There are several IRS tax safe harbors small businesses can use to their advantage.
There are a number of so-called safe harbors that businesses can use to simplify their tax lives. Unfortunately, understanding these safe harbors can be anything but simple. Here’s a roundup of the safe harbors of particular interest to small businesses, and what they mean to you.
In 2015, the PATH Act created a de minimis safe harbor for errors on information returns, payee statements, and withholding. For this purpose, “de minimis” means an unintentional error of an amount on an information return or payee statement (e.g., W-2, 1099-MISC) not exceeding $100, or $25 for withholding. If a business makes a de minimis error, no correction is required. And no penalties are imposed for the errors.
Recipients of payee statements (e.g., employees, independent contractors) can elect not to apply the safe harbor by requesting corrected statements. If corrected statements are issued within 30 days of the request in writing, online, or by telephone (as the business prescribes), the action is treated as reasonable cause for which no penalties will be imposed. The IRS has issued guidance on this election.
Tangible personal property purchases
If you buy tangible personal property, such as tablets, desks, and table saws, you have several options for deducting the cost, including regular depreciation or first-year expensing. There’s also a de minimis safe harbor which allows for an immediate deduction of up to $2,500 per item or invoice. (It has been $500 prior to 2016, but theIRS increased it. Under this rule, the property is not added to your balance sheet and instead treated more like materials and supplies. Using this safe harbor requires an election statement to be attached to the tax return.
Note: Companies with an applicable financial statement (AFS), such as an audited financial statement or SEC filing, have a $5,000 safe harbor limit.
Many small business owners pay their federal income taxes, and where applicable self-employment taxes, through estimated taxes of four payments per year: April 15, June 15, September 15, and January 15 of the following year. If your estimated tax payments fall short by too much, you’ll owe an underpayment penalty.
How do you know what your final tax bill will be before the year is over? You don’t! The tax law lets you use two safe harbors to avoid this penalty, even if you still have to pay a large sum at tax time:
- 90% safe harbor. You won’t be penalized if your total payments for the year are at least 90% of your final tax bill
- 100% safe harbor. You won’t be penalized if your total payments for this year are at least 100% of last year’s bill. However, if your adjusted gross income on last year’s return was more than $150,000 ($75,000 if married filing separately), this safe harbor becomes 110% of last year’s bill.
Other safe harbors
Certain IRS-created tax rules are often referred to as safe harbors. These include:
- IRS standard mileage rate, which can be used to determine the deduction for business driving instead of using actual costs.
- Home office deduction simplified option, which bases the home office deduction on a dollar rate per square foot rather than on the actual costs allocated to the business space.
Safe harbors are designed for simplification, but may not be the best strategy for your situation. For example, using the IRS standard mileage rate may shortchange you if your actual costs of business driving are higher. Work with a tax advisor to determine when safe harbors are a good way to go.