When it comes to paying taxes, every small business owner knows the importance of minimizing costs legally. If you’ve heard about “too-good-to-be-true” tax hacks online, you’re not alone. But here’s the catch, what starts as “smart tax planning” can cross into risky territory all too quickly, and the IRS has a way of noticing.

According to IRS data, 0.38% of returns or 1.1% of millionaires returns were audited in 2022. While aggressive tax strategies can offer substantial savings, an overly bold approach without proper documentation could ramp up those odds and make your business an easy target.

Today, we’ll help you understand the fine line between leveraging tax strategies and stepping into dangerous waters. We’ll explore common tax strategies, their risks, and how to protect your small business.

Top Tax Strategies and Their Risks

Hiring Family Members

How It Works

This is a popular strategy that allows you to hire your spouse or children to shift income into a lower tax bracket. For example, your teenager could help with admin tasks or social media updates for your business. You’re essentially keeping the income in the family while possibly avoiding certain taxes for children under 18.

Pitfalls to Avoid

The work must be legitimate, and payment must be reasonable. If little Suzie is shredding papers twice a month and you’re paying her $30,000 annually, expect the IRS to raise an eyebrow. Document tasks, keep pay in line with industry standards, and ensure any “underage employees” are involved in tasks appropriate for their age.

Nerd Note: Did you know hiring your child might be a great way to fund a Roth IRA? Funding an IRA requires "earned income" and their legitimate earnings can be invested for the long term!

S-Corp Salary Splitting

How It Works

For S-Corporations, you can split income between salary (subject to FICA taxes) and dividends (not subject to FICA), reducing tax obligations.

Common Misuse

Some owners abuse this by paying themselves very low salaries and taking the majority of income as dividends, which triggers red flags for auditors. While there’s no hard rule on what counts as a “reasonable salary,” using industry benchmarks and documenting your reasoning is crucial.

Nerd Note: One trick? Check industry salary data and justify your income with comparable positions to avoid audit headaches.  We conduct reasonable compensation studies using Bureau of Labor Statistics data to determine the appropriate salary for the business owners we work with.

Vehicle Deductions Under Section 179

How It Works

Do you use a heavy vehicle (over 6,000 pounds) for business? The Section 179 deduction allows you to claim its cost for business purposes.

Potential Red Flags

If you’re claiming that brand-new SUV solely for business but also using it for family road trips, it could spell trouble. Detailed mileage logs are critical to proving it’s used for business at least 50% of the time.

Nerd Note: Even if you buy a qualifying vehicle late in the year, make sure actual business use matches what you’re claiming. Otherwise, that end-of-year purchase might raise questions.

Conservation Easements

How It Works

This strategy involves investing in land conservation, allowing you to claim a deduction based on the appraised value of the donation. Until recently, multipliers made these deductions extremely lucrative.

Why It’s Risky

Abused appraisals led to IRS crackdowns, and since 2022, deductions are capped at 2.5x the contribution. Supporting documentation and honest appraisals are non-negotiable if you choose this route.

Leveraging the Augusta Rule

What It Is

Named after the Masters golf tournament, this rule allows you to rent your home to your business for up to 14 days tax-free allowing them to charge a reasonable rental rate based on local benchmarks.

Common Pitfalls

Inflated rental costs, charging $5,000 a day for a standard home office, will invite scrutiny. Do your research and document comparable rates from sites like Airbnb for similar properties.  Additionally, with all business deductions, the expense needs to be "ordinary & necessary", not just another day to write down that you took as a call from home.

Why Documentation Is Your Golden Ticket

Every aggressive tax strategy must be backed by meticulous records. Whether it’s pay records for hiring family members, mileage logs for your vehicle, or rental data for utilizing the Augusta Rule, documentation is your best defense if the IRS investigates.

Nerd Note: Fun fact, the IRS can audit up to three years back, but for substantial errors, this timeline can extend to six years. Thorough documentation helps safeguard your business.

What Happens if You’re Audited for Aggressive Strategies?

The Fallout of Losing an Audit

If your aggressive strategy doesn’t hold up, you could face stiff penalties, back taxes, and potential damage to your reputation.

How to Handle Audits

If you’re audited, don’t panic. Work with an experienced accountant, be transparent about your records, and avoid hiding issues. The key is staying calm and prepared.

Nerd Note: The IRS collected $4.1 billion from audits in 2022 alone with recent upticks in enforcement actions. The cost of non-compliance far outweighs any potential tax savings!

How to Maximize Savings Without Crossing the Line

Aggressive tax strategies can significantly benefit small business owners, but the risks of overstepping are real. By staying informed, documenting thoroughly, and seeking professional advice, you can minimize taxes safely and effectively.

If you’re uncertain about how to integrate tax strategies into your business or need help maximizing your savings, connect with HealthyFP today. Our expert team will guide you, ensuring your money works harder, without crossing the line.