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What you need to know to navigate your 2011 tax forms
Many spa owners would choose undergoing root canal over doing their taxes. After all, there’s Novocain available for dental procedures, but nothing mitigates the pain of dealing with Uncle Sam. That's why DAYSPA gathered guidelines from experts to ease the ache of tax season.
1 Consult a professional.
No, not a psychiatrist, a tax professional such as a CPA. Even if you’re blessed with financial acumen, only a tax expert can thoroughly understand the IRS’ intricate, year-to-year changes in policy.
“Oftentimes, business owners do not know all of the requirements for which kinds of returns are required for their business,” says Michele O’Donnell, HR Services Manager with MMC, Inc., a Los Angeles-based HR consulting firm. “In addition to those required by the federal government, there are state, city and local returns that may be required.”
Angela Cortright, owner of Spa Gregorie’s, with three locations in Southern California, has always enlisted an accountant to prepare her business taxes. “Our area of expertise is spa and salon; his is accounting,” Cortright says. “He wouldn’t try to do our work and I wouldn’t dare do his!”
2 Consider deductions related to fixed assets.
We could devote a very long piece to this complex topic alone. For the full lowdown, it's best to visit the IRS website (irs.gov) and scroll down to Section 179 (Property Deductions).
But first, here are a couple of key fixed asset-related issues to keep in mind this year. First, the Tax Relief Act allows the expensing of up to $500,000 of the price of most new or used fixed assets purchased in 2011 (this will be reduced to $125,000 for 2012 purchases). Second, there’s an additional provision for 100% bonus depreciation (capped at $2,000,000) in 2011 for certain new assets purchased between September 9, 2010, and December 31, 2011, as long as they were placed in service in 2011. It even allows for the 100% reduction for certain assets not placed in service until 2012. Qualifying assets include: business equipment; vehicles in excess of 6,000 pounds; computers; software; office and spa equipment; and furniture. And, loss carry-forwards—applying the current year’s net operating losses to future years’ profits—are allowed if the deduction exceeds the profit of the business.
3 Seek tax credits!
Some spa owners may be unaware of the many tax credits available to small businesses. Your accountant can tell you about those unique to your situation, but there are also a couple of new credits you should be aware of:
• The Health Care Tax Credit, made available via the September 2010 Small Business Jobs Act, is for small businesses that pay at least half of employee healthcare coverage.
• Businesses with 10 or fewer full-time employees who earn less than $25,000 annually are eligible from 2010 to 2013 for a tax credit of up to 35% of the money spent on health premiums. (That credit iteratively reduces for companies with up to 25 employees and/or with average wages above $25,000.)
• For the self-employed, there are new 2011 credits related to the Alternative Minimum Tax, the nearly flat rate on income, that may help reduce your bill. Be sure to visit the IRS website for details.
4 Define deductible expenses.
The IRS says a business expense must be both ordinary and necessary to be deductible. An ordinary expense is “one that is common and accepted in your trade or business” (think treatment tables), while a necessary expense is “one that is helpful and appropriate for your trade or business” (think spa management software).
Don’t underestimate the importance of good recordkeeping to justify expense deductions. “To ensure that you obtain all the deductions to which you are entitled and include the appropriate amount of income, it is important to provide a complete, accurate set of records to your tax preparer,” says Ted Hoover, who as a CPA and partner with Padgett Business Services in Newport Beach, California, provides accounting services for a number of day spas.
Complete records include cash receipts, potential non-revenue items that might have been mistakenly counted as revenue (such as transfers from other accounts), fixed asset purchases, credit card charges (they can be deducted on the date of the charge, not when paid), all checks written during the year, and vehicle mileage records. For a complete list of deductible and non-deductible expenses, refer to IRS Publication 535 (Business Expenses), on the IRS website.
5 Use medical spending and retirement accounts.
No matter how small your spa, you can take advantage of deductions related to medical expenses and retirement accounts.
The most common medical expense deduction is the Flexible Spending Account, which allows workers to set aside a certain amount from each paycheck to cover medical expenses with pre-tax dollars. The only drawback to these accounts is that any funds not used in a calendar year are forfeited. Another popular employee health benefit—available to self-employed individuals and most companies with High-Deductible Health Plans—is the Health Savings Account, which is owned by the employee and does not include a “use-it-or-lose-it” provision.
Certain retirement plans also are tailored to small businesses. An example is the SEP-IRA, a special IRA into which a self-employed business owner can channel up to 25% of her income, on a pre-tax basis. These contributions can be made any time prior to filing the return (i.e. April 15, or if an extension is filed, October 15). Another is the SIMPLE IRA, an employee retirement account to which employees and their employer contribute (employers match employees’ individual contributions by up to 3%).
6Be aware of potential penalties.
For example, “Make sure employees receive their W-2s on time,” O’Donnell cautions. “In that same vein, all required 1099s [for independent contractors] must be issued on time.” Employers are required to provide both of these forms no later than January 31. (If you missed that deadline, file for an extension right away to prevent further penalties!)
Business tax returns must also be handled on time. “The penalties for late filing are pretty stiff and can add up quickly,” O’Donnell says. Other filing requirements include state returns, as well as city and local returns in some areas of the country. Payroll tax quarterly filings must also be done on a timely basis. The penalty for failure to file a return on time is 5% of the unpaid tax for each month it is unpaid, up to a maximum of 25% of the tax due.
If a pattern of tax evasion behavior is uncovered, more serious consequences—including criminal charges—can result. Even if you don’t have all the funds available to pay the tax bill on time, you should always file the return, or an extension, by the due date. Partial payments will reduce your penalty and interest due to the IRS.
7 Learn about income deferrals.
There are certain income deferral opportunities unique to retailers and service businesses, particularly concerning gift cards. “Under certain circumstances, accrual basis taxpayers”—those who recognize credit and other long-term transactions other than cash—”may defer advance payments such as the sale of gift certificates for up to one year,” Hoover says. “The IRS recently modified the provision allowing deferral of advance payments received to include certain gift card sales.”
He adds that it’s a complex area, and as such may require an application for a change in accounting method for advance payments. “However,” Hoover notes, “if you qualify, it could provide significant deferral of income.”
Also note that, effective for taxable years ending on or after December 31, 2010, gift card sales where (1) the taxpayer is primarily liable to the customer, and (2) the gift card is redeemable by the taxpayer or by another entity that is legally obligated to the taxpayer to accept the gift card, accrual basis taxpayers may be able to defer the revenue recognition for up to one year.
8 Bone up on “the tipping point.”
The IRS website references four key tax items regarding tip income: 1) Tips are subject to federal income, social security and Medicare taxes; 2) Tips should be reported on the tax return in the gross income area, including tips received under a tip-splitting arrangement; 3) Tip income of $20 or more per month should be reported to the employer for withholding; and 4) IRS Publication 1244 (Employee’s Daily Record of Tips and Report to Employer) should be used to record tip income. IRS Publication 531 should be consulted for more guidance regarding tip income treatment.
9 Consider new policies. For example, “Businesses that provide indoor tanning services on or after July 1, 2010, must collect a 10% federal excise tax on the indoor tanning services they provide,” Hoover says. “The tanning tax must be paid by the person who pays for tanning services, but must be collected and sent to the IRS by the business that receives payment for the tanning services.” The tax is reported on IRS Form 720-Quarterly Federal Excise Tax Return.
With good recordkeeping, tax planning and some informed professional assistance, dealing with the IRS can be relatively painless this year! Keep these strategies in mind, and you might just reduce the check you owe your least favorite uncle come April 15.
Sidebar: Misclassified Information
The IRS Voluntary Reclassification Program for Independent Contractors
There are three primary determinants that distinguish an employee from an independent contractor: 1) behavioral control; 2) financial control; and 3) relationships of the parties. According to the IRS, “an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.” So, it applies to your business only if your therapists handle their own marketing, management, cash flow and policies.
Ted Hoover, a Southern California-based CPA, cautions spa owners that employee classification is becoming a greater area of emphasis for the IRS, pointing to the program launched in September, 2011, to allow those employers who have misclassified workers a period of amnesty—there was no official deadline at press time—to “come clean.” Hoover advises consulting a tax advisor before making any reclassifications, but says that this year, a worker who’s determined to have been misclassified as an independent contractor can render the employer subject to back employment taxes for past years, plus penalties and interest.
To be eligible for misclassification amnesty, Hoover names three criteria that must be met: 1) You must have consistently treated your workers as non-employees; 2) You must have filed all required Forms 1099 for the workers for the previous three years; and 3) You cannot currently be under audit by the IRS, or currently under audit concerning the classification of your workers by the Department of Labor or a state government agency.
If the requirements are met, Hoover indicates that the terms of the amnesty settlement are potentially favorable:
• You pay only 10% of the employment tax liability that may have been due on compensation paid to all workers for the most recent year;
• You will not be liable for any interest or penalties on the liability;
• You will not be subject to an employment tax audit for the worker classification of the workers for prior years; and
• You agree to extend the period of limitations of assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which you agreed to begin treating the workers as employees.
Form 8952 (Application for Voluntary Classification Settlement Program) should be used to apply for the settlement offer. However, exercise caution before proceeding with the filing, advises Michele O’Donnell, HR Services Manager with MMC, Inc. in Los Angeles. “Analysis should be completed to determine if there are workers that are truly classified incorrectly,” she warns. “Many times employers rush into these decisions without carefully considering all of the information or consulting an expert in the subject matter.” O’Donnell reminds that a spa owner can’t “un-ring a bell” once a reclassification has been made. “Obviously, the best thing for employers to do is make sure workers are properly classified from the beginning, and that all appropriate taxes have been paid on those workers,” she says.
Sidebar: In the Pipeline
2012 tax developments that may impact your spa!
With the flurry of legislative activity in Washington in recent years, it has been difficult to keep up with tax law changes that impact spa businesses. According to CPA Ted Hoover, the following stands to impact your 2012 business tax filings:
• A cell phone provided by an employer to employees primarily for business reasons is an excludable fringe benefit. The employee’s personal use of the phone will not be taxable to the employee.
• The standard mileage rate will remain at $0.555.
• 50% first-year depreciation will be extended to apply to property placed in service after September 8, 2010, and before 2013.
• The section 179 expensing limit will be reduced from $500,000 to $125,000.
• Enhanced auto, van and truck first-year depreciation cap for bonus depreciation-eligible vehicles will be extended through 2012.
• A provision in the Patient Protection and Affordable Care Act (PPACA) will require employers to disclose the value of the benefits they provided for each employee’s health insurance coverage on annual Form W-2s beginning in 2012.
• Also related to the PPACA, over-the-counter drugs still are not allowed to be purchased through pre-tax medical spending accounts.
J. Tol Broome, Jr. is a freelance financial writer.
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