We all make mistakes from time to time, whether it’s rolling through a stop sign, forgetting an anniversary or leaving the wallet at the gym. But some mistakes can be far more costly than others—especially when it involves Uncle Sam and your small business.
When you operate a small business, avoiding any costly penalties, fees and audits from the Internal Revenue Service (IRS) is crucial. Here are some of the most common small business tax mistakes and how to prevent them.
1. Failing to file and pay your taxes on time
Determining the correct IRS tax form and your tax due date depends on your business structure. For example, if you run your business through an S corporation, you’ll likely need to fill out a Form 1120S for income taxes (due on March 15). With a sole proprietorship you’ll need to use a Form 1040C instead (due on April 15).
Forget to file and you’ll pay for it: The IRS imposes a 5% monthly charge for those who file late, up to the first five months following the return’s due date (up to a 25% maximum charge). Forget to pay your taxes, and it gets even worse: the IRS charges 6% interest a year on unpaid taxes, in addition to late payment penalties of .5% per month after the April 15 deadline.
The bottom line is you should both file and pay Uncle Sam on time to avoid costly penalties, so keep this in mind before tax season rolls around.
2. Forgetting about estimated tax payments
Some businesses are required to make quarterly estimated tax payments during the year on income that is not subject to withholding. This includes money you earn from self-employment, interest, dividends and gains from the sale of assets.
If you are filing as a sole proprietor, a partner, an S corporation or a self-employed individual, you generally will have to make estimated tax payments if you expect to owe tax on $1,000 or more when you file, according to the IRS.
If you do not pay enough tax by the due date of each of the four quarterly payment periods, you’ll face a penalty unless you meet certain circumstances such as becoming disabled or having a similar reasonable cause for not making the payment.
You can figure out how much you’ll need to pay in estimated taxes with a Form 1040-ES worksheet. Since it’s a confusing issue for many small business owners, seeking professional help from an accountant or tax attorney can be a wise move.
3. Not taking business deductions—or taking excessive deductions
You can potentially reduce your tax burden by taking several legal business deductions. The IRS says you can deduct all “ordinary and necessary” expenses you incur while operating your business.
For example, if your home is the principal place of your business, you may be able to deduct several business-related expenses. This might include rent, insurance, utilities, office supplies and real estate taxes. If you use your car primarily for work, you may be able to deduct expenses such as gas, mileage, oil changes, parking charges and insurance premiums.
The most common overlooked deductions by small businesses include depreciation (30%), which refers to the decrease in the value of assets over time due to wear and tear; out-of-pocket expenses (29%), such as the purchase of new equipment; and auto expenses (16%), according to a Xero survey.
On the other hand, taking excessive deductions or mixing personal and business deductions—like claiming a family vacation as a business expense—is not allowed and can lead to an audit, or worse, a federal tax fraud charge. Just look at reality TV star Mike “The Situation” Sorrentino, who was recently charged with failing to file a tax return and tax fraud for allegedly claiming fancy clothes and sports cars as business expenses, according to Forbes. Sorrentino, who appeared on MTV’s “Jersey Shore,” pleaded not guilty to the charge.
Be careful of what you decide to deduct, and ask your accountant or a tax attorney if you are unsure of anything.
4. Keeping poor records
Record keeping is one of the most important aspects of running a small business. With good records, you can properly deduct all business-related expenses, track and manage inventory, maintain and report employee payrolls, limit the potential for costly legal errors, keep a detailed record of your business so you can track its progress, and prepare accurate financial statements for the IRS.
Keeping good records is all about being organized. Don’t just rely on your memory. Instead, try to keep all of your receipts for every expense you incur in one place. This should include all business purchases, including office supplies, equipment, rent, gifts, advertising and travel expenses, as well as employee payroll information.
You can do this by keeping all business documents in a filing cabinet, documenting purchases by each month and year. Another option is an online accounting software program like QuickBooks, which can help you automate record keeping.
5. Misclassifying employees as contractors
Some small businesses may try to treat workers as independent contractors to save money, as payroll taxes are not due for contractors. However, this can end up costing you if the IRS disagrees with your assessment.
The IRS’ classification will depend on a number of factors, including whether or not you have control over the worker’s hours, what work is being done and how it will be done, and if the work performed is a key aspect of the business, according to the agency.
“Watch out for who controls their time and work environment,” says Guy Baker, a certified financial planner with Wealth Team Solutions in Irvine, California. “How many organizations does the person work for? If you are the only one and they get 100% of their income from you, it is likely they are an employee.”
If you classify an employee as an independent contractor and you’re wrong, you can be held liable for employment taxes for that worker, according to the IRS. For more information on how to correctly determine whether an individual is an employee or independent contractor, visit the IRS website.
By being aware of some of the most common small business tax mistakes, you can avoid leaving any money on the table—which means more dough to reinvest in your fast-growing business.
Paperwork image via Shutterstock.
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