Everyone dreads tax season, but for the small-business owner, filing can be especially frustrating. Mistakes and misclassifications can cause severe problems down the road. If you’re not a tax expert, you run the risk of making mistakes that can lead to IRS trouble no business wants to have.
Here are some common small-business tax mistakes and what you should do to avoid making them. A good place to start comes down to a basic skill every business owner should have: organization.
On a day-to-day basis, managing urgent and ongoing business operations routinely takes precedence over administrative tasks like filing and recordkeeping. Unfortunately, this often comes back to haunt small business owners come tax time. Missing receipts, invoices, and other paperwork can leave serious holes in your tax return. How will you know what expenses to deduct? How will you prove the income of your business? This can cost you more in taxes than your burden should be – or worse.
The easiest way to avoid this is to save and record everything that shows income and expenses for your business, even if you are not sure it will be relevant to your taxes. Use accounting software, such as FreshBooks or QuickBooks, to record income and expenses. Turn to your bookkeeper, accountant, or another employee to file receipts and other items away for taxes. Keeping good records goes a long way in ensuring you’re recording all of your income, which brings us to our next point.
Even for business owners who keep good records, income may still be misreported for a variety of reasons. Many of them come down to the nuances of tax reporting, including:
Reporting income for tax purposes depends on the accounting method used. Businesses using the cash method will report income in the year it was received. For example, if you sent a vendor an invoice in December 2016, yet you didn’t receive payment until January, the funds will be recorded on your 2017 return.
If you include sales tax in your prices, be sure to exclude them from your reported income. While this sounds like common sense, it’s easy to overlook when you’re busy. While the IRS allows businesses to pass the sales tax burden onto customers, this doesn’t count as business income.
Some businesses handle a lot of cash, which isn’t automatically recorded like electronic payments or point-of-sale (POS) system transactions. This cash must be documented in real time, as it’s tough to go back and recreate the payment timeline. Not reporting all cash as income is a common type of underreporting.
The IRS offers small businesses plenty of opportunities to take deductions. In return, you need to understand deduction rules to avoid inaccurate reporting. These deductions are a prime target for scrutiny by IRS auditors.
Some expenses are 100% deductible, such as office rent. Other seemingly straightforward deductions also have limits: start-up costs have a $5,000 deduction limit, subject to certain modifications, while the rest can be amortized. The same applies to office furniture. Meanwhile, only 50% of meal and entertainment costs deductions can be claimed.
Of course, deductible expenses aren’t the only thing commonly misinterpreted by small-business owners.
Paying salaries and wages to employees comes with a set of tax obligations that every business owner must handle. As the owner, you are responsible for matching Social Security and Medicare taxes, paying periodic employment taxes, and completing Form W-2 when filing income tax. Contractors are different; they’re accountable for their own taxes and expenses, meaning there’s little burden on employers apart from paying them for their work.
Some business owners are tempted to classify employees as contractors to avoid paying taxes. Others may misclassify them because they’re unfamiliar with the definition of contractor. Does the employer have control over their hours? Does the worker have the freedom to pursue other jobs? The definitions of employees and contractors are specific. If the IRS catches you misclassifying employees as contractors, you’ll end up paying employment taxes regardless. Don’t risk it.
The easiest way to avoid this situation is to review the IRS’s guidelines that lay out the differences between these worker classifications, or to consult a professional.
Yes, small-business owners may not file their taxes altogether. Perhaps they don’t have the funds available to pay the taxes owed, or maybe they’re behind on completing their returns or forgot about the deadline altogether. Failing to file or pay on time results in the following penalties:
Even if you can’t afford to pay, you should still file on time. Fortunately, small-business owners have options if they can’t file or pay on time. Businesses can file for an extension with Form 7004. The IRS also offers payment plans and installment agreements, which allow owners to pay their taxes in monthly installment. As long as you show a willingness to file and meet your tax obligations, the IRS is willing to cooperate.
Small-business owners can unknowingly make tax mistakes that could result in serious consequences to the business or, potentially, the owner personally. The easiest way to avoid this is to consult with a tax professional, such as an accountant or lawyer, to ensure the business is compliant with all relevant tax laws and is taking full advantage of deductions and tax benefits.
This can save business owners like you time, headaches, and money. Everyone makes mistakes – but mistakes on tax returns are ones you don’t want to make. Keep that in mind when tax season 2018 comes around.