10 Small Business Tax Mistakes and How to Avoid Them
We’re all acquainted with the joys (real or expected) of owning a successful small business. Becoming financially independent and being one’s own boss are powerful motivations.
Then there’s the other side of the coin, the things we don’t enjoy so much.
Nothing represents the other side of the coin for small business owners better than filing and paying taxes.
More often than not, the reason for small business tax mistakes isn’t miscalculation or malfeasance, it’s simply bad habits.
Generally speaking, if you get educated, get organized or get help, you’ll stay in the good graces of tax authorities at all levels while maximizing the hard earned cash you keep for yourself.
With this in mind, here are 10 common small business tax mistakes and suggestions for avoiding them.
#1. Choosing the wrong business type
First of all, as a small business owner you definitely want to form some kind of business entity so you can separate business and personal expenses and take business deductions.
Many business owners default to a sole proprietorship, which requires no IRS paperwork to form and involves the simplest tax filings. However, sole proprietorships offer the least liability protection.
Meanwhile, a C corporation provides better liability protection but can result in double taxation, once on business earnings and a second time on dividends distributed to shareholders.
Subchapter S corporations and LLCs are good choices for most small business owners, but you never know which entity is right for your business without talking to a professional. Ask your tax advisor and/or a business attorney which makes the most sense for your business type.
#2. Not keeping detailed records
Bosses chastise their employees for sloppy expense documentation, but many business owners aren’t much better.
If you’re going to take the right expense deductions in the right amounts, you need good information on the type and reason for each expense.
Whatever you do, don’t just stash receipts in a drawer to review the week before your taxes are due. First, you’ll face the Herculean task of making sense of your receipts for the entire year all at once, and second you’ll have forgotten what many of your expenses were for.
For best results, document the details on your expenses as you incur them, either on paper or, better yet, using one of the many small business tax software packages now available.
Annotate receipts or expense records with the purpose of the expenditure as you go so you know how to deduct it later.
And by all means open a business credit card so you can separate business charges from personal and have one statement where you know all your business expenses will appear.
#3. Falling behind
Whether we’re talking about federal estimated tax payments for self-employed persons, state employer taxes or something else, you have to do everything in your power to stay current. This means submitting both the necessary filing and the amount due by the due date.
If you can’t file the necessary forms on time, file for an extension but pay what you owe. If you don’t have the money to pay what’s due, you must still submit the filing and pay what you can but ask to set up a payment plan.
Just please, please don’t bury your head in the sand and fall behind with federal, state or local tax authorities.
Setting aside tax amounts in an escrow account as you receive revenue can help you make sure you’ve got adequate funds available, while tax software applications and tax professionals can help you stay current. Setting electronic calendar reminders is a no-brainer.
#4. Misclassifying workers
Many business owners attempt to avoid payroll taxes by using independent contractors. Much of the time, they do so in error.
The IRS is pretty clear about what it considers an employer/employee relationship. If the person works at your complete direction and control, that person is your employee whether you label them as such or not.
The scary part is that if you make this mistake and the IRS catches it, you’ve opened the door to a reexamination (read: audit) of your returns for this and other errors going back indefinitely.
To avoid these unnecessary complications, get educated on the IRS’s definitions of employees and contractors and don’t push the envelope.
#5. Not taking startup deductions
New businesses can amortize and deduct capital expenditures over 15 years with one major exception: the IRS allows startups to deduct up to $5,000 each for business launch and business organization expenses in the first year of operation.
This means a total deduction of as much as $10,000 for investigation & analysis, advertising, training, travel, legal and accounting services and formation fees.
Note that you have to truly be a small business to take advantage of this one as the deduction opportunity declines with each dollar of startup expense beyond $50,000.
But you definitely want to take advantage of this one if you can. Contact a tax professional if your tax preparation app doesn’t present this opportunity and read the IRS’s guidance on it.
#6. Not taking the home office deduction (correctly)
The home office deduction was once considered a great way to earn unwanted attention from IRS auditors, but with a growing work-at-home economy the IRS has reduced the scrutiny it applies to the home office deduction and even simplified the process for claiming it.
If you run your small business from home you can deduct home office expenses in one of two ways. The percentage of home method allows you to claim a proportional amount of maintenance, repair, utilities, interest, taxes and more. The simplified rate per square foot method requires less detail but usually results in a smaller deduction.
The key, and this is what trips up many small business owners, is that the space has to be truly dedicated to business use and either the principal place of business or a space where you regularly meet with customers or clients.
Just like the employee vs. contractor question, you definitely want to claim this deduction if you’re entitled to it but if you don’t do it correctly you will expose past returns to greater scrutiny. If your tax prep software doesn’t mention this one, ditch it and get a new one! Learn more from the IRS.
#7. Deducting auto expenses incorrectly
First of all, there’s depreciation. Between Section 179, accelerated depreciation and regular depreciation, you can deduct more than 75% of the purchase price of certain vehicles in the tax year they’re purchased. Many business owners miss out on this one.
Then there are every day vehicle expenses. Similar to the home office, you can itemize actual costs (fuel, maintenance & repairs, tires, fees, insurance, even car washes) or claim the standard mileage rate ($0.535 for 2017).
If you choose the former you need to know what portion of your driving is for business, and either way you need to know what constitutes a legitimate business purpose and what doesn’t. Sorry, your daily commute is not deductible. Any decent software package or tax professional can keep it all straight. Learn more here.
#8. Forgetting carryovers
Major deductions are limited by your income. The IRS doesn’t want you creating paper losses for which it has to pay you.
Depreciation is the best example. Let’s say you have $25,000 in depreciation expense in the tax year but only $20,000 in income. In the tax year in question you can only deduct $20,000 with the remaining $5,000 a carryover deduction in future tax years.
If you use the same tax prep software year to year, it should help you remember these. A good tax preparer will track these for you, a lesser one might not.
#9. Overlooking intangibles
Here’s another one that cries out for a dedicated business credit card.
There are myriad everyday business expenses that are deductible if only business owners can classify them correctly. What they usually leave out are things that aren’t tangible. Keep track of and deduct business subscriptions, professional memberships, continuing education and other similar charges.
Use your business credit card religiously and review your monthly statement to make sure you’re finding all of these.
#10. Getting carried away
Business meals and gifts are all deductible, but many business owners fail to read the fine print. In reality, these expenditures are only partially deductible.
Furthermore, don’t fall into the trap of claiming personal expenses as business ones. The mileage example above is a good one. If you deduct all mileage for a car that is used for both business and personal activities, you’re asking for trouble.
If you’re a do-it-yourselfer, review all applicable regulations thoroughly. Otherwise get help.
Avoid small business tax mistakes
Don’t let taxes be the thing that keeps you from enjoying all the best parts of being an entrepreneur.
Read up, stay organized and secure the help of a good tax advisor to avoid these small business tax mistakes. In doing so, you’ll keep what’s yours while staying in the good graces of the tax authorities.
Jacob Dayan is CEO and co-founder of Chicago-based Community Tax, a U.S. provider of tax resolution, tax preparation, bookkeeping and accounting services. He previously worked on Wall Street as an options analyst and as a foreign exchange trader. Jacob holds a Bachelor’s degree in Business Administration from the University of Michigan’s Ross School of Business.Read Full Bio