Benjamin Franklin famously said nothing is certain except death and taxes. For small businesses, the latter is a painstaking but necessary part of growing your company.
If you get things wrong, there is a lot to lose in terms of time and money. But knowing which mistakes to avoid can help create a smoother, painless process and ensure you always pay the fair amount. From choosing the wrong form of business to paying employees as independent contractors, here are the common tax mistakes many small business owners make and how to prevent them.
Not selecting the right business type
One of the most important tax mistakes to avoid when filing as a small business is selecting the wrong business type on the forms. There are many different types of businesses that an owner can apply for before tax season, such as:
- Sole Proprietorship
The problem is that many businesses apply as a basic C-Corp or LLC, but this isn’t always right, and it can affect a company’s future. For example, applying as a C-Corp can double the amount of taxes owed, and an LLC may decrease the amount of investor funding received.
The best thing to do is talk to an experienced accountant, and they can help advise on the best business type depending on the company’s structure, the number of employees, and goals. This is extremely important when a business starts out as it helps prevent any losses in the long run.
Classifying staff incorrectly
When a business first hires employees, they may not know what classification their staff falls under. This makes placing staff into the wrong category a common tax mistake that can harm your business. Many companies rely on independent contractors to save money on their taxes, but this doesn’t always work.
If your independent contractors work on-site or are expected to work certain hours, they could qualify as regular employees, which means you could face severe tax penalties. Make sure you understand the IRS stipulations for independent contractors and other forms of workers before making your hires.
Failing to keep distinct business accounts
As a small business, it can be easy to fall into the habit of using business accounts for other expenses. However, the IRS likes expenses to be clearly stated and using business accounts for personal expenses is a huge red flag. When filing taxes, a company needs to differentiate what expenditures were used for personal reasons and for business. The best way to do this is by keeping a separate business account and not getting it mixed up with any other spending.
You also need to know what sort of things are and aren’t covered. For example, not all business entertaining is covered and nor are commuting costs – but other business travel expenses are to a certain extent. Be careful not to take risks or treat yourself to that extra dinner when you’ve extended your stay on a business trip. If in doubt, ask an accountant for guidance to prevent scrutiny from the IRS and keep everything organized.
Figuring out which deductions are valid and which aren’t can be a headache, but missing out on deductions you’re entitled to is one of those critical tax mistakes to avoid.
As a rule of thumb, a new business has the opportunity to deduct up to $5,000 in startup costs, although the total amount will all depend on the size and type of business. You can also deduct interest on personal loans and credit cards if you can show it was for a business expense.
Unpaid goods in your inventory and continuing education costs related to your business are also deductible – as is your home office space, meals for employees and even small amounts like bank fees. So when it comes to looking at expenses, don’t forget the deductibles you’re entitled to, track all your expenses and make sure you claim them.
Deducting startup costs incorrectly
A new business owner may feel the need to track every expense, no matter how small, so it can all be written off when tax season approaches. However, it’s best to keep in mind that tax savings aren’t that simple, and many limitations have been put in place by the IRS for startup deductions. As previously mentioned, a company can only deduct up to $5,000 in startup costs in the first year, and you can also deduct up to $5,000 in organizational costs. Additional expenses can be deducted over the next 15 years, and there are special measures if your costs exceed $50,000. So don’t assume everything will be covered.
Choosing the wrong retirement plan
Tick off two must-haves: a plan for your future and reducing tax liabilities. Retirement plan contributions will reduce your taxes, but you need to choose the right one for your business. You don’t want to limit your deductions or obligate yourself to employee contributions you can ill-afford. If you are starting a retirement plan for your business, you may also qualify for a tax credit. But once you have one set up, make sure you are funding it adequately – around 10 to 20 percent of your income each year.
Getting on top of taxes
Being responsible for business taxes is extremely important, and it’s vital to keep them accurate and up-to-date. Owners need to stay accountable for what they have filed, and the best way to do this without any issues is by avoiding these common tax mistakes. Whenever someone is still unsure, it’s recommended to seek help from a tax professional. They can advise on what’s best to do and help stay on track in the future.