Small business tax issues: 4 common pitfalls to avoid
No one said being a small business owner was going to be easy, but managing business tax can sometimes feel like you’re entering a quagmire. In fact, many entrepreneurs find themselves trying to hack blindly through the process. A survey from CNBC revealed nearly a quarter of small business owners didn’t know their effective tax rate — a problem further muddied by a slate of ever-changing tax laws.
Unfortunately, missteps in the tax process can lead them to trouble. ComplYant is here to show you how to stay above ground. Learn the four most common pitfalls small business owners face along their business tax journey.
Pitfall #1 - Failing to File
By now, you know that filing tax returns for your business is required each year — but that doesn’t make it any less daunting. It’s not uncommon for some business owners to avoid filing altogether, whether it’s because they fear a high balance or because navigating the process simply feels too overwhelming.
However, filing is absolutely critical to maintaining the integrity of your business. Failing to file your business taxes can lead to severe penalties, including a 25% failure-to-file penalty for tax bills that are more than four months late. Taking action early can help you avoid penalties, and there are options, such as payment plans, that can help you manage large tax bills.
In addition to your annual tax return, you’ll need to also file quarterly estimated tax payments. Not only will these payments help to reduce the amount you owe when you file your tax return — you might even qualify for a refund — but it will also keep you in compliance with tax law.
If you expect to make at least $1,000 and you don’t withhold taxes from your paycheck like a traditional W-2 employee, the IRS expects you to make quarterly estimated tax payments.
Failing to file your business taxes can lead to severe penalties.
Pitfall #2 - Inaccurate Reporting
To manage your business effectively and comply with tax law, you need to maintain clear, detailed bookkeeping. This is especially true for businesses that are cash-based or take cash payments.
Be sure to file 1099 forms to substantiate income, and account for all income, even if it’s not reported on a 1099 form. If your business is ever audited, the IRS will probably start with reviewing your income for any potential income that wasn’t reported. Correctly filing forms, keeping organized paperwork, and maintaining detailed ledgers can help you prove that you’ve reported all income.
Organized, itemized, and detailed bookkeeping can help you manage and correctly report deductions. IRS rules regarding business and personal expenses can be complex, and generalized write-offs are sometimes flagged as suspicious. If you can’t provide specific details about phone use, home office, or business travel expenses to justify these costs, you may not be seen as eligible for otherwise valid deductibles.
Pitfall #3 - Mismanaging Self-Employment Tax
While the need to pay taxes such as income tax and sales tax may seem obvious to small business owners, other taxes may be lesser-known. For example, in addition to income tax, you will also be responsible for an additional 15.3% in self-employment tax, which is applied to your net self-employment income.
Traditionally, W-2 employees share the burden of a Social Security tax and Medicare tax with their employers. This means that the employee is only responsible for half of this burden, which works out to 7.65%. Because small business owners are self-employed, they are responsible for the full 15.3%.
Paying at a rate of 15.3%, however, only applies up to a net annual income of $147,000. Income above this threshold may be subject to a different rate, depending upon your circumstances. Fortunately, tax budgeting tools can help you plan ahead and make accurate on-time payments so you can avoid a large taxes-due bill when you file your annual return.
Pitfall #4 - Misclassifying Independent Contractors or Employees
Classifying the people you work with is affected by a variety of factors. While it may be tempting to label all of the people who work for your company as independent contractors, to avoid sharing the burden of Social Security and Medicare tax. However, the IRS has regulations that govern who can qualify as a contractor and who must be considered an employee.
The risk of misclassifying your partners can vary. For example, if you misclassify an independent contractor as an employee, you’ll withhold payroll and income taxes unnecessarily but these can be refunded. However, if you classify an employee as an independent contractor, despite them not meeting the criteria to be considered a contractor, you could be found guilty of tax fraud, even if the misclassification was inadvertent.
If your tax remittance is lower than expected and you’re audited, the Employee Development Department can examine the classification of employees and independent contractors within your business. You could face additional penalties if you have people on your staff who have been misclassified.
Be aware, also, that states may have separate laws regarding independent contractors and who can be classified as one. You’ll also want to correctly price goods to account for not withholding payroll taxes. If you fail to do so, you may end up with a larger tax liability when you file your annual return.
Get ahead of tax season
Each year, you’ll need to look for changes in tax law that may impact your business. For example, in 2022, the second half of an employer's Social Security tax deferments are due and will need to be accounted for when you file in 2023.
Other regulations for the year affect employee retention tax credits, net operating rules, and excess business-loss limitation rules. Changes were also applied to interest expense limitation rules and charitable contributions.
Staying up-to-date on tax laws and regulations can seem daunting, but you don’t have to adventure alone. Our tax tools and resources have helped thousands of small business owners plan ahead and stress less about business tax.