Whether you started your small business years ago or more recently hung out your shingle, you probably don’t spend a lot of time thinking about taxes. Small business owners usually tend to focus on attracting customers, rather than on paying Uncle Sam. Yet, entrepreneurs who don’t take a proactive approach to their tax obligations could miss valuable deductions and credits, end up paying unnecessary penalties and fees, and face time-consuming and nerve-wracking audits.
Here are the biggest tax mistakes small business owners make — and how you can avoid them.
1. Choice of entity
Some entrepreneurs rush into creating a specific type of business entity, like a C-corporation or a Limited Liability Company (LLC), drawn to the benefits of that type of structure without fully evaluating their options. The reality is that there are pros and cons associated with every type of business structure; there are no one-size-fits-all businesses. The right choice for your venture depends on a variety of factors. It’s worth spending the time to evaluate various considerations, including how your choice of entity impacts your future business and individual tax obligations.
2. Organization (or lack thereof)
One of the most common—and most preventable—pitfalls is failing to organize and stay on top of financial and tax records. While it’s easy to simply throw receipts into a shoebox, that can become frustrating when it’s time to figure out your taxes and deductions. Inadequate recordkeeping can lead to missed deductions and credits, or even to errors that trigger tax audits. Consider investing in software tools designed to make organizing receipts and tax records simple.
3. Underreporting income
Another issue that can result in regulatory scrutiny for your business is hiding cash or intentionally underreporting your income. The IRS and state tax authorities compare income reported on tax returns with income reported to them through other sources including 1099 forms. Discrepancies are a near guarantee that you will face questions at the very least. Keeping detailed, organized records should help you avoid this problem.
4. Taking unlawful deductions
There are many legitimate tax deductions and credits available to entrepreneurs. However, if you try to claim an unusually high number of deductions when compared to similarly-sized businesses of the same type, or if you try to claim deductions for things that you cannot defend as being legitimate business deductions, your audit risk will go up. For example, the home office deduction is real, but if you intend to claim it, make sure you meet the qualifications to do so.
5. Not classifying workers correctly
Be sure you understand the difference between independent contractors and W2 employees. If you miscategorize the people who work for you, your company could end up in hot water while also missing out on potential tax deductions. If you have questions about the status of your employees or contractors, ask a lawyer.
6. Only thinking about income tax
As an employee for another company, your annual tax filing usually just refers to income taxes. However, as a small business owner, you may be subject to payroll tax, sales tax, self-employment tax, franchise taxes, and other obligations. It is important to understand what those obligations are, and which tax authorities you need to deal with. Be sure to file and pay on time, too, as missing deadlines can result in hefty late filing and late payment penalties plus interest on amounts not paid.
7. Thinking you can do it all alone
Last, but not least, don’t make the mistake of thinking that you can handle the complexities of business tax filings on your own. Most small business owners have an entrepreneurial spirit and tend to want to do things themselves. However, when it comes to taxes and small business accounting, this strategy can backfire. Small business owners have enough on their plates without worrying about missing filing deadlines or fielding audit inquiries from the IRS or other tax authorities. When you hire a professional, you can be confident that your business will be able to take advantage of credits and deductions, while avoiding common audit triggers.
Do you have questions about starting or running your small business? Ask a lawyer for help today!
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