In Part 1 of Salon Savvy: Avoiding Tax Pitfalls with Style, we explored what can happen when a business misclassifies workers as independent contractors, puts off delinquent tax liabilities, or when tax returns are filed late, or not at all. Part 2 of this guide aims to continue equipping you with the knowledge necessary to sidestep the most common industry pitfalls and maintain a seamless tax compliance strategy.

Overclaiming the Employee Retention Credit

The Employee Retention Credit (ERC) has been a valuable lifeline for many businesses impacted and recovering from the pandemic. However, it has also been the target of numerous scams, leading to overclaimed credits and subsequent liabilities.

Attorneys, CPAs, and EAs, as well as any other individual who for compensation prepares or assists with the preparation of all or substantially all of a tax return or claim for refund, are ethically prohibited from charging their fees based on the amount of ERC and associated interest paid to the business under the IRS ethics rules for tax practitioners (Circular 230)

However, a handful of ERC businesses, which the IRS often refers to as “ERC mills,” have attempted to get around this rule by acting as ghost preparers, which the IRS defines as someone who doesn’t sign the tax returns they prepare. Not having your return(s) signed by the individual/company that prepared the return(s) is an ERC red flag. Being charged a percentage of your ERC refund/interest is an ERC red flag.

The IRS currently has three years to audit any payroll tax returns claiming ERC for Q2 2020 - Q2 2021. The IRS has five years to audit Q3 2021 and Q4 2021 payroll tax returns claiming the ERC. The Tax Relief for American Families and Workers Act of 2024, includes a provision that will extend the ERC audit statute of limitations to six years from the filing date for Q2 2020 - Q4 2021. While the Act has passed the House, it awaits voting and approval by the Senate. The IRS is expected to ramp up ERC audits in the coming months and years as the IRS continues to hire more agents to increase tax enforcement.

Stay vigilant, seek professional guidance, and remember – it's the business that will ultimately be liable for any overclaimed credits, interest, and penalties.

Tax Preparation Without Proactive Tax Planning

While tax preparation is a necessary annual task, it's imperative to recognize the distinction between preparation and proactive tax planning. Engaging the services of a tax attorney can provide strategic guidance to minimize your tax liability, optimize your financial structure, and foster long-term business success. With that being said, some of the biggest missed tax planning opportunities seen in the salon and spa industry include:

1.  S-Corp/C-Corp elections;

2. Cost segregation studies;

3. Work Opportunity Tax Credit (WOTC); and

4. CARES Act Section 2206 (temporary modification to the employee student loan repayment rules).

Think of tax planning as your secret weapon – a proactive approach that can minimize your tax burden, optimize your financial structure, and set you up for long-term success. Just like a fabulous hairstyle, it's all about staying ahead of the game.

Untimely Estimated Tax Payments/Federal Deposits

Estimated Tax Payment Penalties

If you are self-employed and expect to owe $1,000 or more in taxes when you file your annual return, you are generally required to make estimated tax payments. Just like regular trims keep your clients' styles looking fresh, making estimated tax payments throughout the year can help you avoid penalties and maintain a healthy financial 'do. Follow the quarterly schedule, and you'll be one step closer to a tax season that's comparable to a perfectly executed blowout:

• January 1 – March 31: Due April 15

• April 1 – May 31: Due June 15

• June 1 – August 31: Due September 15

• September 1 – December 31: Due January 15 of the following year

Generally, the Underpayment of Estimated Tax Penalty is 5% of the underpaid amount but is capped at 25%. The penalties also accrue interest.

Failture-to-Deposit Penalties

In general, a business owner must deposit federal income tax and additional Medicare tax withheld as well as both the employer and employee social security and Medicare taxes. There are two deposit schedules, monthly and semi-weekly. Deposits for FUTA Tax (Form 940) are required for the quarter within which the tax due exceeds $500. The tax must be deposited by the end of the month following the end of the quarter. Failure to Deposit penalties, which accrue interest, are as follows:

• 1-5 days late = 2% of the late payroll tax deposits

• 5-16 days late = 10% of the late payroll tax deposits

• 16+ days: 10% if you pay within 10 days of the IRS’s first notice, OR

• 16+ days: 15% if you pay 10 or more days after the date of the IRS’s first notice

Want to learn more about your estimated tax obligations? Be sure to read our recent SALON TODAY article, which provides a guide for self-employed individuals needing to make estimated tax payments.

So, whether you're a seasoned salon owner or a freshly minted spa entrepreneur, remember – tax compliance is as essential as mastering the latest hair trends. Embrace these tips, seek professional guidance when needed, and you will be well on your way to a tax season that's as stylish and stress-free as your best work. Not sure where to start? Schedule a free consultation online atAzarvandTaxLaw.com or by emailing Info@AzarvandTaxLaw.com.

Read Part 1 of this Series.

^[1]See Treasury Department Circular No. 230, § 10.27 — Page 21.