5 Common Tax Mistakes Small Businesses Make and How to Avoid Them
As a small business owner, managing taxes can often feel like one of the most daunting aspects of running a company. However, many small businesses fall into the trap of making simple tax mistakes that can lead to costly consequences. Whether it’s due to lack of knowledge, poor planning, or just oversight, these mistakes can be easily avoided with the right approach.
In this article, we’ll explore the 5 most common tax mistakes small businesses make and provide tips on how to avoid them.
Failing to Keep Proper Records
One of the most common and costly mistakes small businesses make is failing to maintain accurate and organized financial records. This can include not tracking receipts, not recording income and expenses, or not maintaining proper documentation for business-related purchases.
Why it’s a problem:
Without proper records, you may miss out on legitimate tax deductions, leading to higher taxable income. Additionally, poor recordkeeping increases the risk of errors and can complicate the process of filing taxes, making it harder to substantiate your expenses or income if you’re ever audited.
How to avoid it:
- Use accounting software: Implement accounting software like QuickBooks, Xero, or FreshBooks to track income, expenses, and generate financial statements.
- Keep all receipts and invoices: Maintain organized records of all business-related expenses. Consider using a cloud-based expense management tool for easy access.
- Hire a professional: If you’re struggling with recordkeeping, consider hiring a bookkeeper or accountant to manage your records regularly.
- Set a schedule for reconciling accounts: Make it a habit to reconcile your accounts monthly to ensure everything is accurate and up to date.
Misclassifying Employees and Contractors
Many small business owners are unsure whether to classify workers as employees or independent contractors. Misclassifying workers can lead to significant tax penalties and missed opportunities for tax deductions.
Why it’s a problem:
The IRS has strict guidelines for differentiating between employees and independent contractors. Misclassification can result in failure to withhold appropriate payroll taxes or pay employment taxes, leading to penalties, back taxes, and interest. Additionally, misclassifying workers can impact benefits, insurance, and other legal requirements.
How to avoid it:
- Understand the rules: Familiarize yourself with the IRS guidelines for employee vs. contractor classification. The IRS uses several criteria, such as control over work and the relationship with the business, to determine classification.
- Consult an expert: If you’re uncertain, seek advice from an accountant or tax professional to ensure you’re classifying workers correctly.
- Use written agreements: Have a clear, written contract with independent contractors to define the terms of the relationship, outlining that they are not employees.
Neglecting to Deduct Eligible Business Expenses
Many small businesses miss out on valuable tax deductions simply because they don’t track or claim all their eligible business expenses. Common missed deductions include home office expenses, vehicle costs, and office supplies.
Why it’s a problem:
Failing to claim all eligible business expenses means you’re overpaying on taxes. Business expenses can reduce your taxable income, so missing out on deductions means paying more than necessary.
How to avoid it:
- Know what you can deduct: Common deductible business expenses include office rent, business insurance, employee wages, office supplies, marketing costs, and travel expenses.
- Keep thorough records: Track all expenses throughout the year. Use accounting software or apps to categorize and store receipts.
- Take advantage of the home office deduction: If you work from home, ensure you’re taking the home office deduction if you meet the IRS criteria. This can be a percentage of your home’s expenses based on the space you use for business purposes.
- Consult a tax professional: A tax expert can help identify deductible expenses specific to your business.
Not Paying Estimated Taxes
As a small business owner, you are responsible for paying taxes throughout the year, not just at the end of the year. If you fail to make estimated tax payments, you could face penalties and interest on any unpaid taxes.
Why it’s a problem:
Small business owners often forget to pay quarterly estimated taxes or underestimate how much they owe, which can lead to large tax bills and penalties at the end of the year. Not paying taxes on time can result in interest charges and additional penalties, increasing your financial burden.
How to avoid it:
- Know your obligations: If you’re self-employed or a business owner, the IRS expects you to pay taxes on income that isn’t subject to withholding (like freelance or business income).
- Make quarterly payments: The IRS requires estimated tax payments four times a year (April 15, June 15, September 15, and January 15). You can make these payments online through the IRS website or via other payment options.
- Estimate your taxes accurately: Use accounting software or consult a tax professional to estimate your income and tax liability for each quarter, so you don’t underpay.
- Plan ahead: Set aside a percentage of your revenue each month to ensure you have enough funds to pay your estimated taxes when they’re due.
Missing Key Tax Deadlines
Tax deadlines are critical for small businesses, and failing to file or pay taxes on time can lead to hefty fines, interest charges, and even legal trouble.
Why it’s a problem:
Missing deadlines for filing your taxes or making payments can result in penalties, and, in extreme cases, an audit. Additionally, late filings can delay any refunds you’re entitled to.
How to avoid it:
- Mark your calendar: Set reminders for important tax deadlines—whether it’s the deadline for your business tax return, payroll taxes, or estimated quarterly payments.
- Use tax filing software: Many accounting tools or tax software will alert you when deadlines are approaching.
- Hire a professional: A tax professional can ensure you meet all tax deadlines and can even file extensions if necessary, giving you more time to file your return.
- File for extensions: If you’re unable to file your tax return on time, you can request an extension. However, keep in mind that extensions only give you extra time to file, not to pay any taxes owed.