Starting a new company or business can often be a bit of a mad dash. So many things. So little time. It can be easy to overlook some of the basic responsibilities of a business when wearing so many hats as an owner. Accounting is far too often one of those things that gets overlooked.
The result can be missed earnings, tax penalties, and worse. There are a few usual suspects when it comes to the big tax mistakes for small businesses and startups. Here is how to avoid them:
Plan appropriately for quarterly taxes
It is not a requirement to pay your taxes on a quarterly basis during your first year of operation as a business. However, it is a good practice nonetheless as businesses are required to pay taxes quarterly thereafter. That includes self-employed individuals and sole-proprietors. Startups frequently make the mistake of waiting until the end of their first year to pay taxes. It can be quite a shock to see that tax bill and have to come up with the payment all at once.
Talk to an accountant about good strategies for planning ahead for that first tax bill, so that you don’t have to dig yourself out of a hole later. This may be as simple as setting aside a percentage of each payment you receive or creating regular profit and loss statements in order to carve out the appropriate cash reserve well in advance of the time it is due.
Keep track of all of your expenses
It costs money to make money. Most business owners understand this. Too many business owners forget that the IRS understands this too. All “ordinary and necessary” business expenses are able to be deducted from your income as long as there are sufficient records of the expenses.
That last part is a very important one. Don’t make the mistake of forgetting to document these expenses throughout the year. Scrambling to find and identify receipts later is much more trouble than simply filing away when they are fresh in your pocket. You can’t deduct what you cannot provide records of, so it is well worth the time it takes to organize those documents when you obtain them. Otherwise, you may be paying for them again later.
There are countless programs and tools for helping to document expenses. Find one that works for you, or outsource this task. Salmon Sims Thomas offers virtual accounting and Quickbooks services to small, medium and large businesses.
Send out 1099s
Independent contractors such as freelancers and any other individuals that you pay more than $600 throughout the year must be issued 1099-MISC forms. These forms must be sent to the contractor by January 31st and then submitted to the IRS by February 28th or March 31st depending on whether you file electronically or not. Failing to meet these deadlines can warrant a penalty of as much as $250 for each form that was supposed to be submitted.
Usually, you do not need to issue these forms to corporations. So, be sure to consult your accountant on the legal status of contractors hired to perform work. Visit the IRS website to learn more about IRS Form 1099-MISC requirements.
Use the Home Office Deduction… Appropriately.
The internet has provided the ability to conduct business from home in a way that was never before possible. As a result, more businesses are run out of home offices than ever before. However, that does not mean you get to deduct your entire mortgage as a business expense.
People frequently do not apply the Home Office Deduction appropriately, which has been well documented as a red flag for IRS auditors. That is not to say avoid claiming the deduction. You are entitled to deduct every cent spent or percentage of the house used for the operation the business. Not to do so would be a mistake. However, be sure to ask your accountant about how to identify exactly what part of the house is dedicated to the operation of the business and how to address it.
If you do qualify, you can write off a percentage of your home expenses including rent/or mortgage payments, utilities maintenance and insurance costs. You can read more about it in IRS Form 8829.
Know the difference between equipment and supplies.
Even experienced businesses often mix up equipment expenses and supplies expenses.
The IRS takes the discrepancy between the two seriously. If they believe you have improperly characterized an expense that should have fallen into another category, you may not be entitled to the deduction.
An easy way to remember the difference between supplies and equipment is asking whether the item “ran out” or was “worn out.” Supplies such as paper, ink, pens, and notepads have run out when there are none left. Equipment on the other hand, are typically items of greater value and duration of use. These items would generally continue to be used until broken or worn out, such as furniture, computers, or technical devices.
Equipment on the other hand, are typically items of greater value and duration of use. These items would generally continue to be used until broken or worn out, such as furniture, computers, or technical devices.
Equipment can be deducted as a portion for each year the item is in use, or all at once at the time of purchase in the full amount with respect to maximum limits that are set. See Form 4562 for more information about capital expenditures of equipment.
Don’t overstate or over deduct your gifts.
Providing gifts through the business is a good practice for business development as well as client and employee appreciation and retention. However, it’s easy to get carried away when under the mindset that it is on the business’ dime.
Only the first $25 of any and all gifts given to any one recipient is deductible. That means that if you provide $25 gift card to someone separately for both their birthday and Christmas, only one of those can be deducted. It also means that if you gift someone with a $250 framed portrait of themselves, only a 10th of the masterpiece is actually deductible.
So, it is important to be mindful that your total expenditure of gifts for the year when divided by 25 should at most equal the amount of people who you can prove you gave a gift to.
Read more about deductible gifts here.
Know the difference between personal and business.
Confusing personal finances and business finances can be very easy for small business owners and startups, as so much of the two overlap. However, it can also be one of the biggest mistakes a business owner can make in accounting. Mismanagement of the two so that they become undistinguishable carries a host of risks and penalties. Business owners should have close and open relationships with both an accountant and a banker in order to create processes and protocols for how their finances are appropriately defined and distinguished.
Above all, take your time and pay attention to detail. This is not an area of business that you can afford to lose focus. The accountants at Salmon Sims Thomas will get you started on the right foot. Contact us if you have any questions. Also, please contact us if you would like more information about our tax or virtual accounting & advisory solutions.