In 2009, Dr. Mike, DC, contacted the IRS, but not to pay his business taxes. Instead, he was giving the IRS notice that it owed him $102,000.
You can imagine that it takes a lot of nerve to do such a thing. Dr. Mike’s nerves were certainly on edge when he did it, and his concerns quickly rose to the red zone when he got a reply.
Unsurprisingly, the IRS responded to his request for $102,000 with an audit. And Dr. Mike was worried.
Recently, with some outside help, he had found and hired a new tax team to develop a smarter tax strategy for his business.
Because he wasn’t a tax expert, he put his trust in the team. And now, the immediate outcome of the team’s advice was an audit. He wondered, “Did they go too far? Did he just do something illegal?”
Fortunately, this story has a happy ending. But to get there, we’ll start from the beginning. You’ll discover why Dr. Mike asked the IRS for $102,000 and examine how you, as a business owner, may be able to do the same thing.
Start with structure
Before Dr. Mike began working with a new tax team, he was in a bad spot.
Despite paying high fees for a quality accountant, the advice he received was unsatisfactory.
Although he was the perfect candidate to have his business classified as an S corporation, a structure that comes with major tax benefits, his accountant wrongly advised against it. An S corporation allows you to avoid payroll taxes, otherwise known as the self-employment tax for business owners, on a major portion of your income.
Under the requirements of classifying as an S corporation, you have to pay yourself a reasonable salary, which is subject to payroll taxes. But after that, you can receive regular distributions from your company for any amount, and these are not subjected to the 15-percent payroll tax. For Dr. Mike, switching to an S corporation would have meant saving about $20,000 per year.
Separate to save
When a business asset loses value, it’s called depreciation. And depreciation can be counted as a business expense, which lowers your taxable income.
Here’s a rough example: If a $10,000 business asset depreciates to $8,000, then you can write off the $2,000 depreciation as a business expense, which lowers your taxable income by
$2,000. There are all sorts of IRS rules governing depreciation, so it’s best to talk to your accountant about your specific situation.
Dr. Mike’s business owned a building that could be completely depreciated over 39 years as deemed by the IRS. If the tax team didn’t know to hire an engineer, that would have been the end of the gains. But because of something called cost segregation, an engineer can identify pieces of a building that the IRS allows to depreciate at a faster rate.
For example, carpet, which doesn’t typically last 39 years, can be depre- ciated much faster. Usually the IRS allocates five years. That means you can deduct one-fifth of the carpet cost annually for five years, significantly reducing your taxable income. “Having the ability to depreciate things like that at a different speed helped signifi- cantly,” Dr. Mike said.
Three years in review
Dr. Mike’s tax team looked at his returns from the past three years and realized he missed out on some major savings. Fortunately, the IRS allows you to amend tax returns up to three years later and reclaim savings you may have missed. That’s how Dr. Mike came to ask the IRS for $102,000.
Much of that savings came from missed cost segregation opportunities, but other earnings came from tax write-offs like mileage when using a car for business—and that’s exactly what triggered the audit. The IRS had questions about how Dr. Mike was using his car for business, and whether he qualified for those savings.
So what happened? What was the result of the audit?
“We think of audits as probably one of the last things that you ever want to have to experience,” Dr. Mike said. “But it wasn’t painful at all. There were a few phone calls and a few documents we had to submit, and that was it.
Everything else was handled, and it came back that we didn’t have to pay anything more.”
The IRS decided that Dr. Mike was correct to write-off his mileage. In fact, his only mistake was not writing off enough. The IRS allowed him to write- off more mileage than he had asked for in the beginning.
A few morals emerge from this story. One, hire an accountant who specializes in business and can help you pick the appropriate corporate structure.
Two, get a second opinion on your last three years of tax returns. Another set of eyes may be able to identify savings you wouldn’t have received otherwise, including cost segregation and business mileage.
And three, audits are only scary if you’re cheating the tax law. If you’re working with an accountant who knows the law and can use it in your favor, then you have nothing to fear. You can feel confident taking every tax savings legally allowed.
Garrett B. Gunderson, a lifelong entrepreneur, is a financial advocate to chiropractors and engages in a vitalistic financial philosophy to assist DCs in creating sustainable wealth. His company, Wealth Factory, helps entrepreneurs navigate personal finances and investing. He wrote the New York Times’ bestselling book Killing Sacred Cows. Get a signed hardcover copy at ebookforchiros.com.