for listening and be sure to like subscribe and leave a review if you found this episode helpful. Thank you Lawrence.
[16:12] Thank you Leann again have a great day.
[16:15] You too.
[16:16] Thanks for watching be sure to hit that like and subscribe button and leave us a review in the comments.
[0:08] Welcome to Tax Problems Explained from the perspective of an attorney, CPA, and former IRS agent with Lawrence T. Ullmann.
[0:18] With decades of experience inside the IRS and in private practice, Lawrence helps individuals and businesses understand
[0:27] how the tax system really works and how to resolve serious tax issues.
[0:33] I'm Leann Lyon and today we are talking about tax issues that can arise for small business owners
[0:42] often without them realizing there's a problem until too late.
[0:48] Hello Lawrence, great to see you.
[0:51] Lawrence, can you explain how do small business tax issues usually begin?
[0:58] Normally when someone's running a business, unlike an employee who's just going to a job and getting a W2 and wages,
[1:06] someone running a business has a lot of things they're doing.
[1:09] They're trying to have a good, well keeping system that tracks all of their activities.
[1:18] They're trying to make sure that they comply with payroll tax responsibilities for their employees.
[1:28] They're trying to make sure that they take care of estimated tax payments because unlike an employee that has withholding coming out of his or her salary,
[1:40] normally a business is making estimated tax payments four times a year.
[1:46] These are things that can result in problems coming up if the individual business owner is an on top of everything
[1:59] or another problem is if the business owner basically lets someone else take care of some of these activities
[2:07] and that someone else is incompetent to do so.
[2:10] So there's a lot of different things in a small business or a large business for that matter.
[2:15] They can result in problems with the tax filing responsibilities of that business owner.
[2:23] So what tends to happen when business and personal finances are not clearly separated, maybe especially for a startup business, but could be any business?
[2:34] Well first of all if you're mixing business with personal expenses and what have you and an internal revenue age it like myself comes in and sees that obviously we're going to look much more carefully at the books and records than we might have had that not been a problem.
[2:56] So that's one thing one reason you certainly don't want to mix business with pleasure.
[3:02] Secondly, if you are, let's say for example a corporation, normally the corporation is only going to pay corporate deductions.
[3:16] If the corporation pays personal expenses of a taxpayer, two things will happen. First of all the corporation will lose that deduction because it's not the corporation's deduction.
[3:30] But what's even more concerning is that since the taxpayer may very well be a shareholder with the corporation in turn revenue service will determine that this payment was basically like a distribution from the corporation over to the taxpayer who then use the money to pay the expense.
[3:51] Now that didn't happen but constructively that is what took place and there's a provision that provides for constructive dividends.
[4:02] So in other words this expense that's paid on behalf of the taxpayer personally can result as a loss of a deduction to the corporation and then a dividend income item to the individual shareholder.
[4:20] So these are just some of the problems that can result when you sloppy and you're mixing up business with personal expenses.
[4:30] How does the IRS respond when deductions are claimed but are not properly documented?
[4:36] Well the first response is going to be usually to think about disallowing the deductions.
[4:46] Now there may be other ways that you can reconstruct or explain that a deduction did take place but it basically sends a message to the revenue agent that this particular taxpayer isn't careful.
[5:04] It isn't being responsible in running this business and it's going to result in the IRS looking more carefully and more exhaustively into the tax return than may have been what the intention was in the first place.
[5:25] So what happens when income is under reported even if it isn't intentional?
[5:31] If income doesn't get reported it's a serious matter because even though it's not intentional it may be because of sloppy books and records.
[5:44] It may be because of sloppy behavior by the taxpayer.
[5:49] It may be because there's cash involved.
[5:52] It may be many many reasons why income is understated but if it is it's serious and it will normally result in the revenue agent either going more deeply into the books and records or it could even wind up if it was serious enough for the revenue agent to refer the case over to criminal investigation
[6:20] and social agents then would get involved on a criminal tax fraud.
[6:25] So you want to be very very careful and make sure that all income including cash is reported because normally during the ordering process this weighs the revenue agent through a bank deposit analysis cost of living analysis can tell what's going on.
[6:44] The taxpayer is living like someone who makes a million dollars a year but only reporting $50,000 a year.
[6:52] There may be reasons maybe that taxpayer is getting money as gifts or whatever but I mean it's certainly going to result in a revenue agent looking more carefully at the return.
[7:04] Why do payroll and employment tax issues tend to create the problems for small business owners?
[7:10] Payroll tax problems are a huge problem and the reason is because payroll taxes are so complicated. First of all, you normally have weekly or buy weekly requirements to deposit funds with the IRS that are withheld from the tax pay the employees wages or what have you.
[7:37] There's four quarterly tax returns that have to be prepared and filed timely. There's a 940 tax return at the end of the year that has to be applied and a filed for few to tax.
[7:55] Then there's reporting requirements for W2s to the Social Security Administration.
[8:01] The reason this becomes even more of a problem though is if these payments are not made timely there are penalties.
[8:11] Failure to file failure to pay that can get up into the 50% range and then what's even worse is these are trust funds that the taxpayer business owner is holding.
[8:23] It's not their money. It's money they withheld on behalf of the taxpayer to pay over to the government. These trust funds are such that the internal revenue service which normally could let's say only go after the corporation for payroll tax delinquencies can now go on what's called the trust fund recovery penalty and go directly after a responsible person.
[8:52] That person could be the president it could be a book keeper it could be anyone who had the requirement to pay these monies over and for whatever reason didn't and by the way the normal reason these payments don't get paid is because it's the end of the month.
[9:10] The taxpayer says oh my god I've got to pay this expense this expense so he uses that money for this this improper purpose and then one thing leads to another and pretty soon the taxpayer is in very bad situation.
[9:28] So basically as I say payroll tax problems are really really expensive.
[9:34] They're fraught with penalties and they're fraught with all kinds of problems.
[9:39] So let's talk about since we are talking about small business owners at what point does a small business owner need to start paying those quarterly estimated taxes.
[9:49] What if they're not profitable in a particular year?
[9:53] Well the estimated tax payments are normally computed on what you think your taxable liability is going to be.
[10:06] Now if you realistically and somewhat accurately compute that this is my first year or my second year or there have been problems it's COVID I'm not getting the income I once have.
[10:21] Then you may the tax pay may very well take the position that he doesn't have any estimated tax payments for that particular quarter but you have to be careful because if you're wrong not only are you going to have a big tax bill at the end of the year but you may very well also get hit with what's full a failure to pay estimated tax payments.
[10:48] And some other penalties under payment that sort of thing and what type of penalties could that be.
[10:54] I mean how much can that mean for a small business?
[10:57] Well if we started this situation with failure to pay failure to file if a taxpayer let's say gets way behind and says oh my god I've got to get caught up somehow and I'll file a return when I get called.
[11:16] By the way normally doesn't happen you can have 25% penalties for failure to file 25% for failure to pay you can have accuracy related or negligence penalties at 20% I deal with cases sometimes where penalties are two three times what the taxes.
[11:42] Especially if they're older and then of course all these penalties have interest built in if they go back a certain amount of time right we haven't even talked about the interest part of this yet so that's another.
[11:54] Another form of penalty so can you walk us through a general example of a small business owner who thought things were being handled correctly maybe a real estate agent within later ran into tax problems well let's say you're a real estate agent.
[12:10] You have responsibilities for your sub agents that work for you and you obviously not only have professional reporting requirements as a real estate agent but for tax purposes you've got to make sure that the income and the expenses are being properly courted and filed with the tax return.
[12:38] And if this doesn't happen it becomes it starts a spiral and what happens is you get behind on one thing and then you get behind on another and then a third thing happens and now you're afraid to even file a tax return one thing leads to another it just becomes a real problem.
[12:59] Absolutely so what patterns do you tend to see when smaller tax issues turn into a more serious issue.
[13:07] The first is failure to really apply or to notices things of that nature in other words turning your head and pretending the problem doesn't exist as we said earlier in this discussion.
[13:25] There are some taxpayers that think if I don't do anything it'll go away it doesn't go away sometimes it may take a year or so for the IRS to really get involved especially in today's world where the IRS is overworked and underfunded but it doesn't matter sooner or later they will get caught up and when they do.
[13:50] The problems will be a lot worse because they're going to take the position that we sent you notices we asked you to try to respond to this and you just basically blew us off and you're not going to get a whole lot of sympathy in a situation like that.
[14:06] So as we wrap up today when a business owner does realize that there may be a problem they're getting a notice what should they take into account before deciding how to respond.
[14:19] If the taxpayer knows what the problem is that's a start but many times taxpayers know they have a problem but don't know why it may require what I would call forensic accounting times there are times where taxpayer has no idea why they're behind in this or why they're behind in that.
[14:47] The bookkeeper maybe didn't do a good job of reporting everything and the taxpayer was out busy performing his business activities and it's like anything else the longer you get the more time and the longer it takes for you to figure out there's a problem normally the problem is going to be bigger.
[15:11] So it normally pays to get a professional in whether it be an accountant to forensically go through the books and records and see what's going on someone who is knowledgeable in payroll tax responsibilities and filings to go through and see if everything was filed.
[15:32] It really pays because again these penalties can get so huge that the money you save by not getting someone who knows what they're doing involved is very short-sighted.
[15:44] Well that is it for today's episode of tax problems explained from the perspective of an attorney a CPA and a former IRS agent all in one.
[15:55] If you are a business owner and have questions about your tax situation you can visit Lawrence T. Ullmann.com.
[16:04] Thanks for listening and be sure to like subscribe and leave a review if you found this episode helpful. Thank you Lawrence.
[16:12] Thank you Leann again have a great day.
[16:15] You too.
[16:16] Thanks for watching be sure to hit that like and subscribe button and leave us a review in the comments.
