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3 Biggest Tax Mistakes Small Businesses Make and How to Avoid Them

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January 27, 2020

Working with hundreds of small business owners over the years had yielded hundreds of different business situations, stories, and challenges. Every business is different, every business owner has taken a different path to get where they are today and the solutions we offer to small businesses can look different every day as well depending on the business’s needs. This is one thing we absolutely love about what we do here at Steadfast! We love a good challenge, we love to crunch numbers until we’ve finally solved a mystery and we absolutely love aligning businesses to a point that they are set up just as they should be so that tax time is not a nightmare for their business. 

 

As we work with each and every client, there are some common mistakes that we see over and over again. Today, I want to list these out for you and then also provide some guidance on how you can avoid them. If you have made one of these mistakes, don’t beat yourself up! As a business owner, you wear many hats and you likely made decisions or chose a path based on the knowledge you had or something you read or heard somewhere else. That’s ok – none of these are detrimental to your business so be assured that it’s not the end of the world. Now is a great time to make changes and start moving in the right direction!

 

#1 – Becoming an S Corp before it’s actually beneficial for you

I can’t tell you how many business owners I’ve spoken to that either started their business as an S Corp from Day One or moved to an S Corp quickly or even are about to become an S Corp because they heard somewhere that it “saves so much money on taxes”. Seriously though, if I had $1 for every conversation I’ve had surrounding this topic, I’d probably be able to buy that dream vacation home on a beach somewhere! Whether you’ve talked to a CPA, read an article somewhere or talked to a friend who is a business owner as well, it seems that everyone has some piece of advice about becoming an S Corp. It seems a little cliche to call that out when here I am, giving you advice about becoming an S Corp BUT I’m confident that this is the best advice you’ll ever read/see/hear surrounding this topic. So when should you become an S Corp, you ask? Well, that is going to look different for every single person reading this post right now. It’s true! There is no magic number (sometimes you hear when you reach six figures in revenue, or when you reach $250k in revenue), there is no magic formula – there is no magic about it at all. It all boils down to not only your business and how it’s doing but also your personal finances as well. You see, as an S Corp owner, your profits from your business still pass through to your personal income. Yes, as an S Corp owner, you are also required to take a salary but that doesn’t mean that the rest of your profit just goes untaxed. No way! The moment you become an S Corp you are required to pay yourself an actual salary with taxes withheld each time. That means payroll software expense, payroll tax expense and probably a higher cost from your bookkeeper who will now be managing that payroll. Those are definitely some things to take into consideration. Not only that though, your profits still pass through to your personal income and while it’s true that you are taxed at a lower percentage on those profits then you are when you are a sole proprietor, you need to make sure it makes sense for your tax situation as a whole. How do you do that? Well, you need to consider your status – married or single? Do you have children? Do you have any other sources of income? All of those things will play a major part in determining if an S Corp is right for you. A single woman with no children running an online business generating $250k in annual revenue from her home in California is going to look a lot different than a married woman with two children running an online business generating $250k in annual revenue from her home in South Carolina, whose spouse also produces income. See where those two situations could produce completely different tax outcomes? That’s why you can’t just follow some magic number that says if THIS then THAT – it just doesn’t work that way. The best you can do is consult with a CPA who will do some tax planning for you and work with your specific scenarios to create a plan of when it makes sense for you to become an S Corp. Working with your specific numbers and situations is the only way to make this decision. 

 

#2 – Not paying estimated taxes or not saving for taxes at all

This is another scenario that we have seen over and over again. We start working with a client during tax season only to find they have large profits but not enough money in the bank to pay a tax bill and no estimated tax payments paid in. All of a sudden, they have a large tax bill and nothing but fear and anxiety trying to figure out how to pay it. Like I said at the beginning of this post – if that’s you, it’s ok. This is what CPA firms like ours are here for and we can come up with a plan to figure it out but then the best thing you can do moving forward is change your old habits and have a plan! As a business owner, you are not being taxed on your wages like a traditional worker is. Whether you are a sole proprietor taking only distributions or even if you are an S Corp taking a combination of salary and distributions – you have a tax liability that you are supposed to keep up with throughout the year.  Since your full income is not being taxed, the IRS requires you to make estimated tax payments each quarter. Some simple tax planning done by a CPA will tell you exactly what you need to pay in and when. You can also check out this recent post where we outline estimated tax due dates and provide some more insight on what they are and how to pay them. Trust me, you do not want to get behind on taxes owed to the IRS. It’s just not a fun feeling and it’s really hard to pull yourself out of sometimes. They do offer payment plans and are willing to work with you but it’s hard to dig out of a big debt while you are still trying to keep up with all of the normal business expenses plus pay timely estimated taxes for the current year. One thing you can do is open a savings account specifically for taxes and every time you receive income, simply make a transfer to that account that way the money is safe and sound until it’s time to make those tax payments.

 

#3 – Bad Recordkeeping

I’m going to break this one down into a couple of sub-mistakes because they are both very common mistakes we see and both really important so I don’t want you to miss these.

a.) Mixing Business and Personal Finances – this is not good for so many reasons but since we are talking specifically about taxes, I’ll focus on that area. Whether you are filing your taxes yourself or using a CPA, you are going to have a hard time distinguishing business vs. personal when they are all mixed together. Don’t put yourself in that nightmare of sorting through bank statements, receipts, etc trying to remember what was a business expense and what was personal. Plus, if you are ever audited, you are going to have a tough time proving to the IRS that half of your Target runs were personal and half were business. Keep it all separate and they will ever only see the business portion and not have anything to question. Even if you are a sole proprietor, I recommend opening a separate bank account, credit card, etc that you can use just for your business and keep them all separate. If you are not doing this yet, make it a goal to start in the next 30 days. It will change your business for the good.

b.) Not keeping track of income and expenses at all – huge mistake. How can you really capture all of your income and expenses if you aren’t tracking it anywhere? We’ve seen it before where records are just thrown together right before tax time or the famous “shoebox” of receipts gets brought up and it kind of makes me cringe just thinking about all of the stuff that is going to be missed. There is no way you can remember every single thing that happened over the last 12 months in your business. Sure, you have bank statements to look at but what about those times you had to use your personal card or cash for an expense? What about the times you got paid in cash from your customer and turned around paid some contractors with it? I don’t know about you, but there is no way I would remember that months and months later. And what about your mileage – how will you ever remember those trips to client meetings, networking events, etc?  Without good records, it’s likely that you are missing out on deductions which is so crazy! It’s easy to start – just start somewhere. Whether it’s excel, google docs or a software like Quickbooks Online, get started now and start tracking every little thing that happens in your business. 

 

BONUS – Missing Deductions

Not taking certain deductions that you are entitled to as a business owner is another big mistake we see. We recently wrote a post about the common deductions you can take so make sure to check out that post as well and be sure you are tracking all of those deductions. It would be silly to pay more in taxes than you have to!

 

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