Tax season can be very stressful for small business owners, especially for those who don’t understand the tax paying process. One small mistake can cause overpayment, penalties, and not being able to take advantage of tax savings. To help, we asked the experts to share the most common small business tax preparation mistakes you should avoid.
Below are the top 24 tax mistakes every small business owner should avoid, according to the pros:
1. Failing to Keep Accurate Payroll Records
Kurt Rathmann, CEO & Founder, ScaleFactor
Small business owners are unfortunately prone to not keeping proper payroll records, which can make tax preparation nearly impossible and may result in penalties from the IRS. That’s why it’s crucial to spend time organizing your payroll records and ensure you classify each employee correctly. It will save you time in the long run and make preparing for tax time a lot easier.
2. Mixing Business & Personal Expenses
Charles Corsello, EA, President, TaxDebtHelp
You cannot deduct personal expenses that are not business expenses. For example, if you use your car for personal and business, you can only deduct business use using the standard mileage rate method or the actual expense method. If you meet qualifications for both methods, you can go with the one that provides a larger deduction. Mixing business and personal expenses can create confusion, and it can be time-consuming to account for each expense and identify which is which.
3. 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.
4. Hiring a Tax Preparer Who Is Not Knowledgeable About Retirement Plans
Robert Cohen, CPA, CFP, MBA, Director of Tax, Glass Jacobson Financial Group
All powerful tax planning and preparation ideas should include a determination of the deductibility of the retirement contributions and the type of retirement plan. Depending on the type of plan, the deduction can be a few thousand dollars to much more. One of the greatest benefits of this deduction is that it does not have to be paid until the return is ready to be filed. However, often a tax preparer will not even think about the effect of the retirement plan deduction. Since there are so many different plans and rules, many preparers do not maximize the deduction—if they consider them at all. It’s best for business owners to hire an experienced tax preparer who is extensively knowledgeable about retirement plans to maximize their tax deductions.
5. Not Knowing Which Income Is Taxable
Kosei Okubo, Founder, Founder’s Guide
The IRS is quite strict when it comes to income, so it’s best to report your full and correct income amount, else it will trigger an audit. It’s best to report all your types of income, no matter how small it is, just to be on the safe side. Or if you are unsure, the best move is to work with a tax accountant to help you classify which income is taxable.
6. Failing to Pay Estimated Tax Payments Quarterly
Priya Mishra, Managing Attorney, Top Tax Defenders
Small business owners or contractors need to pay estimated tax payments quarterly, but often fail to do so. Quarterly estimated tax payments are important to avoid paying a penalty with the annual filing and to not face a big tax surprise when April 15th rolls around. Small business owners with employees also need to submit employee payroll withholdings to the IRS. When owners are short on cash, they are tempted to dip into these withholdings, not realizing that this is not their money. The owners can be personally held liable for not submitting this money to the IRS and can face severe penalties. Even if the business is incorporated, the owners will still be personally liable for the amount not submitted to the IRS.
7. Assuming That Fringe Benefits Aren’t Taxable
David Feinberg, VP of Operations & Risk, Justworks
It’s a mistake to assume that a fringe benefit might not be taxable because it isn’t specifically listed anywhere in the tax law or in one of the IRS publications. The only fringe benefits that are listed in the tax laws are those that can be excluded from income, either in whole or in part. Additionally, any or all of a fringe benefit can be excluded from taxable income only if the recipient is not an employee. If the recipient of a fringe benefit is not an employee, then it is not subject to any income tax withholding, but it may have to be reported as income elsewhere, such as on a Form 1099-MISC for independent contractors or a Schedule K-1 for partners.
8. 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.
9. Not Claiming Mileage Deductions
Melissa McKinney-Breyer, Lawyer & Co-Owner, Breyer Home Buyers
There is generally confusion about what qualifies as a legitimate business driving deduction. When you travel from your office to see a customer or vendor, it constitutes business driving. Whether the travel from your home to another location is a business trip depends. If you commute from home to your office, this is a nondeductible personal expense. If, however, you work from a home office for which you claim a tax deduction, then travel from home to any business location and back is treated as deductible business driving.
10. Not Understanding a Business’ Tax Obligations
A.J. Gross, CPA, EA, President, ALG Tax Solutions
Not understanding your tax obligations can be risky. It is recommended that every business owner have at least a basic understanding of the business’ tax obligations. This can be done with at least one yearly review with a tax professional. The tax professional can provide recommendations for minimizing taxes and help the business owner plan for future tax obligations.
11. Not Communicating with the IRS if You Can’t Pay Your Taxes
Josh Zimmelman, Owner, Westwood Tax & Consulting
If you have already filed your tax refund but find yourself unable to pay, don’t just not pay it. The IRS may be open to a tax settlement, but you have to communicate with them in order to make this happen. You have to file all of your past tax returns first before the IRS will be willing to negotiate. The IRS may let you have more time to pay your balance. They may agree to an installment plan, in which you can pay small amounts every month instead of one lump sum. If you can prove that you cannot afford to pay your taxes, the IRS may be willing to make a compromise and reduce your balance.
Contact a tax relief professional and ask them about your options. If all else fails and you must pay your tax balance in full, you might consider paying with a credit card. Even though you might end up paying interest charges on your credit card balance, depending on your rate, that might still be cheaper than paying the IRS’ fines and interest charges.
12. Forgetting to Include Write-Offs & Other Petty Cash Expenses
Brett B. Trembly, Esq., Attorney & Founder, Trembly Law Firm
Forgetting to write off every single item that warrants a deduction can mean letting the IRS take your hard-earned money. Petty cash purchases, magazine subscriptions, classes, or even lunches with clients are all deductibles. These small expenses can add up to thousands of dollars before you even realize it. Make sure you track all your expenses, save all your receipts, and ask your accountant about what you can and can’t deduct.
13. Writing Off Personal Expenses Charged to Business
Paola Garcia, Small Business Advisor, Excelsior Growth Fund
Many business owners think that they can write off personal expenses that they charge to the business. However, per the IRS, any personal expenses that are charged to a business should not be counted as business expenses. The proper way to pay personal expenses from your business is to take a distribution as the business owner, and reflect that distribution as personal income on your own tax return. It can be hard to tell whether some expenses are business or personal, like meals or travel, but others are more obviously personal expenses, like personal care or home services. It’s important for business owners to know this to stay in tax compliance. Business and personal expenses should always be kept separately.
14. Forgetting to Include Receipts for Small Expenses
Jonathan Rosenfeld, Founder, Rosenfeld Injury Lawyers
Don’t forget to include all of your receipts for small expenses such as cab fares, office coffees, and things commonly paid for with small amounts of cash. Over the course of the year, these expenses can add up quickly and if you don’t stay on top of it, you could be throwing business expenses out the window. Ask employees to submit receipts within one week for reimbursement of expenses. Explain that their failure to do so will result in expenses not getting reimbursed.
15. Failing to Deduct the Cost of Health Insurance
Brian J. Thompson, Tax Lawyer & Owner, Brian J. Thompson Law
Self-employed business owners and sole proprietors sometimes forget to deduct the cost of health care insurance. Any ordinary and necessary business expense is a tax-deductible expense. This includes the cost of health care insurance for small business owners and sole proprietors. Health care insurance often costs $5,000 or more annually, and this deduction can result in significant tax savings.
16. Missing Business Deductions as a Result of Ignoring the Grey Area
Samuel V Hicks, CPA, MST, Stern, Kory, Sreden & Morgan
Many business owners, and taxpayers in general, don’t want to have any issues with the IRS out of fear of having to deal with notices, or even worse, going through an audit. This fear keeps many out of the grey area, which is the overlap area of business expenses and personal expenses. Some items are certainly business, other items are definitely personal expenses—but some expenses are both. The fear of taking any portion of these expenses keeps some business owners out of the grey area completely. The correct treatment is allocating the proper portion to business and claiming the right deduction. Sometimes this allocation is best done with the help of a professional.
17. Deciding to Hire a CPA Too Late
Emil Abedian, Founder & CEO, Anchor Bookkeeping
Waiting until March or April to hire and meet with a CPA will not help with your business tax preparation because it is already too late at that point for most tax planning tools. Consider a personalized, done-for-you bookkeeping service so your books are current each month, and meet with your CPA before the end of the year for proper tax planning.
18. Not Knowing About the IRS Section 199A
Harvey Bezozi, CPA, CFP, Founder, Your Financial Wizard
Many small businesses fail to properly implement a most important provision for small businesses in the new tax law: the IRS Section 199A. This allows eligible taxpayers to a deduction of up to 20% of qualified business income. It’s best to work with a knowledgeable and competent tax advisor to find out if you are eligible for the qualified business income pass-through deduction.
19. 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 accounts. If the total of deposits is more than what is reported on the tax return, they 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.
20. Forgetting to File Form 1099
Steven J. Weil, PhD, EA, President & Tax Manager, RMS Accounting
If you paid anyone who is 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.
21. Misusing 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 skip 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.
22. 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 take 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.
For more information on how business structure affects taxes, read our article on the different types of small business structures.
23. 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.
24. Incorporating in the Wrong State
William Perez, Licensed Tax Professional & Staff Writer, Fit Small Business
Sometimes entrepreneurs form corporations or limited liability companies in another state, such as Delaware or Nevada. While there could be perfectly good legal reasons for doing that, be aware this is usually more expensive from a tax perspective.
Entrepreneurs will still need to register their corporation or LLC in the state or states where they will be actually conducting business. That means businesses end up paying state registration fees both in the state where they incorporated and again in their home state. For many small businesses, this is often an unnecessary expense. Consult with a good business attorney and tax professional before incorporating to make sure you pick the right states as well as the right entity structure for your needs.
Every business owner should consider tax planning and preparation a priority. It’s important to keep your books clean, your records organized, and your tax funds intact to prevent any trouble come tax filing time. To help, make sure to avoid the most common small business tax preparation mistakes as recommended by the pros.