Top Tax Mistakes Small Businesses Make
There’s no escaping it – taxes are part of doing business. Filing a tax return for your business each year is something you must do. But, if you are afraid of making tax mistakes that could cost you time and money, read on to avoid errors that could result in overpaying your taxes, accruing penalties, or worse yet, triggering an audit.
- Misreporting Income. The IRS matches income reported on 1099s to the income reported on your tax return. It is essential that you pick up the information correctly. If you receive an incorrect 1099, and can’t get the sender to correct it, make sure to report the income as shown, and then make necessary adjustments on your return, and include an explanation.
- Underreporting Income. If you barter for goods or services, don’t forget that this transaction is taxable to you, and must be reported on your business return.
- Overreporting Income. If you collect sales tax, remember that the sales tax is not taxable income to you, and should be subtracted from your sales figures.
- Meals and Entertainment. Since the Tax Cuts and Jobs Act, entertainment is no longer a deductible expense. Also, only 50% of the cost of meals is deductible.
- Vehicle Expense. If you use your personal vehicle for business driving, you are required to properly track your mileage. If you do not have an adequate mileage log, your deduction for business miles could be lost.
- Home Office Deduction. Many people think that taking the home office deduction can be an audit red flag. This is not necessarily the case. In today’s world, nearly 52% of all businesses in the U.S. are run from home. However, it is imperative that you document the square footage of the home and have a dedicated business-only space.
- Insurance. If you are a shareholder in an S Corporation, the only way to get a full above the line deduction for your health insurance premiums is to report them as wages on your W-2. These wages are not subject to Social Security, or Medicare (FICA), or Unemployment (FUTA) taxes, and the taxpayer will not incur any additional expenses related to these wages.
- Misclassifying Workers. Make sure the workers you pay as independent contractors aren’t really employees. The IRS is continually on the lookout for this mistake, and it can cost you large payroll tax penalties or disallowance of contractor expenses.
- Retirement. Make sure to utilize retirement plans. Contributions can lower your current tax bill, as you save for the future. There are many plan options that can work for you and your business. Make sure you include all eligible employees in the plan as this can be a costly mistake.
- Startup Costs. The IRS limits the startup cost deduction to $5000 in the first year. Any additional amounts spent to launch your business must be amortized over 15 years.
Failure to Keep Good Records
- Mixing Business and Personal Expense. Keep a separate bank account and credit card for your business. If you don’t separate them, it’s all too easy to overlook a business deduction or erroneously treat personal funds as business revenue.
- Retaining backup documentation. Without receipts, invoices and other papers that show income and expenses, you may lose the deductions you’ve taken if you’re audited and don’t have the records needed to prove entitlement to the deductions.
- Basis Records. Business losses that pass through to partners and S corporation shareholders can be claimed on their personal returns only up to certain basis amounts. For example, an S corporation owner’s loss deduction is limited to basis in stock and loans he/she made to the corporation. Without such records, losses are lost.
- Forgetting Carryovers. Certain unused deductions and credits may be carried over and used in a future year. Some common carryover are: capital losses, net operating losses, home office deductions, and general business credits.
- Charitable Contributions: If you donate $250 or more, you must have a written acknowledgment in order to take a deduction. If you didn’t receive one, ask for it before you file your return.
Other Areas of Concern
- Late Filing. If you don’t file your return on time, you will accrue a failure-to-file penalty until the return is filed. If you are too busy to file on time, on still need to gather additional information, make sure to file an extension. While this does not delay the date of which the tax liability is does give you an additional six months to file your return. Don’t let your inability to pay what’s owed delay the filing of your return. Pay what you can and use an installment payment agreement for the rest.
Underpaying Estimated Taxes. Businesses typically pay quarterly estimated taxes and it’s up to you to determine how much to pay. In general, if you’re making four equal payments, you should be able to avoid a penalty, but you may be charged for underpaying estimated tax. According to the IRS, “If you didn’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and estimated tax payments, or if they paid at least 90 percent of the tax for the current year.”
- Your Tax Professional. Disclose all relevant information to your preparer. Don’t use anyone who suggests that you hide income or take write-offs you know you aren’t entitled to. Also, don’t be a victim to “ghost’ tax return prepares. According to the IRS, a ghost preparer does not sign a tax return they prepare. Unscrupulous ghost preparers will print the return and tell the taxpayer to sign and mail it to the IRS. For e-filed returns, the ghost will prepare but refuse to digitally sign as the paid preparer. Not signing a return is a red flag that the paid preparer may be looking to make a fast buck by promising a big refund or charging fees based on the size of the refund.
Ghost tax return preparers may also:
- Require payment in cash only and not provide a receipt.
- Invent income to qualify their clients for tax credits.
- Claim fake deductions to boost the size of the refund.
- Direct refunds into their bank account, not the taxpayer’s account.
- The IRS urges taxpayers to choose a tax return preparer wisely.
Turning over your taxes to a professional is the easiest way to avoid making mistakes. However, being familiar with tax codes and guidelines and making sure you have all the correct forms and paperwork can potentially save you from paying penalties later.