When you’re a first-time business owner, you simply don’t know what you don’t know. Unfortunately, this can come back to bite you in a major way when you’re filing small-business taxes for the first time.
As you’d imagine, tax issues for small businesses are often just as complex as or even more so than tax issues with your personal taxes. Much like you might hire someone to help you with your personal taxes, it often makes sense to have a tax professional in your corner when you’re starting a business. They can help you avoid many of these common tax mistakes small businesses make.
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1. Not Setting Aside Money to Cover Tax Payments
When you work for a company, your federal and state income taxes are withheld from your paycheck and sent to the proper places. When you run a business, there is no withholding. Instead, you’re responsible for setting aside enough money every day, week, or month to cover the amount of taxes you’ll owe.
Make sure you set enough money aside to cover the amount you’ll owe for not just federal taxes, but any state and local taxes you might owe, as well.
“Unlike many things you have to pay for in your business, paying your taxes is not optional,” says Logan Allec, a CPA and founder of the personal finance site Money Done Right.
2. Not Setting Aside Money to Cover Self-Employment Tax
What may come as a shock to many new small-business owners is the self-employment tax. “Small-business owners not taxed as a corporation also have to pay self-employment tax on their business income,” Allec says.
Technically, this tax is a combination of Social Security and Medicare taxes. When you work for someone else, you pay 6.2 percent of your paycheck to Social Security tax and 1.45 percent of your paycheck to Medicare tax. What you may not be aware of is that your company matches those amounts.
When you’re a small-business owner, you’re responsible for paying both the employee and employer portions of these taxes. That adds up to 15.3 percent and can be a huge shock if you weren’t expecting it.
“Be sure to speak to a tax professional about ways you can reduce it,” Allec says.
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3. Not Making Estimated Tax Payments
So now that you know you should be saving up to pay your taxes throughout the year, you need to make sure you understand when and how to pay the amounts you’re setting aside.
“The IRS and many states actually require most taxpayers to pay their taxes quarterly. If you don’t, you may be subject to an estimated tax penalty,” Allec says.
With the exception of corporations, many small businesses will pay the tax owed through their individual taxes. Quarterly estimated tax payments for individual taxpayers aren’t due on an intuitive schedule. Instead, they’re due on April 15, June 15, September 15, and January 15 of each year.
Talk to an accountant or use the IRS website to figure out how much you should pay for each quarterly payment.
4. Not Keeping Personal and Business Finances Separate
Depending on your business type, you may be required to keep your personal and business finances separate. If you don’t, you could give up liability protections certain business structures offer. However, even if you aren’t required to keep your personal and business finances separate, doing so will make your life much easier.
“Not separating your personal and business finances is asking for a bookkeeping and tax disaster,” Allec says.
“When it comes time to prepare your company’s books and financials — either for your own use or that of third parties — you will have to go through all of your bank accounts to determine which expenses were personal and which were business,” he continues. That could easily take many hours of tedious work.
An easy way to avoid this is to have separate bank accounts and credit cards. Have one set for your personal finances and use those only for personal purchase. Then, open another set for business purchases. Never mix the two.
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5. Missing Deductions You Didn’t Know About
Tax law can be super confusing, especially if you aren’t an expert. If you’re filing your small-business taxes yourself, it’s easy to miss deductions you didn’t even know you could take, particularly if it’s your first time going through the process.
“Some deductions — such as depreciation — aren't always so easy to calculate,” Allec says. If you don’t maintain good bookkeeping records, you may miss legitimate deductions you’re entitled to take. So how can you avoid these issues?
First, a good bookkeeper can make sure you're properly keeping track of and classifying all of your expenses. Of course, you must make sure the bookkeeper gets all of your transaction data, including receipts for cash purchases, for this to happen. When it comes to tax deductions you don’t know about, “you may want to work with a tax professional to make sure you're taking all the deductions that you are entitled to,” Allec says.
6. Choosing the Wrong Business Type
Did you know the type of business you choose could have a major impact on how much you pay in taxes? Recent tax law changes have made this an even more important choice due to new lower corporate tax rates and the pass-through tax deduction.
“Many small-business owners erroneously believe that they have to set up a corporation to legitimize their business,” Allec says. “This is not so and could have adverse tax consequences.” Talk with an attorney and accountant about your business to figure out which business structure is best for your particular situation.
7. Not Properly Classifying Employees vs. Contractors
If you hire others to help you with your business, you might bring them on as employees or hire them as contractors.
But did you know you can’t just choose whichever worker classification works best for you?
While you don’t have to pay benefits, withhold taxes, or pay the business side of Social Security or Medicare taxes for contractors, you can’t simply call someone a contractor that should be an employee.
There are many complex rules, including rulings in court cases, that determine whether a particular individual should be classified as a contractor or an employee.
“Generally, the more control over how or when someone performs services for you, the more likely it is you will have to classify them as an employee. And if you incorrectly classify someone who performs services for your business, this could result in significant penalties for your business,” Allec says.
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8. Not Hiring Tax or Bookkeeping Help
We’ve already alluded to this mistake several times, but not hiring tax or bookkeeping help when you really need it could cause a tax nightmare for your small business, especially if you're filing for the first time. If you have a tax and accounting background, you may be okay to do this work yourself until you have enough business income to outsource these tasks.
Unfortunately, if you don’t have the knowledge, you’re going to need to either educate yourself quickly or find a way to budget for tax and bookkeeping help for your small business to avoid these and other potential tax mistakes small businesses make.
Filing Small-Business Taxes for the First Time: Take Action
Now that you’re aware of these tax mistakes, take action to make sure you’re not making them. If it’s too overwhelming, hire a capable and knowledgeable bookkeeper or accountant who can advise you on filing small-business taxes for the first time and potentially take care of these issues for you.