When it comes to taxes, misinformation spreads quickly, especially this time of year. Whether it’s advice from a well-meaning friend, something you saw online, or just assumptions based on outdated rules, tax myths can lead to costly mistakes. As a small or mid-sized business owner, understanding tax laws is essential to keeping your finances in check and avoiding unexpected IRS issues.
Let’s break down some of the most common tax myths and get to the truth so you can make informed financial decisions.
Myth #1: Retirement Withdrawals Are Always Tax-Free
It’s a common belief that once you retire, the money in your 401(k) or IRA is yours to use without tax consequences. Unfortunately, that’s not the case – withdrawals from traditional 401(k)s and IRAs are taxed as ordinary income. If you take out a large sum in one year, you might even move into a higher tax bracket, increasing your tax liability.
The Truth: If you want to enjoy tax-free retirement withdrawals, consider contributing to a Roth IRA or Roth 401(k), where qualified distributions are tax-free after age 59½, as long as the account has been open for at least five years.
Myth #2: Big Equipment Purchases Should Wait Until Year-End for Maximum Tax Benefits
Many business owners believe that waiting until the fourth quarter to buy equipment maximizes tax deductions for the year. While Section 179 and bonus depreciation allow businesses to deduct large purchases, timing your equipment investments should be based on operational needs, not just tax savings.
The Truth: If your business needs new equipment, buy it when it makes sense for efficiency and growth. Tax laws frequently change, and deductions may be available regardless of when you make the purchase.
Myth #3: A Home Office Deduction Increases Your Audit Risk
Some business owners avoid claiming a home office deduction because they think it will automatically trigger an IRS audit. While this may have been a concern in the past, properly documented home office deductions are legitimate and won’t raise red flags.
The Truth: If you regularly and exclusively use part of your home for business, you likely qualify for the deduction. However, if you’re an employee working remotely for a company, you cannot claim a home office deduction under current tax laws.
Myth #4: Side Gig or Online Sales Income Isn’t Taxable
Thinking of starting a side hustle or selling online? Many believe that small amounts of income from side businesses, freelancing, or online sales aren’t taxable. But the IRS sees it differently.
The Truth: All income is taxable, no matter where it comes from. If you earn money through freelancing, consulting, or selling products online, you may need to file Form 1099-NEC or 1099-K. Failing to report this income can result in penalties and interest.
Myth #5: Social Security and Unemployment Benefits Are Always Tax-Free
Many people assume that government benefits like Social Security and unemployment aren’t subject to taxes. However, unemployment benefits are taxed as regular income, and Social Security benefits may be taxed depending on your total income.
The Truth: If your total income (including Social Security, wages, and investment income) exceeds a certain threshold, up to 85% of your Social Security benefits may be taxable. To avoid surprises, plan ahead and consider withholding taxes from these benefits.
Myth #6: Paying Workers in Cash Means No Tax Reporting
Some business owners assume that paying employees or independent contractors in cash eliminates tax reporting requirements. This is false and can result in severe penalties if not handled correctly.
The Truth: If you pay an independent contractor $600 or more in a year, you must report those payments on Form 1099-NEC. If you have employees, you must report wages and withhold payroll taxes, regardless of how they’re paid. The IRS takes employment tax violations seriously, and failure to report payments can lead to audits, penalties, and fines.
Myth #7: Business Deductions Can Cover All Personal Expenses
Some business owners assume they can deduct personal expenses like dining out, travel, or even home renovations as business expenses. While there are legitimate deductions for business meals and travel, trying to write off personal expenses as business expenses is a big red flag to the IRS.
The Truth: Only expenses that are ordinary and necessary for your business qualify as deductions. If an expense is partially for business and partially for personal use (such as a car or phone bill), you can only deduct the portion used for business.
Myth #8: Selling a Business Is Tax-Free If You Reinvest the Money
Some business owners believe that if they sell their business and reinvest the proceeds, they won’t owe taxes. While real estate investors may be able to defer capital gains tax through a 1031 exchange, business sales don’t work the same way.
The Truth: When you sell a business, you will likely owe capital gains tax on the profit. However, with careful planning—such as structuring the sale as an installment sale or exploring qualified small business stock exclusions – you may be able to reduce your tax burden.
Understanding tax laws is essential for small and mid-sized business owners who want to minimize liabilities and stay compliant. Falling for tax myths can lead to unexpected expenses, penalties, or even an audit.
If you’re unsure about a tax strategy, it’s always best to consult with us to navigate tax complexities, maximize deductions, and ensure compliance – so you can focus on growing your business with confidence.