Common Mistakes Small Business Owners Make on Their Taxes

As a small business owner, you perform many different tasks– from marketing and hiring to customer service and daily operations, many tasks require your time and attention. In addition to daily management, you’re responsible for ensuring your tax matters are taken care of. When you make an error while filing your taxes, you can miss out on deductions or end up owing more than you should. The good news is that the common tax mistakes business owners often make can easily be avoided!

Join our Raleigh CPA team as we discuss common tax mistakes we often see when business owners file their taxes without the assistance of a small business accountant and give you tips so you can avoid making the same errors.

9 Common Tax Mistakes Small Business Owners Often Make

While tax filing and payments are critical to your business, taking this task on yourself can lead to common tax mistakes, including missing deductions that can lower your payments. Whether you are a new or established business owner, the ever-changing tax rules may leave you feeling uncomfortable filing your taxes. Filing business taxes can be complicated, so it’s best to work with a CPA who can prepare and file them on your behalf. 

Not Selecting the Proper Entity

Selecting the tax entity for your company is critical. Many small businesses form as a sole proprietorship or LLC, but these may not be the best business tax entities for your company. Factors in making the right decision are based on your desired business structure, number of employees, and financial goals. Some potential entities for small businesses include:

• LLC
• C-Corp
• S-Corp
• Partnership
• Nonprofit

If you’re not sure which business entity to choose, an accountant may be able to help you choose the structure that fits your goals. Choosing the wrong tax entity for your company is one of the common tax mistakes that can seriously impact your company’s future. For example, forming your company as a C-corporation doubles the amount of taxes you owe. An LLC can substantially decrease the amount of outside investor funding you can receive. A partnership offers less personal liability protection. It's important to understand the benefits and downfalls of each type of entity when starting your business.

Deducting Start-Up Costs Incorrectly

One of the most common tax mistakes that results from preparing your own taxes is deducting costs incorrectly. While start-up costs are deductible, not all expenses are. New small business owners commonly overestimate how much of their start-up costs are deductible. Expenses are categorized as either 1) start-up or 2) organizational costs. Start-up costs are those expenses incurred to research the acquisition or creation of the business as well as the costs of setting up the active business. Examples of start-up costs are investigatory costs such as surveys and travel costs for securing distributors, suppliers, and customers. Organizational costs are the direct costs of creating a corporation or partnership. Examples of organization costs are accounting fees, costs of organization meetings, legal fees to draft the corporate charter, bylaws, and state incorporation fees.

Despite misconceptions, business owners cannot deduct all start-up costs in the beginning. If you spent less than $50,000 total on your business start-up costs, you can deduct $5,000 of start-up costs and $5,000 of organizational costs immediately in the year your business starts operating. If your costs to start the business were more than $50,000, but less than $55,000, you can still receive your deduction. However, the deduction is reduced by the dollar amount exceeding $50,000. 

For example, If you incur $52,000 in start-up costs, you can only deduct $3,000 in the first year ($5,000 minus $2,000). After your first year, you can amortize the remaining costs. If you spend more than $55,000 in starting your business, you won’t be able to deduct any of those costs in the first year and will need to amortize all of them.

Commonly Missed Deductions

A CPA can help you identify and write off every item that qualifies for a deduction. Small items like business magazine subscriptions, printing marketing material, and postage stamps are all deductible, so save your receipts. Here are additional business costs you can take deductions for that are commonly missed:

• Home office - Be sure to read the IRS guidelines for a home office deduction to see if yours is eligible.
• Accounting and bookkeeping fees or software cost
• Tax preparation expenses
• Business use of vehicles such as using your car to deliver products or non-commuting travel
• Insurance, including both health insurance for yourself and your employees
• Travel expenses
• Meals (for example, taking a client out to dinner or buying lunch for your employees) - you can only claim 50 percent

Over-Reporting, Under-Reporting, or Misreporting Income

Reporting a higher-than-average income or not reporting all of your income can trigger an audit. Another one of the common tax mistakes is over-reporting sales tax in your income reporting. Be sure to subtract any sales tax that was paid during the year from your total income. An example of an under-reporting mistake is not including selling business equipment you didn’t need like furniture or a computer. This would need to be included as income on your taxes.

Incorrectly Classifying Staff

Another of the common tax mistakes that is easy to avoid is classifying your staff incorrectly. For example, many small businesses hire independent contractors to save money in tax season. However, if your company’s independent contractors are expected to work certain hours or are forced to work on-site, they may qualify as regular employees. Be sure you understand the IRS stipulations for independent contractors. There are severe tax penalties if you classify them incorrectly.

Not Paying on Time or Failing to File on Time

There are two penalties: 1) Failure to File and 2) Failure to Pay. A penalty for failing to pay tends to be less costly than a failure to file. Even if you can’t afford to pay your taxes immediately, you should at least file to avoid one of the most common tax mistakes. If your business is a sole proprietor, partner, LLC, or S-corporation, you should pay quarterly estimated taxes, especially if you expect to owe over $1,000 when it’s time to file your return. Many small business owners neglect to do quarterly taxes, which can result in a large tax debt that is difficult to pay off. Paying on time avoids paying late fees and fines. Be sure to follow the tax deadline schedule for compliance.

If you need an extension for paying taxes, you can submit Form 4868 for sole proprietors or Form 7004 for all other kinds of business entities.

Keeping Poor Records and Mistakes on Payroll

We know it can be challenging to stay organized and keep precise records when you have so much on your plate. But, having accurate records is crucial to avoiding some of the most common tax mistakes business owners often make. You need precise records for the IRA or else you can lose deductions, which means you lose money. If your business undergoes an audit, you need every piece of paper, folder, file, invoice, and pay stub. If maintaining your bookkeeping records isn't your strong suit, it's ours and we can help you!

Separating Personal Expenses and Business Expenses

With a sole proprietorship or an LLC, your business income will pass through to your personal income and you will report all of it on your personal income tax return. This is convenient but you must keep records organized and have separate bank accounts, allowing you to distinguish expenses and avoid common tax mistakes.

Not Using a Small Business Accountant

Tax software may make it seem easy for small business owners to do their taxes, but it is easy to miss out on deductions and/or misfile. Working with a professional accountant who is experienced in assisting small businesses means that your tax return will be accurate, timely, and more balanced in your favor, thus further helping you avoid common tax mistakes.

Contact Our Small Business Accountants in Raleigh

Many small business owners request the assistance and experience of a CPA, particularly for the first few years of filing taxes to avoid common tax mistakes and get a feel for filing their taxes. C.E. Thorn, CPA, PLLC has been helping small Raleigh businesses with their tax returns and accounting needs for 30 years. We are happy to talk you through it and explain the process, so you will have a much better understanding next year. Call our office at  919-420-0092 or complete the contact form below to learn more about our tax filing and preparation services.