In the US alone, small businesses spend as much as 2.5 billion hours annually preparing for and answering questions regarding their taxes.
As a small business owner, you probably know that filing taxes is one of the most involved processes you have to do for your business. It becomes confusing by the minute, and by the time you’re halfway through, you have no idea what you’re doing.
Still, taxes are a mandatory part of business, and the best thing you can do is avoid making grave tax mistakes. This brings us to the next question. What kind of tax mistakes should you be wary of making?
In this comprehensive guide, we’re going to look at some tax mistakes that could lead to some very serious tax problems. Read on to find out what these mistakes are so you can formulate a strategy to avoid them.
- Not Understanding Which Tax Forms You Should File
If your business is organized as a sole proprietorship, partnership, limited liability company (LLC), or S corporation, then the tax forms that apply to you will be determined by how and for whom your business income is actually earned.
For example, suppose you earn $50,000 per year as an independent contractor. In that case, this income will be reported on Schedule C of Form 1040 and subject to self-employment tax in addition to any other business taxes that may apply, such as federal income tax.
If you earned the same amount working for someone else’s business as an employee, then it would be reported on a W-2 tax form and not subject to self-employment tax. Schedule C is a tax form used by anyone who operates their own business, whether it is a full-time career or a side job.
- Excessive Use of Tax Deductions
There are plenty of tax deductions out there that sound like they would be an excellent choice for any business owner to take. However, if you take too many tax deductions, then the IRS could decide that you are not actually operating a legitimate business and that your taxable profits were normal personal income.
This is one reason why it is very important to keep good records and pay attention to what different tax deductions will cost you when it comes time to file your tax return each year. Taking unnecessary risks with your tax refund is really not worth the risk or hassle. This is one of those common tax issues people don’t understand, and it always leads to serious tax mistakes.
- Not Hiring Professionals When Necessary
Some small businesses may be able to handle their tax preparation, but most can’t. The thing is, business taxes are complex, and keeping up with tax laws and updates is something most business owners are unable to do.
If you find yourself in a predicament, the best thing you can do is hire a tax professional. Alternatively, you can outsource your taxes to professional companies such as Taxfyle, which will get your taxes in order as well.
- Not Properly Recording Income and Expenses
This is one of the top tax mistakes that can get you into trouble immediately. You’d receive an IRS form 1099-MISC if you made $600 or more from a customer who is not your client, such as a subcontractor, office supplier, etc.
If you did not record this income correctly on your tax return but instead used it to pay for other expenses throughout the year, then there’s no proof of payment, and you’ll owe interest and penalties on top of the original tax debt.
- Not Keeping Track of Tax Deductible Expenses
This is among the tax mistakes that’ll cost you more in the long run. If you forget to claim tax deductions for parking or meals, travel and entertainment costs, or transportation fees, then it can add up without your knowledge.
Expenses such as these and most tax deductions and credits are not readily apparent on tax forms. Most tax software programs can assist with this process, but paper forms also list all allowable tax deductions and credits at the bottom of each form.
- Failing to File Tax Withholding Documents
Sometimes small business owners fail to file W-4’s for their employees because they don’t really stay on top of tax issues and tax forms. The W-4 form is a tax document that you give to your employees every year.
This file essentially tells the employer how much tax to take out from their paychecks. When you fail to file these tax forms, it can lead to penalties and the money coming directly out of your employees’ wallets.
- Claiming Personal Expenses As Tax Deductions
This tax issue is pretty common, and one that taxpayers probably don’t realize they’re making until it’s too late. You cannot claim tax deductions for personal items or household expenses such as clothing, groceries, haircuts, and dry cleaning.
The IRS only allows tax deductions for business expenses and travel costs. If you don’t keep records of your tax deductions, then it can be difficult to prove that you used tax-deductible expenses for business purposes only.
- Not Keeping Tax Records for Long Enough
This tax mistake is more common than you might think because some tax preparers don’t know how long you should keep tax records and tax documents before destroying them. The general rule of thumb is to hold onto tax records until the statute of limitations expires for your tax return.
You could also keep your tax returns indefinitely in the case the IRS ever audits you.
- Failing to File Estimated Taxes
Although most small business owners are not required to file tax forms for tax withholding, they may still need to pay estimated business taxes throughout the year. Any tax liability on your tax return is taken into consideration before you find out how much tax you owe at tax time.
If the IRS determines that your tax liability is too low compared with what you actually owe based on what was reported, then that’s when they determine whether or not you have to file estimated taxes.
- Not Understanding Tax Laws
This tax mistake is hard to avoid because the tax law changes every single year due to the constant changing of tax deductions and credits, tax rates, and business expenses. Tax exemptions also change as they are all based on individual taxpayer situations. If you don’t keep up with tax issues, then it’s possible that you could miss something important leading to major tax problems down the line.
Tax Mistakes You Must Avoid
As a small business, the last thing you want to have is tax problems and having to deal with the IRS. The best way to avoid these tax issues is by avoiding the tax mistakes listed above. If they’re too many to keep up with, the best thing you can do is hire a professional.
Other than that, if you liked this post, please check out our blog section!