Last Updated Feb 16, 2011 5:14 PM EST
This article is part of a series this week on how three entrepreneurs survived run-ins with the IRS. Today's story: Leslee Kavanagh runs Ideal Closets, a closet design and installation business, from her home in Somers, NY. When the IRS audited Leslee's business in 2008 and told her she owed several thousand more in taxes, she fought it and proved the government wrong. Here's what happened.
It was scary when I opened my mailbox in August 2008 and saw a letter from the IRS. It said, "We are reviewing your tax records for 2005 to 2007, and A, B, and C are not correct." The IRS claimed that I had miscalculated a number of business expenses, including my phone, internet, tax, and bookkeeping services, and that basically triggered a full-fledged audit. I felt singled out and I kept thinking, 'Why me?'
As you might guess based on my line of work, I keep very detailed records. Still, just gathering all of the necessary paperwork that the government wanted took at least eight to 10 hours. The IRS wanted copies of three years worth of bills. My stress level was very high. It felt like any minute I would get a phone call or a letter from the IRS -- like Big Brother was watching me.
Once we submitted my records, the IRS said I owed $3,200. That's a lot of money to my small business. I'm not GE. This business is just me and my husband. That amount nearly covers our monthly mortgage payment.
We gave the materials to our accountant and that's when I learned an important lesson about taxes: The IRS can make a mistake just as easily as you can. Our accountant quickly realized that my previous accountant had transposed some numbers relating to my expenses; on top of that, then the government made a mistake when it recalculated the amount. When our accountant finally untangled the whole mess, he found that we didn't owe the IRS anything; the IRS actually owed us $600.
The government eventually agreed with him, but it took five months and many hours on the phone with an "examining officer" based in Harrisburg, Pa., to resolve the matter. I probably sent her at least another inch of documents. At one point I had to ask for more time to collect everything because of the demands of my business. She was accommodating -- probably because she was so overwhelmed (I was one of hundred of cases she was working on) and she needed a lot of time to look over everything I sent. I think it helped to be as pleasant as possible, rather than treating her like the enemy.
In the end, the IRS wound up paying me interest on the money it owed, about $34. The biggest surprise: The officer even called to apologize for making the calculation error months before and for the length of time it took to fix the problem. That made the process human for me. Even though the IRS validated that I had done everything correctly, the experience completely changed how I look at buying things I need for my business. I always ask myself: Will this be questioned? I have a heightened sense of the IRS being involved in my business. Now I keep a separate file of receipts for every type of expense, which is probably going a little too crazy, but what can I say? I'm a professional organizer.
Know your deductions:
BNET asked small business tax experts how to find some of the best -- and most overlooked -- deductions.
- Depreciate the full value of your equipment this year. You can expense the total purchase price, up to $250,000, of most qualified business equipment, including computers and printers, furniture, machinery, and vehicles that you put into service in 2010, instead of depreciating them over five or more years, as long as you spend less than $800,000 on them. The items have to be listed on Form 4562 [pdf download] and you must take a Section 179 election, says CPA Howard Samuels, managing partner of S&C LLP in New York City and Fairfield, N.J. Make sure your accountant includes the deduction on the line for "depreciation," rather than "office supplies," or the IRS could disallow the deduction, he says.
- Travel smarter. If you travel to a business convention in Paris, Rome, or Beijing, you'll have to prove that there was a special reason for the meeting to be there, says CPA Philip Liberatore, of La Mirada, Calif. That's not so if you travel to conventions in Bermuda, the Caribbean, Canada, Mexico, or any U.S. territories, all of which have agreements to exchange tax information with the U.S. government. Those are deductible, no extra proof required.
- Put your kids on the payroll. For 2009, you can pay a child under age 18 up to $5,700 that would be exempt from the FICA tax, says CPA Jonathan Gassman, who's based in New York City. He advises that you make sure that you keep good records and pay your child on a scale that is commensurate with the going rate. For instance, Gassman pays his 17-year-old daughter $20 an hour to do office work such as scanning and inputting data.
- Keep those topiaries trimmed. A recent tax court ruling allowed a sole proprietor who regularly met clients at his home to deduct part of the cost of landscaping the property, because it was being used for business, says Liberatore. He was also allowed to deduct part of the costs of lawn care and driveway repair.
- Deduct banking fees. Don't forget to write off banking fees and ATM charges for your business bank accounts and credit card fees for those that are for your business.
- Log those miles. One of the best known but most overlooked deductions for entrepreneurs is the mileage deduction, currently 55 cents per mile. Keep a record every time you travel to a client's office or make a trip to the post office or office supply store. But, "you can't deduct your trip from your home to your office," warns Liberatore.
- Offer long-term care insurance. If you run a C corporation, you can deduct 100 percent of the premiums for long-term care insurance that you offer to employees -- including yourself -- as a benefit, says Gassman. If you are worried about paying premiums the rest of your life, look for a policy that lets you pay off the premiums in a short time, such as 10 years, he advises. Transportable policies are worth considering if you think you will leave the company before you have finished paying all of the premiums. -- As told to Elaine Pofeldt