How you handle your recordkeeping and taxes can make a big difference in your success as a small business owner. Make sure to avoid these common tax mistakes small business owners make:
1. Choosing the wrong form of business.
When you go into business, everyone seems to have advice on how you should set it up. Some people think everyone should have a corporation, and will happily help set it up – for a fee. Other people recommend Subchapter S Corporations, partnerships, or a sole proprietorship.
The truth is, no form of business is perfect for everyone.
For example, a sole proprietorship, which reports income and expenses on Schedule C attached to your Form 1040, requires no setup with the IRS and the least recordkeeping.
However, you may limit your exposure to liability with a limited liability corporation (LLC) (although not always as much as you might think). A regular corporation seems impressive, but you may pay higher total tax if you’re not careful.
Do your homework or get professional advice, and start with the simplest form of business that meets your needs.
2. Waiting until tax time to catch up on recordkeeping.
It’s easy to stash all your receipts and other records in a box somewhere, or in a folder on your computer, and drag them all out at tax time. But that’s not the best use of your time and effort, for several reasons.
It takes longer to get organized when you have to do it all at once. It’s also harder to remember what you spent, meaning you could miss something. If you wait almost until the deadline, you’ll feel rushed.
The best reason not to wait until the end of the year to catch up on recordkeeping, however, is that by keeping good records and paying attention to them, you can use the information you learn to for better tax planning – not to mention better business strategies.
3. Getting behind on tax deposits and estimated tax payments.
Small businesses are often pinched for cash, especially in the early years. A surprising amount of gross receipts should be tucked away for self-employment tax, income tax, and payroll tax deposits. If you get behind on any or all of these tax deposits and estimated payments, it can be very, very difficult to get caught back up.
One fail-safe strategy is to put money for taxes in a separate account as soon as you receive it, so you know the money for taxes is always coming from the gross income to which it applies.
4. Paying employees as independent contractors, or “under the table.”
Payroll taxes are a hassle. They’re also expensive. Wouldn’t it just be easier to pay people who work for you as independent contractors instead of signing them up as employees? Or better yet, just give them cash?
Before you take the easy way out, think about the consequences. The IRS and other governmental agencies have rules about who is an employee and who is not.
If you pay people as independent contractors, and the IRS determines they worked under your control and should have been classified as employees, you could end up paying back taxes and penalties.
Paying people cash “under the table” encourages them to evade income taxes – not a good thing. And you may lose your business tax deduction.
5. Missing out on deductions and other tax benefits.
You can lose the benefit of business deductions in so many ways. You can lose receipts, of course, and not get the deduction at all. You can forget to track your business vehicle mileage. You may not know about energy credits, or tax perks for job-related education.
Another way you can miss out on all the tax benefits from your business is to take certain deductions as itemized deductions, instead of with your business.
For example, if you pay property tax on business property, you should take the deduction with your business, not on Schedule A.
By taking it as a business deduction, you save on self-employment tax as well as income tax. You also lower your adjusted gross income, which can help you qualify for other tax benefits.
To avoid missing out on deductions and other benefits, try to organize your recordkeeping. Make it as easy and as automatic as possible. Online apps, bank and credit card downloads, for example, can improve accuracy and make recordkeeping easier.
In addition, try to answer all the step-by-step questions in TaxAct when you prepare your tax return. The program is designed to help you find all the tax benefits you are entitled to from your business.