If you are inclined to procrastinate until the end of the year or, even worse, until tax-filing season to worry about your taxes, you may be missing out on opportunities to reduce your tax and avoid certain penalties. The following are some events that can affect your tax return; you may need to take steps to mitigate their impact and avoid unpleasant surprises after it is too late to address them.
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We all make mistakes from time to time, whether it’s rolling through a stop sign, forgetting an anniversary or leaving the wallet at the gym. But some mistakes can be far more costly than others—especially when it involves Uncle Sam and your small business.
When you operate a small business, avoiding any costly penalties, fees and audits from the Internal Revenue Service (IRS) is crucial. Here are some of the most common small business tax mistakes and how to prevent them.
1. Failing to file and pay your taxes on timeDetermining the correct IRS tax form and your tax due date depends on your business structure. For example, if you run your business through an S corporation, you’ll likely need to fill out a Form 1120S for income taxes (due on March 15). With a sole proprietorship you’ll need to use a Form 1040C instead (due on April 15).
Forget to file and you’ll pay for it: The IRS imposes a 5% monthly charge for those who file late, up to the first five months following the return’s due date (up to a 25% maximum charge). Forget to pay your taxes, and it gets even worse: the IRS charges 6% interest a year on unpaid taxes, in addition to late payment penalties of .5% per month after the April 15 deadline.
The bottom line is you should both file and pay Uncle Sam on time to avoid costly penalties, so keep this in mind before tax season rolls around.
2. Forgetting about estimated tax paymentsSome businesses are required to make quarterly estimated tax payments during the year on income that is not subject to withholding. This includes money you earn from self-employment, interest, dividends and gains from the sale of assets.
If you are filing as a sole proprietor, a partner, an S corporation or a self-employed individual, you generally will have to make estimated tax payments if you expect to owe tax on $1,000 or more when you file, according to the IRS.
If you do not pay enough tax by the due date of each of the four quarterly payment periods, you’ll face a penalty unless you meet certain circumstances such as becoming disabled or having a similar reasonable cause for not making the payment.
You can figure out how much you’ll need to pay in estimated taxes with a Form 1040-ES worksheet. Since it’s a confusing issue for many small business owners, seeking professional help from an accountant or tax attorney can be a wise move.
3. Not taking business deductions—or taking excessive deductionsYou can potentially reduce your tax burden by taking several legal business deductions. The IRS says you can deduct all “ordinary and necessary” expenses you incur while operating your business.
For example, if your home is the principal place of your business, you may be able to deduct several business-related expenses. This might include rent, insurance, utilities, office supplies and real estate taxes. If you use your car primarily for work, you may be able to deduct expenses such as gas, mileage, oil changes, parking charges and insurance premiums.
The most common overlooked deductions by small businesses include depreciation (30%), which refers to the decrease in the value of assets over time due to wear and tear; out-of-pocket expenses (29%), such as the purchase of new equipment; and auto expenses (16%), according to a Xero survey.
On the other hand, taking excessive deductions or mixing personal and business deductions—like claiming a family vacation as a business expense—is not allowed and can lead to an audit, or worse, a federal tax fraud charge. Just look at reality TV star Mike “The Situation” Sorrentino, who was recently charged with failing to file a tax return and tax fraud for allegedly claiming fancy clothes and sports cars as business expenses, according to Forbes. Sorrentino, who appeared on MTV’s “Jersey Shore,” pleaded not guilty to the charge.
Be careful of what you decide to deduct, and ask your accountant or a tax attorney if you are unsure of anything.
4. Keeping poor recordsRecord keeping is one of the most important aspects of running a small business. With good records, you can properly deduct all business-related expenses, track and manage inventory, maintain and report employee payrolls, limit the potential for costly legal errors, keep a detailed record of your business so you can track its progress, and prepare accurate financial statements for the IRS.
Keeping good records is all about being organized. Don’t just rely on your memory. Instead, try to keep all of your receipts for every expense you incur in one place. This should include all business purchases, including office supplies, equipment, rent, gifts, advertising and travel expenses, as well as employee payroll information.
You can do this by keeping all business documents in a filing cabinet, documenting purchases by each month and year. Another option is an online accounting software program like QuickBooks, which can help you automate record keeping.
5. Misclassifying employees as contractorsSome small businesses may try to treat workers as independent contractors to save money, as payroll taxes are not due for contractors. However, this can end up costing you if the IRS disagrees with your assessment.
The IRS’ classification will depend on a number of factors, including whether or not you have control over the worker’s hours, what work is being done and how it will be done, and if the work performed is a key aspect of the business, according to the agency.
Mike McVay, Accountant - 850-725-5696 www.VirtualBookkeepersUSA.com
With the exception of the occasional James Bond movie that proves the rule, we don’t as a matter of course combine our modes of transportation into one all-purpose vehicle. But when it comes to financial management, there is one tool , commonly called the Budget, that gets applied to all problems involving dollar signs.
Before we get into the details of exactly how bad of an idea this actually is, a little structure would be beneficial, coming in the form of this three-tier hierarchy for financial management.
At the top level resides Strategy and the Forecast, or rather, Forecasts, plural, as the enterprise seeks to gain as much information, insight and foresight from as many sources and time horizons as possible, such as 60-day cash collection forecasts from account receivables, 90-day Ops forecasts from ERP, six-month sales forecasts from the field, 9-month staffing and expense forecasts from the functional departments, 1-year product launch forecasts from marketing, and 2-year industry outlooks from the analysts. Forecasting is also typically the primary focus of analytical techniques in the office of finance, with tools such as econometric, regression and trend analysis applied to avoid the gaming of the system, and to improve accuracy and confidence in both the forecast and the resulting decisions.
At the bottom is of course the Budget, the intended output of the whole process. Between these two levels lives the most neglected and under-resourced activity in finance – Planning. Too often we connect the budget directly to the forecast, resulting in reactive knee-jerk responses and half-way measures such as hiring, salary, capital and travel freezes that please no one, not even the CFO who issues them. Or, when the Budget gets too far out of line during the middle of the year, we confound the situation by substituting Variance-to-Budget with Variance-to-Forecast, which merely moves the game playing to a much more detrimental location - you do NOT want games being played with the forecast. Instead, you want the most accurate picture, the best guesses, put forward, unfiltered and unaffected by the current situation or year-end bonuses.
What should drive the Budgets are the Scenarios that result from the planning process; not just the Most-Likely Case, but also the Optimistic, Pessimistic, Best and Worst cases as well.
To drive this point further, consider these definitions that Steve Player shared with us at the recent ABM Smart conference in Charlotte, NC:
When it comes to the definition of the BUDGET, however, it gets a little messier. Here is just a partial list of what many organizations use the Budget for: Cash planning, Targets and incentives, Investments, Cost understanding, and Resource management. I will submit to you that the use of the Budget should be limited to just that last item – Resource management and allocation, and reallocation, and reallocation, as conditions change, which they always do, and not always in neat 12-month segments aligned with the Gregorian calendar.
The first usage you want to decouple from the Budget are targets and incentives. You cannot be an agile organization, reacting quickly to opportunities and challenges if in order to implement a revised budget you must also renegotiate the associated bonus schemes at all levels across the organization. Targets and incentives are best managed through the use of a Balance Scorecard, where they can be tied to inter-related key metrics and to external benchmarks such as growth and market share that better reflect the health and performance of the organization.
In the next case, investment decisions do not naturally reside comfortably at the level of the budget; they are most at home at the intersection of Strategy and Planning. And lastly, variances to Budget do nothing to improve your understanding of Costs, as they assume what remains to be proven – what SHOULD the costs be. For that you need an understanding of the processes and activities which consume the resources, and the ability to benchmark them with best-in-class players in your industry, capabilities provided by an activity-based management system. As for Cash, we all know that cash ends up being the “plug” that makes the balance-sheet balance, and that every organization relies on a more rigorous treasury process to assure adequate supplies of working capital.
So with the removal of targets, investments, costing and cash, you might ask, “So what’s the Budget for?” The answer: Resource Allocation. And re-allocation, and re-allocation, based on ready-to-hand prebuilt scenarios, complete with predetermined triggers and pre-negotiated revised targets. With that division of labor in place, between budgeting, planning and forecasting, you can react quickly to changing conditions, keep operational activities aligned with strategy, and maintain the integrity of your forecasting process. Leave the “all-in-one-size-fits-all” stuff to James Bond.
Mike McVay, Tax Accountant Blog
Certified QuickBooks ProAdvisor & Licensed Tax Accountant Pensacola, Fl
Mike McVay, Accountant -Experienced IRS Tax Resolution Specialist