Sole Proprietor vs. Incorporating/Audit Risk

What many small business owners do not know is that filing as a sole proprietorship could put you at risk for being audited. With any business, there are of course necessary deductions but a sole proprietorship may raise a few more needless red flags that could be avoided by running your business as a corporation. So what are those pesky red flags and how does a corporation help avoid them? Here are just a few:

// The Home Office Deduction

You may be thinking – yes, yes – we all know about the home office deduction! Unfortunately, most people don’t read through how the deduction actually works. Take into account that most sole proprietors work from home and you can see how trouble can brew. The home office deduction should only be taken if you use the room exclusively for business purposes. The kitchen nook that doubles as your office space is not exactly what the IRS considers an eligible office. The space must be clearly used for business purposes. Remember, only a certain percentage can actually be claimed. The other pesky issue is that all of those business deductions then have to be written on a separate form that itemizes home business expenses which can send up a red flag. On the flip side, with an S or C Corporation, you don’t have to file a separate deduction form.

Schedule C

Ultimately, the problem with a sole proprietorship is that no matter what you deduct, the Schedule C form draws attention. In 2006 alone, 4 percent of all sole proprietors filing a Schedule C were randomly audited as compared to less than 1 percent of all corporations who filed either Form 1065 or Form 1120S. Why? Well, the IRS is on the lookout for those business owners who hide portions of their earnings because so many people historically attempt to overstate their expenses or downplay their actual cash earnings.

Cash Based Businesses

One of the IRS’s biggest concerns is the sole proprietor with a cash based business. Caterers, personal trainers, dog walkers, this means you. Many self-employed professionals tend to receive large amounts of cash that go undeclared. And unfortunately, the IRS is all too aware of that.

Understating Earnings

Another common mistake is “understating” your earnings by “overstating” your deductions and expenses on your Schedule C. And, well there is a difference between deducting a few business meals a month and deducting your weekends out with your spouse for the entire year. Again, entertaining business clients or paying for business meals may be part of your job but only a certain portion can be deducted and only under certain conditions.

The other thing you want to avoid is taking too much of a deduction on your automobile expenses. You can deduct the cost of your car if used for business purposes. That means you can either deduct the mileage at the rate of 44.5 cents per mile in 2006 or you can deduct the ordinary expenses you incur such as gas, oil changes, and parking fees. But, when you also start to deduct the cost of gas on your family road trips to the Grand Canyon or Yellowstone National Park, you may raise a few eyebrows.

Other No-No’s

There are a few other areas where a sole proprietor can get themselves into a bit of trouble. One of the biggest no-no’s is co-mingling business and personal expenses and monies in the same bank account. It makes the business look like a hobby more than a business and it makes bookkeeping infinitely more difficult. Solution? Always use separate bank accounts.

Oh, and estimates might get you into a bit of heat as well. It is rare that you will get your meals or other deductions to equal a perfectly round number so jotting them down on a Schedule C that way can easily send up a red flag. Solution? Never use round numbers.

The Benefits of a Corporation

With a Corporation, your expenses are entirely separate from the expenses of the business. It is likely you will have a separate credit card and banking accounts where you can track business meals, gas for business, and other issues. Also, the IRS forms are consolidated and filed separately from your personal expenses because the business is a separate legal entity.

We’ll be discussing liability issues later as well, but taxes are a biggie.


LLCs and Corporations for Internet Marketers

Hello Internet Marketers!

This blog will contain information on Limited Liability Companies, “C” and “S” corporations geared toward Internet Marketers or any other small business owners. I am an expert in this field, having been a corporate consultant for the top incorporating companies in Nevada, which incorporates more companies than the other 49 states combined. I’ll let you know why this is in later posts.

I also have 2 decades experience on Wall St. as a stockbroker/supervisory principal and have participated in 6 or 7 dozen IPOs and a half dozen secondary offerings, none under USD $25 million. I have pretty much single-handedly brought 2 Chinese companies public under NV. Regulation D so I have a well rounded corporate background.

Since I have entered the IM arena, I have noticed that many Internet Marketers are very under informed on how to structure their businesses for maximum liability protection as well as tax savings. Some are getting just downright bad information from licensed professionals such as attorneys, CPAs and financial planners.

In some cases, this has cost them thousands of dollars and, in more extreme cases, caused them serious problems with both state and Federal agencies.

I will be addressing many of these issues and will reveal resources to help business owners keep more of their hard earned money while showing techniques that will legally protect their assets and obtain every tax break they are entitled to.

I also invite comments and resource providers that will benefit everyone safely and legally.

See ‘ya on the next post, FranksternVegas.