Tax tips for small HVAC shops
Small shops have special considerations when it comes to filing returns
Much of the HVAC construction industry, especially those in the residential realm, is comprised of small shops or even one or two-person operations. Many of these “pocket contractors” operate as sole proprietors.
Often these fledgling entrepreneurs are thrust into business lacking experience or knowledge of matters such as payroll, taxes, accounts receivable, accounts payable, insurance and business regulations. It can be overwhelming to small operators and make them feel like they can’t succeed.
An area that should not be ignored by small contractors just starting out is the importance of staying on track with the Internal Revenue Service and personal income tax liability.
Let’s imagine that until recently you were just an employee. Maybe an HVAC service technician, maybe an installer or more likely, a little of both. Now you’re an entrepreneur. Your own boss. The CEO. The “big wig.” Now reality must be dealt with. Now you have many jobs: sales staffer, designer, fabricator, installer, service tech, maintenance technician, shop supervisor and bookkeeper.
It’s being a bookkeeper that’s especially easy to neglect but it’s also the one that causes much grief with the IRS. Whether you are doing the books yourself or have an accountant or family member do the books, the responsibility of accuracy for all income and expenses is still yours.
Assuming you haven’t made the decision and taken action to become a limited liability corporation, an S corporation or other legal entity that requires filing papers with your state, you are now a sole proprietor. The good news is that you can start conducting business today without doing anything except earning and spending. You are the business and the business is you. The accounting is very simple — IRS regulations don’t even require separate checking accounts for you and the business; only that the records are kept separate.
Directions to follow
Even though this is allowable, it’s a bad idea. You may not be able to easily track your business expenses and know if you’re profitable. Many companies go out of business because they don’t know what it costs to be in business. If you want to close, run your books through your personal checking account. If you want to stay in business, follow these rules:
Rule No. 1: Establish a separate business account in your name under a DBA (doing business as) prior to opening. Get a debit card linked to this new business account or better yet a credit card with your business name. Use this debit or credit card for business purchases only. Carry a debit card or credit card linked to your personal checking for all personal expenses. Don’t mix them up.
If you’re a sole proprietor, transfer money from your business account to your personal account as needed, either electronically or by check. In your accounting books, this will be labeled a profit distribution. Remember, once you take this, you’re going to have to pay taxes on it because you’re telling the IRS this is net profit becoming your income.
Rule No. 2: Make your first business purchase small-business accounting software. Many programs are beginner friendly and you can learn as you go.
When you do you taxes as a sole proprietor, you will be required to complete a schedule C “profit or loss from business or profession.” This tells the IRS everything it needs to know on one page about your HVAC market business. It shows your revenue, that’s the total amount you collected from customers for the year, and it shows all your deductible expenses. The difference is going to be your profit. This is what you’re taxed on.
Using accounting software and making daily entries of all income and expenses will allow you to produce a profit and loss statement and other reports that will put everything the IRS needs at your fingertips, instantly.
Rule No. 3: Report all income. Yes, that means cash, too. A lot of owners make the mistake of hiding cash and then can’t get a mortgage or business loan. Report it. It will pay off in the long term.
Failure to report income to the IRS could be viewed as fraud punishable by fines or imprisonment.
Taking questionable deductions can only be viewed as a mistake or poor judgment, punishable by penalties. See the difference?
The IRS really doesn’t expect you to know the 9,000-page federal tax code, but they do expect you to know what income is. They are somewhat reasonable with deductions.
Rule No. 4: Pay estimated taxes if you can. If you’re a sole proprietor, the IRS does not require you to pay quarterly estimated taxes your first tax year in business. This is because there is no basis for an amount because you don’t know how much you’ll make. Just be aware that your total tax liability, including the full Social Security burden, will fall somewhere between 25 and 40 percent of your net profit, or the profit distributions from your business account to your personal account.
Pay close attention to the amount of taxes you will owe throughout the year and try to set this amount aside in an account linked to your business checking account. Periodically look at the amount of profit distribution you have taken year to date and try to set aside 30 percent. This should keep you out of trouble.
The IRS has algorithms that are a set of rules or formulas that knows approximately what your schedule C tax form should look like based on the total sales you report. It knows that your job materials should be somewhere between 30 to 50 percent of total revenue, they know payroll should be around 20 to 25 percent, and so on. These formulas are based upon millions of returns over many years and when you fall outside the formula, a buzzer goes off. Then humans look at the return and decide if pursuing an audit could potentially produce substantial money for the IRS. If the answer is yes, you’re getting audited.
Staying on top of your bookkeeping and specifically the IRS requirements will ease the transition as your business grows. If you develop good accounting habits in the beginning, you won’t have problems later.