TAXES

Are You Breaking Tax Laws Without Even Knowing It?

With new Internet sales tax rules on the horizon, it's clear that tax laws are so complex that you may be unknowingly breaking all sorts of them.
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So you heard the news: Congress is considering letting states charge sales tax on Internet purchases for the first time. Right? Well, not exactly. The fact is, most states already charge tax; it's just that they don't have any effective way to collect it.

So, the bill in Congress, which has passed the Senate but is more controversial in the House, would shift the burden for collecting and paying state sales tax from Internet buyers to Internet sellers. Thus, it could easily become a huge headache for your business. (That's in part why eBay has been pushing its sellers to lobby against the proposed law.)

Right now, for example, someone in California who buys something from a private seller in Connecticut--say, a 1:720-scale model of the U.S.S. Roosevelt aircraft carrier on eBay--is supposed to pay sales tax on it. You heard that right: The buyer is technically supposed to keep track and pay those sales taxes with their state tax return. But almost nobody complies, and a lot of people probably aren't even aware of the law.

When state tax authorities catch up, however, the ramifications can be enormous. Just ask former Tyco CEO Dennis Kozlowski, who went to prison after an investigation that began with his failure to pay New York State sales tax on expensive artwork.

That got me thinking: laws can be complex. Sometimes the government even changes the rules in the middle of the game. And even when the laws stay static, it's easy for even well-meaning entrepreneurs to break them without even meaning to. (Case in point: As I was writing this column, former Fugees singer Lauryn Hill was sentenced to three months in prison for failing to pay taxes on time, although she ultimately paid every dime.

Here are a few other examples of where it's easy to go wrong.

Failing to turn over payroll taxes.

If you have employees, you have an obligation to withhold their federal income taxes and turn those taxes over to the federal government. Unfortunately, sloppy bookkeeping, bad luck, or other circumstances often lead small business owners to fail to do so, even with good intentions.

Every year, thousands of business owners hold back the taxes they owe in favor of paying other expenses. Facing what they hope will be temporary crises, they use the cash thy owe the governmetn to pay rent, or vendors, or other critical expenses. They hope that this way, they'll at least have a fighting chance to stay in business--and they'll make things right with the tax authorities later.

It's a dangerous game, though. If a company that failed to pay taxes goes under, the the IRS can and does go after principals and others it deems "responsible persons" individually. In other words, the tax debt doesn't necessarily die with the company.

Deducting personal expenses as business expenses.

This one is pretty obvious, but it's an easy pitfall, especially for entrepreneurs and "solopreneurs." A lot of expenses are useful for both business and personal purposes, and that can become awfully tricky to report correctly.

Of course, there are a lot of excellent, creative, and perfectly legal business expenses you can legitimately deduct. The most important rule seems to be, keep good records!

Collecting Internet sales taxes.

Wait, you might say--I thought we established at the start of this article that the law currently doesn't require you to collect sales tax for Internet purchases, and that instead it's the buyer's responsibility to file and pay.

Like just about everything in this field, there are exceptions and then exceptions to the exceptions.

The most relevant exception here is that if you have a physical presence in the state where your buyer is located, generally you're going to be expected to collect and pay sales taxes. Thus, a seller in San Diego who ships an Internet-purchased product to a buyer in Sacramento is likely to be on the line for state sales taxes. Again, though--there are often complex "exceptions to the exceptions."

All of which leads to two points: First, our tax system is complex, confusing, and often counterproductive, and second, if you want to be an entrepreneur, I hope you've got a good accountant you can trust!

Last updated: May 7, 2013

BILL MURPHY JR. | Columnist

Bill Murphy Jr. is a journalist, ghostwriter, and entrepreneur. He is the author of Breakthrough Entrepreneurship (with Jon Burgstone) and is a former reporter for The Washington Post.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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