For any small business owner, tax compliance can be a huge source of anxiety. That really cannot be overstated.
According to a Forbes survey review, income taxes and tax compliance were the #3 and #5 responses on the list of things that keep small business owners up at night.
Both concerns are way above cash flow and sales, securing a loan, business competition, and 67 other responses given.
Don’t let the stress that comes with handling your small business taxes get to you. And don’t let the complexity result in mistakes and missed opportunities.
Instead, give yourself an advantage by reading up on some of the most common mistakes so you can avoid them.
1. Misclassifying a Hobby as a Business
First, be certain that the business venture you’ve started qualifies as a business for tax purposes. If you have not yet generated enough income, the IRS may still classify the business you’re starting as a “hobby.”
It’s important to understand this because when starting a business you may be counting on certain tax deductions for things like supplies or even home office space.
Make sure you’re aware of the requirements so you can avoid a financial setback. Take some time to familiarize yourself with IRS resources for small business owners.
2. Failure to Accurately Separate Expenses
When you own a small business you’ll need to separate personal and business expenses for the purposes of filing taxes. If you’re not meticulous about record keeping, this process can really become difficult.
For instance, you’ll want to deduct for the mileage from the trip you took to the post office when mailing out packages to customers. Be mindful that the deductible mileage stops when you make a second stop to pick up your groceries.
When it comes to these types of expenses, it may become impossible to accurately separate personal and business expenses if you’re not tracking them day to day.
You can make this process much easier and more successful in a few ways.
First, you should have a separate credit card and bank account for your business. Consistently use the designated account and keep all of your business receipts and records separate.
Also, consider paying yourself a salary instead of just drawing from your business earnings as needed. This will make tracking and reviewing your spending much more clear.
This is one of many cases where careful record keeping is your primary method to avoid scrutiny from the IRS. In the case that your business is ever audited, it will make thing much easier for you.
3. Insufficient Record Keeping Throughout the Year
Good record keeping includes saving all of your receipts, tracking and categorizing all sales and all expenses, and logging business activities.
No matter how small your business operation is, it’s never worth it to slack on your record keeping throughout the year.
First of all, keeping good records and analyzing your progress is the only way to effectively improve business strategies and plan for better business practices. Additionally, it can be greatly beneficial when it comes to tax filing.
It may be tempting to simply stash all your receipts in a box or store digital copies in a folder on your computer. You might think it will be easy enough to just sort through it all at tax time. Underestimating the importance of diligent record keeping is a common mistake and a regrettable one to make.
If you wait until you’re nearing tax time you’ll be creating an unnecessary headache for yourself. Worse than that, you will probably find that you’re rushed. This is how you can easily miss deductions or make other mistakes that you’ll pay for later.
You may find detailed and persistent record keeping and analysis difficult. You can always hire staff for that purpose or outsource the role to a professional bookkeeping firm.
4. Not Hiring an Accountant or CPA Firm
You may want to save money by preparing and filing your small business taxes yourself. There is business tax software to help with the process. But it’s important to understand what you’re missing by taking that less expensive route.
Any competent tax professional or CPA should be able to ensure that you avoid all of these common filing mistakes for your small business taxes. When taking the work into your own hands you’re much more likely to miss valuable deductions and perks simply because you’re unaware that they exist or apply to your business.
Hiring a professional has other major benefits as well. Tax preparation means recording an analyzing income and expenses to some extent.
This is the start of the work that’s necessary to more effectively run your business. It is necessary to develop your vision for growth and your plan to achieve it.
5. Missing Applicable Deductions
There are so many ways to miss out on tax deductions for your small business. If you lose receipts or fail to record mileage you won’t be able to claim those expenses. You also may not be aware of certain tax benefits that apply to you.
Here are some examples of deductible expenses for your small business taxes:
- Office furnishing and supplies
- Licensing expenses
- Business equipment
- Interest on your business debts
- Legal fees
- Travel expenses (including meals)
- Accounting, bookkeeping, and tax professionals
- Certain federal, states, local, or foreign taxes
It’s possible that your business could also be eligible for tax credits, like the business energy credit or tax benefits for job-related education.
Understanding your eligibility and applying for the tax credits can be a complicated process. If you want to try to tackle it yourself, be sure to review IRS guidelines carefully.
Keep in mind that carelessly claiming deductions that you’re not entirely sure you’re eligible for is a good way to attract IRS scrutiny. Of course, that’s the last thing you want to do, especially because penalties for incorrectly claiming a deduction can be severe.
6. Inaccurately Reporting Business Income
Under-reporting or over-reporting your business income can be an honest mistake, but it’s one you should be very careful to avoid.
At the same time, purposefully under-reporting to pay less in taxes can be a tempting prospect, and it does happen often enough. Doing so makes attracting the attention of the IRS more likely and can put your business at serious risk.
The IRS takes action continuously, in an attempt to shrink the “tax gap.” That’s the difference between how much is reported and paid in taxes and the amount that is actually owed.
The under-reporting of income, especially from cash transactions, is the biggest contributor to the tax gap when it comes to small business taxes. Therefore, any red flags in the reporting of income is the first indicator the IRS is looking for to target their audits.
Whether you have inaccurately reported your business income or not, an audit can cause a lot of stress and additional work. It can even create more expense if you don’t already have a full time professional on staff to handle the work.
If you have reported your income inaccurately, the consequences may be as small as paying slightly more in taxes than you owe. However, in the worst case scenario, you could be facing serious fraud charges. Civil penalties may include large fines, and potential criminal penalties can even result in jail time.
Mistakes can occur from a simple oversight. For example, your clients’ pay periods may overlap different tax periods, leading to some confusion. If you discover you’ve made any errors on your taxes you should promptly submit corrected forms.
These errors can occur because you have not taken enough care to keep records that are clear, detailed, and accurate. It’s important you are mindful with record keeping and certain you have the information you need to report accurately.
7. Filing Incorrectly for your Employees
When you’ve hired employees you’ve put your business in a new position with additional tax complications. You need to be certain you know how to file for W-2 employees differently than when hiring 1099 contractors.
It’s very important that you accurately comply with mandatory payroll deductions and submit them to the appropriate tax agency. Failure to do so can result in penalties and fees.
You may also have employees who opt into voluntary payroll deductions for certain benefits.
With so many complications, it requires meticulous record keeping and attention to detail. This is how you can ensure that both you and your employees are contributing fully to the taxes owed.
Filing accurately for your employees is just as important it is if you’re a business who must follow HIPPA Compliance standards as outlined on https://www.compliancehome.com/why-is-hipaa-important/.
8. Falling Behind on Estimated Tax Payments
Sometimes people running very small businesses, especially when just starting up, mistakenly believe that estimated tax payments are optional in their case. If you own a small business, it’s likely you’ll have to pay estimated tax, unless your business income is very small.
As a business owner, you’ll have to pay taxes quarterly. That entails estimating your total yearly earnings and paying quarterly based on that amount.
When starting a small business, money is tight and it’s possible to be faced with difficulty keeping up with these payments. It’s important that you’re attentive to these tax payments because failure to pay or underpaying can result in penalties and interest owed.
One way to play it safe is to pull money from your earnings as it comes in. Create a separate account to cover your quarterly tax payments.
This is another instance where tax and accounting professionals can be very helpful. If you’re doing tax preparations on your own you should start by referring to IRS information on estimated taxes to determine if you must pay estimated tax and how to do so.
9. Paying Employees Under the Table
Taxes are expensive and the process is a lot of work. It might be tempting to sidestep part of these responsibilities by keeping some employees off the books (paying them under the table).
This kind of tax evasion is accomplished by treating workers that should be employees on your payroll as independent contractors, or by simply paying in cash and not reporting it.
The IRS has very clear cut rules about what constitutes an employee. If you’re thinking about cutting expenses or just making things easier for yourself by not reporting employment accurately, you should first know the risk.
If you pay workers as independent contractors and the IRS determines they should have been classified as employees, at best, you will be forced to pay back taxes and penalties.
If it is determined to be a case of willful misconduct or fraudulent tax reporting, the penalties can be very strict. Of course, you should always be certain that you’re accurately reporting.
10. Filing and/or Paying your Taxes Late
This might seem obvious and simple enough to avoid. But of all the mistakes you’re likely to make, this is one that could end up costing you the most. So it’s worth taking into consideration.
When filing taxes late, you could face penalties and fees. Monthly interest will add up very fast and can be a major setback in the progress your business is making.
When filing late the IRS could impose a 1% penalty for each month you’re late. Paying this tax debt late has much higher penalties.
If your business earnings are small enough, you may not be required to make estimated quarterly payments. In that case, you could fall behind on preparing for annual tax payments and end up being late.
It’s always an option to elect to make estimated payments quarterly.
If you do find yourself in the position where you’re running late on filing your taxes, you should definitely be sure to file for an extension.
But do not think that means the deadline is essentially “suggested.” It’s very important that you’re sure to leave more than enough time for tax filing.
Filing Your Small Business Taxes Effectively and Efficiently
You’ve taken the first step of familiarizing yourself with the most common mistakes made with small business taxes. But there’s more you can do.
Be sure you’re not making the process more difficult than it needs to be or missing deductions. You should speak to professionals by contacting us and getting the assistance you need.