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3 Mistakes to Avoid This Tax Season
Tax season is a stressful time of year for many individuals. Collecting documents, locating records, and researching tax laws and forms can be overwhelming and time-consuming. This stress and confusion is felt more acutely by the small business owner.
While individuals search out mortgage forms and tax history for the year on their own individual taxes, the small business owner must do his or her personal taxes and the taxes for their business. The tax job is literally double the work for the small business owner. Moreover, small business taxes are often more complex and require more detailed record-keeping than individual income tax returns.
The complexity of small business taxes can lead to errors or mistakes that may be costly to you or your small business.
Importance of Tax Season
Very few people look forward to doing their taxes. Taxes are a burdensome chore and can easily be put off into the procrastination bucket. However, the cost of avoiding or delaying taxes can be high which can add even more stress . Even accidentally forgetting to file taxes timely can leave individuals and small business owners open to fees and penalties that can quickly escalate.
Filling out tax forms improperly can be equally consequential. If you are not familiar with tax preparation, seek resources to help you or consider hiring a tax professional for assistance.
If you are comfortable with your own tax preparation and you are interested in learning how to file taxes timely and accurately, there are also online resources that can help you identify and avoid common tax filing errors.
Error 1: Underpaying Estimated Taxes
Individual filers and small business owners can both fall victim to underpaying the estimated taxes owed. An individual working for an employer has his or her income tax taken from their paychecks. If the individual underestimates these taxes by not paying enough into their income tax withholdings throughout the year, the individual may face an income tax bill owed at the end of the year when he or she files his or her tax return.
Similarly, small businesses should also be paying an estimated tax throughout the year. If your business owes more than $1,000 when the tax return is filed, you are required to pay an estimated tax. To estimate tax, you will need to calculate your business’ annual adjusted gross income, taxes, credits, and deductions. This calculation can usually be done by using the prior year’s information since much of the information remains relatively stable from year to year.
The IRS uses Form 1040-ES to help people calculate and pay estimated taxes. You can utilize the Electronic Federal Tax Payment System (EFTPS) to pay estimated taxes throughout the year. This system can let you pay estimated taxes throughout the year to avoid paying a large sum when filings are due.
One of the biggest errors you can avoid is underpaying these estimated taxes. Calculating the estimated tax properly and making timely payments can help avoid having to pay additional taxes when your small business tax return is filed.
Underpaying estimated taxes can also lead to a penalty. If you owe more than $1,000 at the time of filing and paid less than 90% of the total taxes due, you may face a penalty for underpaying estimated taxes. To avoid this error, complete the 1040-ES at the beginning of the year and pay the estimated taxes in smaller increments throughout the year to avoid owing taxes at the time of filing.
Error 2: Not Separating Personal and Business Taxes
The temptation to use personal credit cards and personal bank accounts for business expenses is common. It seems simple to use the personal bank account to help float the business at times, but mixing the personal account with the business account can lead to tax confusion.
An unclear distinction on a business tax filing can raise red flags that result in an audit. If the records are not kept carefully and separate from individual accounts, the business expense is unclear and difficult to explain.
An unclear line between personal and business finances leads to questionable validation of business expenses. This can lead tax reviewers to question the legitimacy of tax deductions. This can potentially lead to audits. If the record-keeping cannot clearly differentiate between a personal and business expense that you have attempted to write off as a deduction, this error could lead to penalties or fines from the IRS.
Be sure to keep your personal accounts separate and for personal use only. Even if you run a sole proprietor company, your small business record keeping will benefit from having a separate account, separate credit cards, and accurate bookkeeping records. This is because business expenses can be tax deductions.
If you are paying business expenses through a personal account, it is difficult to differentiate the expense from your own personal expenses, which are likely not tax-deductible.
Some examples of common business expenses include:
- Advertising
- Delivery charges
- Business-related subscriptions
- Employee benefit programs
- Insurance
- Interest paid
- Legal fees
- Licenses
- Office expenses
- Postage
- Wages paid to employees
- Supplies
- Travel
- Rent and utilities
These common business expenses, when paid from a personal account, can very easily be confused with personal expenses, which are not tax-deductible. Separating accounts is the most effective way to prevent tax confusion and unnecessary fees or penalties.
Error 3: Miscalculations or Incorrect Forms
Errors such as miscalculations or incorrect tax forms are another common mistake that occurs when filing taxes. Simple errors, such as using the wrong tax identification number or the wrong bank or routing number, can cause delays and lead to stressful situations. The misidentified tax identification number can lead the IRS to believe that your business did not file tax returns timely, which could lead to fines, penalties, and possible interest.
Leaving information blank where an entry is required can also lead to problems with your tax return filing. The easiest way to avoid these errors is to compare your filed tax return with the previous year’s filed return.
Miscalculations are also common and, unfortunately, cannot be avoided by copying from the prior year’s filed return. Keeping track of business expenses and receipts, and invoices can help when it is time to calculate deductions and income. Check and recheck the calculations to ensure you come to the same sum each time. If you find yourself struggling with the calculations of the tax forms, seek out the help of a professional tax preparer or a licensed CPA.
Tax forms for small businesses are dissimilar to individual tax forms. Just because you are successful at filing an individual tax return does not mean that business taxes will be as easy. Be sure to educate yourself on the essential tax forms for your small business. What forms you will need will depend on the type of forms you will need to complete.
The general five types of business taxes are:
- Federal Income Tax
- State Income Tax, (if applicable)
- Self-Employment Tax
- Employment, or Payroll Tax
- Sales, Use, and Excise Taxes
All businesses need to file annual federal income tax returns, and related State income tax returns. Most businesses should schedule estimated tax payments throughout the year to avoid tax penalties when those income tax returns are filed. If you have net earnings from self-employment related to your sole proprietorship or partnership you must also file Schedule SE, Self-Employment Tax, which is simply attached to your personal income tax return.
If you have employees working for your small business, you have a responsibility to pay employment taxes. Employment taxes include Social Security tax, Medicare tax, Federal income tax withholding, and Federal and State unemployment tax.
Sales and Excise taxes are owed if your small business sells or manufactures certain products, operates certain kinds of businesses, uses various kinds of equipment, facilities, or products, or receives payment for certain services. Sales and use tax returns may be required on a more frequent basis than the annual tax returns required for income tax.
To learn more about tax preparation, or to seek help or guidance on how to complete your small business taxes, contact the experts at NASE. NASE has CPAs and tax professionals with over 100 years of small business tax experience. Our professionals will be happy to answer any questions you have.