[This article has been updated to reflect the new tax law that went into effect on January 1, 2018]
Tax Strategist or Tax Evader?
C’mon…admit it. You know someone who’s done it. Maybe they:
- Took some petty cash and used it to pay for a couple of cases of beer, some food at the store, and lunch with friends.
- Shared a company car with a teenage daughter on the weekends.
- Charged that expensive dinner with the missus on the corporate card.
- Bought a bunch of clothes and other household stuff, and charged it to the business.
- Wrote off an entire resort vacation with the family because they made a single, one-hour sales call to a customer while in town.
- Had the contractor who upgraded a home kitchen send an invoice to the company.
Yeah, you know someone who’s done this stuff. Or at least some of it. Right?
The truth is, many small business owners have, at one time or another, blurred the lines between “business” and “personal” expenses to try to save money on taxes. No one’s perfect. No one talks about it, or likes to admit it.
But it’s too tempting.
Charging a personal expense through the business means taking a deduction for it against income. And if our state and federal tax rates are somewhere between 20 to 30% combined, then effectively that could be like getting a 20 to 30% discount on those things purchased. It’s a perk of being a business owner, right?
What harm is there?
And really, who’s going to know? Chances are someone probably won’t even get audited. And besides, even if a small business owner fudges the numbers a bit on their tax deductions, it’s such a small amount, relatively — the IRS has much bigger fish to fry, right?
Is charging personal expenses through the business legal? Of course not. It is fraudulent. But the legality is not the issue. There’s another bigger issue at stake here…
Tax Minimizer or Tax Evader?
My dad used to tell me there are two types of taxpayers in this world: tax minimizers and tax evaders.
Smart business people are tax minimizers. These business owners do everything they can, within the law, to minimize their taxes. They plan. They defer income where they can, and increase expenses when they’re able. They take advantage of credits and deductions. They may take an aggressive position here or there, but always with good, documented reasons. Considering that taxes are the number one highest expense for any business person, smart business people are always good at (legally, prudently) minimizing their tax obligations.
But dumb business people are tax evaders. These are the people who seek to reduce their taxes by any means, legal or not. These are the people who cut corners and cook the books. This is not a good practice.
Running personal expenses through a business may not seem significant. It may only represent a small amount of your overall expenses. But it represents something much more significant: Someone who willfully runs personal expenses through the company without any explanation, justification, or reason, has officially categorized themselves as a tax evader. And, if they one day are unfortunate enough to be the subject of an IRS audit, an IRS auditor will judge them on this behavior.
Going through an IRS audit is a stressful and risky endeavor for tax evaders, because it opens up their entire business finances to stricter scrutiny. A $500 fraudulent deduction for personal expenses could be, in the eyes of an IRS agent, a clue to something much, much bigger. If there is distrust or lack of credibility with the business owner, then the agent may dig further, create more havoc, and spend more time disrupting the business — whether there’s good reason or not. That stupid $500 personal dinner bill that was run through the company could cost countless unproductive hours responding to IRS requests. That’s painful — and the tax penalties, business disruptions, and other potential consequences are not even remotely worth it.
So, the next time you see someone charging a personal expense to their business, do them a favor and share this article with them. It’ll make you a better friend, and help them become better business owners.
New Tax Law
Also, under the new tax law that took effect Jan. 1, 2018, there are significant tax breaks for small business owners. For example, business owners who operate their businesses as pass-through entities (LLCs, partnerships, S corporations, or sole proprietorships) can now take a special 20% deduction on their business income (with certain limitations). Taxes are never fun, but why bother trying to cheat on your business expenses when the government is giving you this new deduction?
Talk to your tax adviser about what the new tax law means for you — and keep on being a smart tax minimizer, not a dumb tax evader.
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