Tax Traps

The One Big Beautiful Bill Act (OBBBA) extended the statute of limitations for many tax provisions, making it more important than ever to be aware of the many “traps” in our tax laws—new and old. After all, accidentally falling into one of those “traps” can leave every firearms, ammunition, and related outdoor business—and their owners—open to possible penalties and fines.

While the structure used to conduct your business is already in place, is it the entity that will produce the lowest tax bills and most liability protection for its owners?  Choosing the original business structure—be it sole proprietorship, LLC, S or regular corporation—may have been done without considering all of the tax implications. Or, the ever-changing tax rules may make switching entities today worth your while.

Tripping over the S Corporation limits on the number of owners is another potential trap, as is ignoring the so-called LLC “loophole” where the firearms business is treated as a pass-through entity. If not avoided, both traps can be expensive.

Record Failures

Failing to maintain accurate and detailed financial records, especially receipts and invoices, makes it difficult to remember—and substantiate—deductions. Without substantiation, not only can deductions be disallowed, but tax bills can increase along with penalties. Either digital or paper records can prove the business purpose, amounts, dates, and recipients of all expenditures. Those records can also make audits less stressful and less expensive. 

Unpaid Payroll Taxes

Unpaid payroll taxes have long been an expensive trap. All employers are required to deposit all taxes withheld from an employee’s wages as well as the operation’s share of those taxes. As businesses collect these taxes throughout the year, the law requires employers to forward the amounts to the IRS on a quarterly, monthly, or biweekly basis.

When a retailer, distributor, or manufacturer collects payroll taxes from its employees but fails to remit those funds to the IRS on time and in full, it is vulnerable to harsh penalties and even possible jail time. What’s worse, it is not only the business that can be held responsible for unpaid payroll taxes; everyone from the operation’s bookkeeper to its owner, or even shareholders, are potentially responsible for those so-called “trust fund” amounts, penalties, and fines.

Ignored Income

Failing to report, or underreporting, the operation’s business income, whether it is received in cash, checks, via online platforms, or through third-party payments, is a major audit trigger and could lead to civil fraud charges. Form 1099-K helps both the firearms business and the IRS track all taxable income accurately. Form 1099-K is a report of payments received for goods or services during the year.

Digital payment apps such as PayPal and Venmo must issue 1099Ks to users who received over $20,000 in gross payments and have more than 200 transactions. Not too surprisingly, forgetting to report this income can trigger substantial penalties.

Avoiding this potential trap simply means tracking all income received through third-party payment platforms or from credit, debit, or stored value cards, such as gift cards (payment cards) and payment apps or online marketplaces, also called third-party settlement organizations or TPSOs.

“Overboard” Deductions

Quite a few businesses go overboard when searching for tax deductions. Unfortunately, finding too many write-offs or making tax deductions up, or artificially enhancing existing write-offs to inflate deductions or expenses, is increasing as the IRS’s audit figures go down.

Naturally, not every cost can be claimed as a business expense. Nondeductible expenses, such as personal expenses unrelated to the business, fines, or penalties including traffic or parking fines, have no place on a business’s tax returns or financial statements. Bottom-line, all deductions must be “ordinary and necessary” and related to the business.  Otherwise, if the IRS catches the business claiming false deductions, penalties could be 20 percent of the disallowed amount for filing false claims or $2,500 if the IRS determines a frivolous tax return was involved. And, remember, there is no statute of limitations for fraudulent tax returns.

Personal or Business

Mixing personal and business finances is an all-too-common error. Using a single bank account or credit card for all expenses makes it difficult to distinguish legitimate business costs from personal expenses. This can cause errors in claiming deductions and raise audit red flags.

While it can be tempting to use one bank account or one credit card for all expenditure, doing so can make it difficult to tell legitimate business expenses from personal ones. Using a separate business bank account and a business credit card can avoid scrutiny, potential audits, and help with an operation’s financial planning.

The OBBBA and QBI

The OBBBA (One Big Beautiful Bill Act) made the deduction for Qualified Business Income (QBI) permanent, allowing a 20 percent deduction from the income of small businesses such as sole proprietorships, partnerships, and S Corporations. While making the 20 percent deduction for QBI permanent, the new law also added new restrictions, such as a $5 million gross receipts cap and stricter phaseout for so-called “Specified Service Trades or Businesses.” 

Failure to follow the complex wage and property limits may cause the deduction to be lost. Working with a tax professional to ensure all eligibility requirements are met for the QBI deduction is a good way to avoid this tax trap.

State and Local Tax Traps

State and local income taxes, sales and use taxes, transfer taxes, gross receipt taxes, and more are often overlooked. A retailer operating across multiple states must navigate a patchwork of different tax laws, including sales tax nexus and withholding requirements, which can be overwhelming and lead to non-compliance if overlooked. 

Failure to register, collect, and remit sales tax in a state where the retailer has nexus can lead to back taxes, penalties, and interest. Ignoring the sales tax that might be due on the sale of a business is common, as are the state-specific requirements for equipment sales and other buy-and-sell transactions.

After the Fact

With taxes, one of the biggest traps is failing to plan for succession. If the owner dies and the business passes via inheritance, in addition to licensing issues, there could be estate taxes, valuation issues and disputes over what is “fair.” Also keep in mind that if the business is “gifted,” the IRS will view it as a taxable transfer.

Gifting now might reduce the estate tax bill later but cost more in capital gains. Inheritances come with a stepped-up basis, which means re-setting the value to the date-of-death amount. If it’s sold to family members for what it’s worth, the original basis goes with it, resulting in capital gains taxed on the entire difference.

When it comes to a retail, distribution, or manufacturing business operated as an S corporation, transferring shares the wrong way can nullify the operation’s S corporation status and triggering serious tax consequences. Avoiding this trap is easy.  Using so-called “grantor trusts” or direct gifts often softens the potential tax consequences.

Drafting a buy-sell agreement spelling out who can buy, how the value of the operation will be determined, and what happens upon the owner’s leaving the business or dying often avoids this trap. Overlooking the value of a buy-sell agreement can mean anyone can become the owner of the business or it could be dissolved.

Sidebar: Avoiding Tax Traps Legally

Avoiding potential tax traps involves a number of tried-and-true strategies such as:

• Separate Finances. Using bank accounts and credit cards dedicated strictly for business use separates personal and business expenses.
• Document Everything. Keep detailed documentations, such as receipts, invoices, and contemporaneous logs, for all transactions that will be claimed as deductions.
• Labeling all income. Attempting to label a bank deposit or payments from third-parties months after they occur can result in an IRS label of cash income whether the sums were for business or not.
• Be Aware of Common Mistakes. Awareness can help tame the stress at tax time and ensure accurate reporting of the sporting firearms and ammunition operation’s income and deductions.
• Go Paperless. Filing tax returns electronically can help avoid simple math errors and ensure timely submissions.
• Stay Informed. Keep up to date with the ever-changing tax laws and regulations (federal, state, and local) or work with a professional who does.

It is no secret that a business’s taxes can be complicated. The IRS is increasing audits of businesses and high-income individuals, especially for those with income over $400,000. Obviously, keeping good records, using accounting software, or seeking professional advice on a regular basis will help avoid potentially expensive tax traps.

Caption: For tax purposes, it is important for small retailers to keep personal and business expenses separate.