Taxes are a challenge for many small business owners. Between the complicated regulations and juggling the responsibilities of running your business, it is easy to make mistakes with your tax return no matter how much experience you have.
We’ve identified a few tax preparation errors that small business owners tend to make and offered suggestions for how to avoid them.
Deducting startup costs improperly.
The costs your business incurs before you open your doors, such as renting space, purchasing equipment, organization costs, labor supply, and legal fees, are considered startup costs. Many new business owners run into trouble at tax time because they assume all of these costs are deductible. In fact, startup costs cannot be deducted until you make your first sale and are then deducted over 15 years.
Maintaining detailed expense records before your business is operational is critical. Make sure to keep the receipts and invoices that back up each claim. If you started a business in 2016, review the latest IRS regulations to determine which ones qualify for deduction.
Choosing the wrong business structure.
Choosing the legal structure for your company is one of the most important business decisions you can make, and it has a direct impact on how much you pay in taxes. Many small business owners structure their companies as C Corporations because of the liability protection this offers. The corporation itself is held legally liable for the actions and debts the business incurs, so you are not putting your personal assets at risk.
However, filing as a C Corporation means double taxation. Because the profit of a corporation is taxed to the corporation when earned and then taxed again to the shareholders (including you) when that profit is distributed as dividends, you essentially pay taxes twice.
Look into other more tax-friendly structures for small businesses. The S Corporation is a popular choice that provides owners with the liability protection of a C Corporation, but profits and losses can pass through to your personal tax return. Only the shareholders are taxed, not the business itself. A limited liability company (LLC) is a hybrid that is also gaining traction with small business owners. It combines the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Here’s a quick look at the most common forms of business entities and a few of the pros and cons associated with each.
Mixing business and personal expenses.
It may be easier to lump your business and personal expenses together, but it will make tax time a lot more complicated and potentially costly. You, your bookkeeper, and/or your accountant will have to invest long hours in separating what was actually business-related and what was not. This will not only cost you in professional fees, but it may result in missing possible deductions and incorrectly reporting income.
Business owners who run personal expenses through their business, such as home mortgage payments, pet expenses, groceries, and clothing purchases, are likely to attract unwanted attention from the IRS. The solution here is simple: Keep these expenses separate. Set up a company account and avoid using business credit cards for personal expenses.
Misclassifying workers.
This issue is becoming more commonplace as businesses rely more and more on independent contractors for their staffing needs. By classifying a worker as an independent contractor instead of employee, an employer eliminates certain taxes such as Medicare and unemployment compensation.
However, the IRS has strict regulations for determining whether a worker is an employee or independent contractor. Misclassification is considered a serious offense that can result in significant payroll penalties. If the IRS suspects fraud or intentional misconduct, it can impose additional fines and penalties.
As a small business owner, you are responsible for making every effort to properly classify your workers. Before you decide to classify an employee as a contractor, be sure you know if they legally qualify as a contractor.
Failing to file or pay on time.
Some small business owners fail to file their tax returns on time because they aren’t clear about the deadlines. Others don’t have the funds to pay what they owe.
Every small business owner needs to be aware of his or her filing deadlines each year and to know whether or not they have changed. If you will not be able to file by the deadline, request an extension from the IRS and make any estimated payments if you expect to owe money.
If you file on time but cannot pay your tax bill in full, pay what you can and then contact the IRS about setting up a payment plan. A monthly penalty is usually added to income tax bills that are not paid on time or in full. Late payment penalties are also assessed for failing to make payroll tax deposits on time.
Not working with an experienced professional.
Small business owners often believe they can manage everything themselves and don’t need any advice or help. However, tax laws are complex and often difficult to understand. Working with a knowledgeable tax attorney or accountant is well worth the expense.
An experienced tax professional can review your files and identify tax breaks and deductions you might otherwise miss. They will also alert you to any red flags the IRS may audit, and they can advise you with what corrective actions to take. Make sure you have updated records and reconciled books to review with them.
As a small business owner, it’s easy to put taxes on the back burner. However, waiting until the last minute makes tax preparation more complicated and can limit your money-saving options. Instead of treating your income taxes as a once-a-year event, make tax planning an ongoing activity. Tax time can be relatively painless when you follow the correct procedures all year long.
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