As a small business owner, it’s important to understand the small business tax preparation process to avoid making mistakes that may trigger overpaying taxes, incurring penalties, and causing errors. To help, we asked the experts to share the most common small business tax preparation mistakes that you should avoid as a small business owner.
Here are the 25 small business tax preparation mistakes you should avoid:
1. Improperly Classifying an Employee as an Independent Contractor
Mike D’Avolio, CPA & Senior Tax Analyst, Intuit ProConnect
While it may be tempting to misclassify an employee as an independent contractor because of the cost savings, it might not be good for your business. There are strict rules surrounding proper classification of a worker and steep penalties for failure to apply the law correctly. Also, if you misclassify your independent contractors as employees, you may end up paying higher taxes than you should.
2. Making Business Decisions Simply for the Tax Impact
Grafton “Cap” Willey, CPA & Managing Director, CBIZ MHM
Some businesses make decisions not on good business judgment but for the tax impact. A classic example is trying to advantage of the direct expensing provisions of acquiring capital assets (Section 179). Before you acquire an asset, ask yourself if you really need it to improve your profitability. If you’re buying an asset just so you can take advantage of the direct expensing, then it won’t be a wise decision.
3. Not Making Tax Payments a Priority
Mark J. Kohler, Author & Speaker, Markjkohler.com
If you don’t make paying taxes a priority, it can devastate your small business. Make sure that you set aside enough money for your taxes. Do not use all your funds for marketing strategies and other business expenses. After all, if you have to choose between paying your office rent or paying the IRS, you should pay the IRS.
4. Commingling Personal & Business Funds
Jared R. Callister, California Tax Attorney, Fishman, Larsen & Callister
While this seems obvious, many small business owners fall into the trap of not following the business formality of maintaining separate financial accounts for their business. Mixing your business and personal finances can be very chaotic during tax filing. Also, if your business is ever audited, this can get you into a lot of trouble with IRS.
5. Procrastinating During Tax Filing
Michael Eckstein, Enrolled Agent, Eckstein Tax Services
Good old fashioned procrastination can often be one of the most costly tax mistakes a small business owner can make. When you leave your bookkeeping and tax filings until the last minute, it can lead to missed deadlines, IRS/state agency letters in the mail, penalties, and interest – all of which can be very costly to fix.
6. Failing to Consult With a Certified Public Accountant
Mario Costanz, CEO, Happy Tax
Whether your small business is your main income source or just a side hustle, it’s best to consult with a Certified Public Accountant (CPA). A good accountant can make sure you take the deductions you’re entitled to and check your tax return for any of the common mistakes that can land you in hot water with the IRS.
7. Failing to Pay Your Taxes
Josh Zimmelman, Owner, Westwood Tax & Consulting
Not paying your taxes is the biggest mistake you can make. The penalty for late payment is 0.5% of your unpaid taxes for each month that the payment is late. The longer you wait to pay your delinquent taxes, the larger the interest charges and penalties will be. Further, you could even face jail time.
8. Not Organizing Your Receipts in Advance
Nicole Martins Ferreira, Ecommerce Entrepreneur & Author, Nicolemartinsferreira.com
One big mistake that can cost you a lot of money when it comes to filing taxes is not being able to organize your receipts. If you want to avoid chaos trying to figure out your business expenses, it’s important to file your receipts in an organized manner since the beginning of the year and not wait for the last minute to do this.
9. Not Setting Aside Money in a Separate Tax Account
Nelson Caldwell, Founder, Caldwell Copywriting
Never underestimate the amount you need to set aside in a separate account, every single time you get paid, in preparation for your quarterly estimated tax payments. If you don’t, there’s a chance that you’ll run short of funds come tax payment time. Ideally, you should set aside at least 36% of your income for tax purposes.
10. Not Keeping Your Accountant Informed
Ben Taylor, Founder, Home Working Club
One of the biggest tax mistakes most small business owners make is failing to keep their accountants in the loop about changes in the business. If you don’t keep your accountant informed about what’s happening to your business, they wouldn’t be able to give you effective advice. And often, when it’s time to do the accounts, it’s too late to make savings they could have assisted you with.
11. Not Having a Tax Organizer
Marty Wilkins, CEO, Go Fund A Hero
It’s important that every small business owner has a tax organizer because this gives you a glimpse of all the questions that the IRS asks your business, such as about travel, entertainment, and other important expenses. Keeping track of these things will save you time and will be of great help if you are ever audited. Not having a tax diary will give you a lot of headache during tax season.
12. Structuring Your Business Incorrectly
Samuel Nichols, Public Relations Specialist, Tax Reduction Concierge
How a business is structured can hugely affect how they are taxed. If you structure your business as a C-Corp, it means you are taxed twice. If you go for a sole proprietorship but do not know how to account for certain items like self-employment taxes, it can also create problems later on. Generally, an S-Corp or an LLC may be the best alternative.
For more information, read our article on the different types of small business structures.
13. Failing to Pay “Trust Fund” Taxes
Matthew T. Eyet, Partner, Sandelands Eyet LLP
A trust fund tax is any tax which the business collects from a third party and holds “in trust” until the business pays it to the government. The most common trust fund taxes are sales and payroll taxes. For businesses, the government pursues unpaid trust fund taxes much more aggressively than unpaid income taxes. They can also subject the corporate officers personally responsible for the unpaid tax.
14. Having Disorganized Financial Records
Dave Du Val, Chief Customer Advocacy Officer, TaxAudit
A disorganized financial record is one of the most costly business tax mistakes we see. If you properly document your business expenses, it can help reduce your taxable income. Also, all your financial transactions should be properly recorded. You may use accounting software like Quickbooks to do this. Make sure your financial documents, such as financial statements and balance sheets, are accurate and readily available anytime.
For more information on the different software that works for taxes, check out our ultimate guide on the best small business accounting software.
15. Not Using the Section 179 Tax Exemption
John Caruso, VP of Funding Operations, LeaseQ
The Section 179 of the IRS tax code lets businesses deduct the full purchase price of equipment and/or software purchased or financed during the tax year. Some small businesses, however, do not use this tax exemption and its available accelerated depreciation. It’s important to be aware of this section especially when buying or financing equipment because the deduction is “use it or lose it” if a purchase isn’t completed by year-end.
For more information, read our article about Section 179 deduction for property, equipment, and vehicles.
16. Not Making Yourself an Employee of the Business Entity
Brian J. Thompson, CPA & Attorney, BrianThompsonLaw.com
Even if you are the owner of your business, you still should make yourself an employee of the business entity with a reasonable salary. Failing to do so may result in additional social security taxes, which are usually collected in the form of self-employment tax. When in doubt, it’s best to consult a CPA or a tax lawyer about this.
17. Forgetting to File Form 1099
Enrolled Agent Steven J. Weil, Ph.D., President & Tax Manager, RMS Accounting
If you paid anyone that’s not incorporated $600.00 or more during the last calendar year, you need to send them a 1099-MISC. The name on your 1099 form should match the name on the checks you paid to them. Also, include their Social Security Number or Tax ID. Additionally, 1099-MISC is also required if you paid $600.00 or more for legal services even if they were incorporated.
For more information, read our article about the IRS form 1099 reporting for small business owners.
18. Using the Money Intended For Taxes
Thomas J. Williams, EA, Tax Accountant, National Association of Enrolled Agents
Most tax matters arise because of tight cash flow or mismanagement of funds. Some business owners dip into tax monies they have collected from a customer (sales tax) or employee (payroll tax) and skips tax payment deadlines. The best way to avoid the situation is to create a business budget, minimize personal bills, maintain separate bank accounts, and activate automatic tax withdrawals from your account, so the money is out of your hands.
19. Setting Up Your Company as a C-Corp
Scott Kacmarski, President, RepsDirect.com
Structuring your company as C-Corp can be a big mistake when it comes to paying taxes because for C-Corp companies, the income paid as dividends are taxed twice. To avoid this cost, it’s better to set up your business as S-Corp or LLC instead.
20. Not Understanding the New Tax Bill
Kevin Miller, Chief Marketing Officer, The Neat Company
Not understanding the new tax bill can cost you more money on taxes. One aspect of the new tax bill that small businesses may not be aware of is that they can no longer deduct 50% of their client entertainment expenses, like your monthly golf outings with your top contractors for instance. However, you can still use your client spend budgets for meals because they are still deductible by 50% under the new bill.
21. Being Unaware of the Required Use-Tax
Chris Denny, Owner, Lead Optimize Outsource Marketing
Most small business owners are unaware that all purchases they make from out-of-state vendors – whether they are office products from Amazon or monthly software subscriptions – require use-tax to be paid. Business owners usually pay sales tax every month but fail to report use tax, and this can lead to penalties especially when your business is audited.
22. Not Reconciling Your Checking Accounts With Your Tax Returns
Stephen Moskowitz, Tax Lawyer, Moskowitz LLP
One of the first things that the IRS does in an audit is to add all the taxpayer’s deposits in all their business and personal bank account. If the total of deposits is more than what is reported on the tax return then accuse the taxpayer of having unreported income. To avoid this, make sure to reconcile your checking accounts to your tax returns and that all your income is reported accurately.
If you add more contribution to your retirement plan than the law allows, you could be penalized with a 6% excess contribution penalty which will apply every year until you correct the excess. Workful Blog suggests that you find out what’s the maximum contribution for retirement plan and calculate your annual contributions carefully.
For more information, read our article on the types of retirement accounts.
If you over-report your income, this will lead you to pay more taxes than required. For instance, if you sell goods on which you collect sales tax, your reportable income should not include the sales tax. American Express recommends ensuring you subtract the sales tax before reporting the income from the sales.
Tracking business kilometers is important, yet not all small business owners keep a mileage log for this. According to The Globe and Mail, if you use your personal vehicle for business travels, the fuel that you spend for these travels should be logged as a company expense, and you can use these to claim for deductions during tax filing. Make sure that these are supported by necessary documents.
For more information, read our article about the best mileage tracker apps for small business.
Bottom Line – Small Business Tax Preparation Mistakes to Avoid
As a business owner, tax planning and preparation should be considered a priority. Filing for taxes can cause a lot of headaches if your books are not clean, your documents are not organized, and your tax money is not enough. To help, make sure to avoid these 25 small business tax preparation mistakes as recommended by the experts.