As a tax professional, part of the value you provide to clients involves anticipating roadblocks before they appear, come tax time, and offering guidance on how to navigate. For your small business clients, these potential tax mistakes could have a significant impact on your client’s business.
Here are five common tax mistakes small businesses make, and how to advise your clients on how to avoid them:
#1: Improperly Classifying Workers as Independent Contractors Versus Employees
It may be tempting for a client to want to classify an employee as an independent contractor because of the cost savings. However, there are strict rules around the proper classification of a worker, and steep penalties and interest for failing to apply the law correctly.
Refer to this article to help your client distinguish between the two.
#2: Mixing Business and Personal Accounts and Expenses
While your clients might think it’s easier to just put all their business and personal expenses into one bucket, it’s best to advise them against this. While having separate bank and credit accounts isn’t strictly required, doing so will not only make tax time easier for you and your client, but also ensure much more accurate bookkeeping and financial reporting overall. If the personal and business accounts are “commingled,” deductible business expenses can be missed, and income can often be missed and end up unreported.
#3: Overstating Business Expenses or Missing out on Valid Deductions
One way to quickly get the IRS’ attention is to have expenses that either exceed the business’ income over several years, or have certain types of expenses that are outside of common percentage thresholds. Whatever the deductions are, the IRS computers are good at looking at what similar small businesses in an industry type spend on similar expenses.
Schedule C small businesses often have the most challenges when it comes to business expenses, since many items may be partially used for business purpose and personal use (mixed-use assets). On the other hand, there are many deductible expenses that the IRS defines as “ordinary and necessary” as part of running a small business – just make sure your clients keep the receipts.
For most small businesses, operating expenses are deductible in the year they are incurred. However, capital expenses, such as the cost of purchasing vehicles, buildings and long-life manufacturing equipment, can be depreciated over several years.
#4: The Business Can’t Pay off its Taxes
It’s not uncommon for a business to fall several months behind on taxes, and even longer, to catch up and pay off all the fines and penalties they’ve accrued. The IRS usually adds a penalty of 0.5 percent to 1 percent per month to an income tax bill that’s not paid on time. The IRS computer automatically tacks on this penalty whenever you file a return but don’t pay the full amount owed (or when you pay late).
If your client has a history of not being able to pay taxes on time, advise them to create a separate bank account for taxes. As they generate revenue, they can automatically set aside what they will have to pay in taxes, so those funds will be available when tax day arrives.
#5: Not Properly Deducting Startup Costs
This is an area that can often give new small businesses trouble when it comes to taxes because many small businesses assume they can deduct all of their costs in starting a new business, but they cannot do so until they have their first sale.
Expenses for your client’s business incurred before the first sale are considered startup costs (e.g. buying computers and equipment, and renting office space). These costs cannot be deducted until the first sale, and are then deducted over 15 years.
However, your client can elect to deduct the first $5,000 in the first year of their business for startup costs, and another $5,000 in organizational costs (e.g. costs for setting up their business as a corporation, legal fees, etc.); however, they can only deduct these if the total startup costs were $50,000 or less. If the costs were over $55,000, your client won’t get that initial $5,000 deduction at all.