1. Not Paying Your Quarterly Taxes
Businesses, including self-employed sole proprietors, are required to pay taxes on a quarterly basis. During your business’ first year, you get a free pass, and there are certain other exceptions based on how much you make. However, even if you’re not required by the IRS to pay quarterly taxes, it’s still good practice — waiting to pay a year’s worth of taxes in one lump sum can give you quite a shock.
The best way to stay on top of your quarterly tax obligation is to get into the practice of automatically setting aside a percentage of each payment or revenue. Then, take stock of your profit/loss statement at each quarter and pay your quarterly bill accordingly. A financial advisor can help you estimate these payments if you need some help.
2. Not Keeping Track of All Your Expenses
Your biggest mistake is not keeping track of these expenses throughout the year and trying to gather every receipt when it’s time to file.
Your biggest mistake is not keeping track of these expenses throughout the year and trying to gather every receipt when it’s time to file. The bottom line is you can’t deduct what you can’t document, and failing to record as you go most likely means you’re forgetting expenses and leaving money on the table.
Find a method for documenting expenses that works for you. There are dedicated apps such asExpensify for tracking expenses, Milebug for recording mileage, or Shoeboxed for capturing paper receipts. In addition, an accounting program, such as Mint, QuickBooks orFreshBooks will let you record and manage expenses.
3. Not Taking the Home Office Deduction
Many startups, small businesses and other work-at-homers get discouraged from taking the home office tax deduction, because it has traditionally been considered a red flag for getting audited. However, if you are legitimately entitled to the deduction, there’s really no reason not to take it.
To qualify, your home office needs to be used exclusively for business purposes. This could be a dedicated room or part of a room in your house. But holding a meeting at your dining room table or working from your living room couch won’t entitle you to the deduction.
If you do qualify, you can write off a percentage of your home expenses including rent/ or mortgage payments, utilities and insurance costs. You can read more about it in IRS Form 8829.
4. Mixing Equipment and Supplies
Both first-time and experienced business filers get tripped up by which expenses are considered equipment vs. supplies. Supplies include things that you use during the year (e.g. printer paper, pens, toner cartridges). Equipment (i.e. capital expenditures) are typically higher-value items that will last significantly longer than one year. For example, a new computer, server and office chairs are examples of equipment.
When it comes to equipment, there are a couple of approaches: You can write off a portion for each year the appliances are in use, or write off the full amount — there’s a max limit here — for the year you purchased it. So, if you bought a few new laptops for the business in 2013, you can write off the full price with your 2013 return — but you’ve got to report these purchases as a capital expenditure by filing Form 4562.
If you mistakenly deduct your equipment or capital items as supplies, the IRS could determine that you improperly characterized the expense and that you’re not entitled to the deduction.
5. Not Sending 1099s
If you’ve paid any freelancers, contractors, attorneys or other individuals more than $600 throughout the year, you’re required to issue 1099-MISC forms to both the individual and the IRS. You’ll need to send a copy to the individual by Jan. 31 and to the IRS by Feb. 28 (or March 31 if you’re filing electronically). You typically don’t need to issue a form if you’ve paid a corporation.
If you don’t file on time, you can expect up to a $250 penalty for each form you needed to send. You can check out IRS Form 1099-MISC for more details on which types of payments require a 1099.
6. Over-Deducting Your Gifts
Maybe you gave your clients holiday presents, or sent a colleague a thank you gift in appreciation for a valuable referral or piece of advice. Business gifts can be deducted, but there’s a big catch. You can only deduct the first $25 given per recipient as an expense. So, if you sent Jack a $150 gift basket, you can only deduct $25 for it.
If you end up reporting $3,000 in deductible business gifts for the year, make sure you can back that up. It means you gave out gifts to at least 120 different people. You can read more about deductible gifts here.
7. Choosing the Wrong Legal Entity
Your startup’s legal structure affects how you report your taxes and how much you pay, so it’s important to choose the right entity. For example, many start out as a sole proprietor or partnership, then find themselves paying too much in self-employment taxes. Creating a C Corporation, S Corporation or LLC that is taxed like an S Corp could help lower their tax bill.
A quick discussion with a tax advisor or CPA can help you figure out which structure is right for your situation.
8. Mixing Personal and Business
New startup founders and small business owners often invest so much of their time and money in the company that their personal and business finances become indistinguishable. This practice can lead to major confusion come tax time, and in some cases, can lead to legal infractions or loss of company status (Any corporation or LLC is required by law to maintain separate financial records and accounts.) Avoid trouble by establishing a company financial account from the start and maintaining separate records for the business.
Above all, any startup or small business owner must think of taxes as a year-long obligation, not just something to revisit once a year.
Are there any lessons you’ve learned the hard way with your business? Tell us in the comments.