Common Tax Pitfalls for the Small Business Owner
It is a challenge for a new business to get set up and begin to operate. For you to take that step, it takes a lot of work and a fair amount of smarts. Even if you are up and running, there is always the proverbial ‘wrench in the operation’ – decisions to make, problems to solve and bills to pay – the list goes on. And then you worry about making a mistake or worse – the ‘F’ word – failure!
According to statistics published by the Small Business Administration (SBA), about half of all employer establishments survive at least five years and a third survive ten years or more. This is a far cry from the previous long-held belief that 50 percent of businesses fail in the first year and 95 percent fail within five years.
Initially you will need help with all areas of developing and running your business. There are many ‘moving parts’ to running a business. Today, I want to address just one part: Common Tax Pitfalls.
What entity do you choose?
Sole proprietor, Limited Liability Company (LLC), Partnership or Corporation. Pitfalls of each exist.
A Sole Proprietor entity offers no protection between creditors and yourself.
One member Limited Liability Company (LLC) is not recognized by the IRS and is treated as sole proprietors. However 2 or more members are treated as a Partnership.
Corporations, which you can choose to be a C-Corp or an S-Corp, must file separate returns for the business and must maintain separate bank accounts for each. No co-mingling of funds.
Estimated Taxes
One headache you can expect to deal with is estimated taxes. They can be especially tricky if you're beginning your first year in business. These taxes are due quarterly, however, if your expectations are way off in the first quarter, you can recalculate what you owe in the next, but expect a penalty.
Underpaying Estimated Taxes
Many small business owners get hit with the estimated tax penalty. All self-employed individuals must estimate their income tax for the year and pay it in quarterly installments throughout the year. You must come pretty close to paying everything you will owe. Work with a tax professional on a regular basis to understand your estimated taxes to avoid underpayments and penalties.
Self-Employment Tax
Your estimated taxes are not just about income tax. You must calculate and include your self-employment tax as well. When you're an employee and you work for someone else, you and the employer each contribute half toward your Social Security and Medicare taxes each year. When you're self-employed, you don't have an employer to share the cost, so you must pay it all yourself. Many sole proprietors consider this extra tax quite a burden, and it's necessary to include it when estimating your quarterly payments.
Schedule C
Schedule C has a reputation for being a red flag for IRS audits, especially if there are losses or expenses not consistant with those in your industry. The "Profit or Loss From Business" form itemizes all income you took in during the year and all the business expenses you paid. It's a good idea to keep a meticulous record of all income you take in so you don't overlook anything, and to back up all your claimed business expenses with documented proof of what you paid.
These are just a few of the Common Tax Pitfalls, if you decide to hire a tax professional, make sure you are hiring one with a long standing reputation of honesty and transparency. That could help put you on a successful small business financial path.