Paying taxes is bad enough, but making mistakes and overpaying is even worse. Don’t even get me started on tax mistakes that can lead to an IRS audit. Talk about flushing money and time down the drain. Keep reading as we share 24 common tax-filing mistakes that often cause drama for small-business owners.
As you read them, you may say to yourself, “I would never make these idiotic tax mistakes.“ Let me assure you that the more successful your business is, the more complicated the tax filing will be, which leads to more opportunities for mistakes.
Filing your small-business taxes each year does not have to be stressful or a pain in the butt to do. With a little work throughout the year, filing your taxes can be quite easy. Do what you can to avoid making the following 24 small-business tax mistakes. Doing so could help you save time and it may prevent you from paying the government more in taxes than is absolutely necessary.
1. Misreporting income
The Internal Revenue Service uses a computer to match what has been reported to it with what has been reported by you. For business owners, it is often done via various 1099 forms. Some of your income may be reported to the IRS (and to you) on the form, such as the 1099-MISC which lists non-employee compensation. You will also likely receive 1099s from your investment account as well as a 1099R for retirement accounts. You will need to include all of that income on your tax returns, but listing income in the wrong place could lead to additional IRS scrutiny.
2. Failing to report all of your income
When you run your own business, it may be tempting to underreport your income. Some business owners may even try to get paid in bitcoin or another virtual currency.
3. Overreporting income
Many people like to talk about their gross income rather than net income. It sounds much cooler to say, “I made $1 million last year” instead of, “My profit was $400,000.” If you are selling a product, you must factor in the cost of goods sold. On a financial-planning note, don’t set your personal budget on sales, either. Use your take-home pay instead.
4. Attempting to deduct 100% of your meal expenses
This one bugs me a little. You can be wining and dining several clients at one time, and only 50% of the bill will be deductible — assuming it meets the rules to be serving a legitimate business expense. Under the Trump tax plan, entertaining a client is no longer deductible, which is unfortunate for networking business owners.
5. Mixing personal and business finances
Keep separate accounts and credit cards for business expenses. That will make it much easier to track deductible expenses. It will also help make it clearer that an out-of-the-ordinary expense has a true business purpose. Typically, groceries would not be a business expense; on the other hand, if you are buying refreshments for a client, they would be. Paying for business expenses like that on a company credit card will make it easier to show the distinction.
6. Not doing any tax planning
Not all tax advice is the same. Many people treat tax preparation like recordkeeping and only complete their tax forms with information that happened last year. Consider working with a tax professional who can help with your tax planning. Think of that person as a coach who is helping his or her team figure out how to win. Doing so may help lower the stress many feel when filing their taxes, as well as ideally lowering the overall taxes due. At the very least, the tax-planning professional should help you avoid a shockingly terrible tax bill when you weren’t expecting it.
Filing your taxes during tax season should not leave you shocked by what you end up owing. Work with your tax preparer and tax-planning expert to look for ways throughout the year to minimize your tax bill. Proactive tax planning at best can help reduce your overall tax liability; on the worst end, prevent a surprise and scary tax bill when you eventually file. Tax planning may also help prepare you to file your taxes earlier rather than wait until the absolute last extension deadline.
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7. Skipping the home-office deduction
There is a persistent myth out there that taking the home office deduction is a big audit red flag. Like any tax break, abusing this deduction can get you in trouble with the IRS. Conversely, if you work from home and are eligible for the home-office deduction, you should take it.
8. Not having a mileage record
Many business owners have personal vehicles that they sometimes use for business purposes. To claim a mileage deduction, you will need to keep certain records of your driving. The IRS requirements for deducting miles are in IRS Publication 463.
9. Underpaying estimated taxes
Paying quarterly taxes is the bane of many business owners’ existences, and writing large checks to the government is never fun. For those who need to pay estimated taxes, make sure you account for all of the taxes you will owe. That includes the self-employment tax, Medicare taxes (0.9% on earned income and 3.8% net investment income above certain levels). If you don’t pay your quarterly taxes throughout the year, you can trigger tax penalties. In my opinion, the only thing worse than paying too much in taxes is paying tax-filing penalties.
10. Not claiming the qualified business-income deduction
The Qualified Business Income Deduction (QBI), also called the Section 199A deduction, for owners of pass-through entities is based on your business income. It is not technically a tax deduction, but it can be a valuable way to lower your tax liability nonetheless. The QBI tax break value will vary depending on your income level, business structure, and type of business.
11. Ignoring business startup expenses
In your first year of business, it is easy to miss money spent getting the business up and running. I recently had someone ask how he could pay to incorporate his business if he hadn’t already set up the business. If you asked a similar question, you are not alone. Many people buy domain names, set up websites, and maybe even rent space before they have all the business-formation tasks finalized.
In your first year of business, you may able to deduct startup costs before you even open the doors to your business. That can be up to $5,000 in your first year, with the additional expenses to be deducted over the next 15 years. When startup costs exceed $50,000 special rules will apply, so talk with your tax-planning expert.
12. Choosing the wrong retirement plan
Retirement-plan contributions are one of the easiest ways for small-business owners to both plan for the future and reduce their current tax liabilities. You will want to work with a trusted certified financial planner to make sure you choose the right retirement plan for your small business. Choosing the wrong plan could limit your deductions or require you to make contributions to your employees that you can’t afford.
Good news: You may also qualify for a tax credit when starting a retirement plan for your business. In many cases, the Solo 401(k) will allow for the largest contributions for a small business. If you are doing well and already maxing out the Solo 401(k) plan, check out a Cash Balance Plan, which can potentially allow you to shelter hundreds of thousands of dollars of income each year.
13. Not contributing enough to your retirement plan
Step one is to set up the retirement plan. Step two is to fund it adequately. Strive to save 10-20% of your income, each year, into a retirement plan. Most contributions are pre-tax, which will make saving easier.
14. Overlooking carryover deductions
Several tax breaks are limited, or you may not have been eligible to fully utilize them in a prior tax year. The good news is that they may be deductible now. A few common items to check for include capital losses, net operating losses, investment interest, and the home office deduction.
15. Not keeping charitable-contribution receipts
For charitable contributions of more than $250, you are required to keep a written acknowledgment from the nonprofit in order to take a deduction.
16. Filing your taxes late
Watch your tax-filing deadlines. If you are unable to file your business taxes on time for any reason, ask for a filing extension. The more complex your business (or businesses), the more likely you will need to file on extension each year. Be sure not to use that as an excuse to procrastinate, and make sure you file by the time your extension ends.
17. Failing to attach required forms, schedules, or election statements
A tax return is not a tax return without all the necessary paperwork being submitted. If you are working with a tax professional, she will take care of that for you. That assumes you have provided her with all of your tax forms.
18. Putting off taxes until the last minute
Rushing around and trying to file your taxes at the last minute is when mistakes happen. I can almost guarantee you that your CPA is more exhausted on April 15 at 10 p.m. than today. Take the time to gather your tax information well ahead of the tax deadlines. Doing so will give you extra time if you are missing information or get stuck on a specific part of your tax return.
19. Not staying up on tax developments
If you have an amazing financial planner and tax pro, you can probably skip this one. All the same, it is still important to have at least a basic knowledge of major tax changes that could affect you. The Trump tax plan brought some major changes starting with your 2018 taxes. Not being aware of them could leave you paying more taxes than needed.
20. Tax mistakes due to not disclosing everything to your CPA
This one is pretty straightforward; if you don’t tell your CPA, he won’t know. Not providing all of your tax forms is the easiest mistake to avoid. Alert your CPA of changes in marital status, income, business structure. The IRS can impose accuracy-related penalties, so try to avoid typos.
21. Making business decisions simply for the tax impact
Should you buy a tractor in order to get a big tax break? I’m going to guess that most who are reading this don’t have much use for a tractor in your day-to-day businesses. So, buying a tractor would be a waste of money for most of you. You would be spending dollars on an unnecessary item in order to save pennies.
I’ll admit that I’m a fan of tax planning, and I hate seeing people waste money. Before you buy something for your business to get a tax deduction, ask yourself, “Will this help me make more money, and do I need it for my business?”
22. Failing to keep cost-basis records
Owners of pass-through businesses can claim only a certain amount of losses on their personal returns. For example, an S Corporation owner’s loss deduction will be limited to the basis in stock and loans she has made to the corporation. If the basis isn’t tracked, no deductions will be allowed.
If you happen to sell your successful business in the future, your taxes will not be based on the amount received, but rather on the gains above your basis in the business. Also, the basis can be increased by capital improvements to the business.
23. Not understanding the differences in federal and state tax rules
Taxes at the federal level apply no matter in which state you happen to run your business. Each of the 50 states has its own quirks. Some tax breaks are limited in some states but are more generous in others. You may need to do tax planning with both state and federal taxes in mind.
24. Ignoring your bookkeeping throughout the year
I’m guessing at least a few people reading this still have shoe boxes of receipts. If that is your case, I’m guessing tax time is a nightmare for you. Do yourself a favor and get some online software, like QuickBooks, to track your spending and income. If nothing else, the software can do the math for you. When you attach your credit cards and bank accounts to the software, all of your transactions will download into it. You will still need to do a little legwork to categorize your income and spending properly, but it sure beats adding up a pile of receipts from a shoe box.
If you have numerous vendors and invoices, you should look at working with a bookkeeper. If nothing else, look at it as a time saver.
Most business owners work hard to have profitable businesses. Taking the extra step for tax planning is another way to increase your take-home pay. You work hard for your money; you might as well work hard to keep more of it. At the very least, be proactive to avoid these 24-common tax-filing mistakes that befall many business owners.