Oh No! I Made a Mistake and Now My Business Owes the IRS
There are many reasons business owners find themselves in the middle of a tax controversy with the IRS. Owning and running a small business is a more complicated than many people can begin to comprehend. Many taxpayers think: Hey, I’m really good at my profession I should open my own business doing that work. Then instead of making money for someone else I will get to reap the rewards of my own hard work. More often than not, this is not the case.
The first three to five years many businesses make no profit at all, many even go bankrupt. This is mainly because, despite your knowledge and proficiency in your particular line of work, you lack the acumen necessary to run a successful business.
There is much more to running a successful business than just doing a job. Businesses require a business plan, bookkeeping, a knowledge of accounting and tax procedures, and much more. You may be a good contractor or plumber, but do you know how to prepare a profit and loss statement? If you don’t have a great knowledge of taxes and accounting, can you afford to hire someone to help keep you compliant?
Most small business owners do not employ any part-time bookkeepers or tax professionals to assist them in running their business and that is a big mistake. I will try and cover a few common small business mistake and misconceptions, which land Joe the Plumber in hot water.
Dipping into employee withholding
I don’t have enough money for my bills this month, I will just use some of the employee withholding and put it back before anyone even knows it’s gone.
STOP RIGHT THERE! This misstep could cost you hefty penalties. You are entrusted with your employee’s’ withholding, this is not your personal bank account to help pay bills. A willful misuse of these funds has serious consequences and you can be held personally liable.
I know what I’m doing I don’t need a bookkeeper.
This may or may not be the truth. Holding onto your receipts in a box in the corner of your office is not how a successful shop operates. It is naive and an incorrect way of thinking. You must implement the appropriate software, have a chart of accounts, accurately report your costs of goods sold, have great attention to detail, and have a good knowledge of accounting.
QuickBooks and similar companies offer many classes, most of which are free or relatively inexpensive. Even if you are not doing your own books, you want to make sure your bookkeeper isn’t cheating you or doing something underhanded. Owning a business requires constant learning. You can never learn too much. As for bookkeepers my suggestion to most small business owners is get an easy to use program where you can enter all your invoices, vendors, employees etc. You should do a majority of the data entry, but at the end of each month pay a bookkeeper to reconcile your books. This is a nominal fee to pay compared to fixing the problems after the fact.
I will just explain to all my employees that they are independent contractors.
This is not how it works. You can’t just decide to call someone an independent contractor and wave your entrepreneur wand and it is so. There are terms and conditions that mandate how a worker is categorized. To define your workers you must ask yourself: Are they truly independent from me? Do they set their own hours? Do they decide what jobs to take on and what jobs not to perform? Do you have a say in how a job is completed?
Although it is expensive to pay all the taxes and have employees, there is a right and wrong way to classify your workers. If you incorrectly classify someone and the IRS finds out about it, you’re in big trouble.
When in doubt, deduct it!
No small business owner should think this way. It’s better to play it on the safe side. If you are unsure about a particular deduction consult with a tax professional. If you are still unsure, maybe the answer is just don’t risk it. Tax law is extremely complicated and after many years of study most practitioners have not mastered more than a few specific or niche areas in which they have a vast knowledge.
Some other things to consider before you start deducting are: Do you own a business or is this more of a hobby? Have you made a profit from this new “business?” How can I deduct startup costs when I have made no profits? Have I even made my first sale?
Familiarize yourself with the difference between an immediate write-off and something that must be depreciated over time. Things like computers and office furniture need to be on a depreciation schedule and not written off in full the year they are put into service.
What’s the big deal if I use the same bank account for business and personal needs?
Intermingling of funds, cards and accounts is a big no-no. Not only is it a headache when trying to prepare taxes, but if you are ever audited it can raise a lot of red flags for the IRS or state agencies. Get a credit card for your business and do not buy personal items on it. Get a separate bank account and don’t mingle personal and business transactions.
Also, meet with a business planner before starting your new business venture. Talk to them about a business plan and get an Employee Identification Number (EIN). The EIN will help to further differentiate between your two types of accounts. The business plan can come in handy if you ever have to debate with the IRS on whether you have a business or a hobby.
If you meet with an accountant, business planner, or enrolled agent before you begin your business (I strongly recommend you do this), that is a good time to discuss the best format for your business. There are advantages and disadvantages to each business type, so find what works best for the type of business you will be running. Often times they will recommend an S Corp for small businesses to avoid hefty taxes.
I don’t need to file 940/941.
So you failed to file 940/941 and did not pay the taxes when due. This can cause a sizable tax bill. Business owners fail to file and pay for many reasons. Most often it is due to a lack of cash flow. My advice is to at least file all necessary forms, reports and returns when due. This will help you avoid the failure to file penalties and keep you at least somewhat compliant with what the IRS is looking for. Never put off filing. The IRS takes this very seriously.
If you find yourself in a situation where you owe the IRS, do not hide or ignore the letters or requests. The IRS is there to keep you as a compliant law abiding business. If you are unable to pay your taxes, you can ask for an extension or even an extended payment program. If you find that month after month, year after year you are coming up short, you may want to rethink your business.
If you do not have bookkeeping, implement it as soon as possible. It can help you pinpoint where the deficiency occurs. If you never made a business plan try and work backwards because it can also spot errors in how things run.
The bottom line.
Owning a small business is not easy and a lot of people are unsuccessful with meeting all the demands on their plate. If your business is not producing enough income for you to pay yourself, your employees and the federal and local government, things need to change. Don’t let a small problem snowball. Don’t be embarrassed to ask for help. Inquire within your family and friends. Use your connections. You might find out a good friend does bookkeeping on this side.
Always stay positive, continue to learn, and do yourself a favor: Make sure you are compliant with the IRS.