Can you think of anything more American than starting your own business? Okay, probably a few things come to mind. But becoming an entrepreneur is definitely toward the top of the list.
However, an easy undertaking it is not. When you first start out, it’s easy to jump in head first and figure things out along the way. And even if you’re the type of person who likes to research and plan, nothing can quite prepare you for what you’ll face in those beginning seasons (and even years down the road).
That’s especially true when it comes to taxes. The American tax system is a complicated beast, and it becomes more complicated by business ownership. Winging it is never when you’re talking tax obligations, but it’s surprising how many people do that very thing in their first years.
You’re almost guaranteed to fall into tax traps that way. Business tax obligations can catch you off-guard and are more involved than you imagine them to be. And that makes it easy to incur big penalties and nose-pinching frustration later on down the road. (This is the point at which I usually find people walking through my door to get help.)
Now because I’m here to serve you, I want to highlight the three most common tax-related business problems I see business owners running into and get you some thoughts on how you can steer clear of that mess. And even if you’re not here, you can always share this with someone else just starting out.
Tax-Related Business Problem #1: Underpaying Uncle Sam
As a regular taxpayer, you take care of paying taxes once a year. Not true for most business owners. When you own a business, you’ll most likely need to plan to make Estimated Tax Payments every quarter, so you’ll need to have a good idea of how much you’ll owe the government in income tax and self-employment tax (a whopping 15.3%).
That first year it can be difficult to really know where things are at in your business, so making estimated payments can feel a bit like guesswork. If you overestimate, you’ll be fine (though you’d also be making an interest-free loan to the government). But underestimating and underpaying can mean a penalty of up to 20 percent! (Oof!) And of course, there’s always interest to pay as well.
The IRS cracks down on negligence and unreasonably careless reporting. And don’t fraud the IRS about what you’re bringing in either… that can mean even bigger fines down the road.
Sometimes new business owners, especially those picking up a side hustle without a lot of thought about the tax implications of being self-employed, can miss paying estimated taxes altogether, leading to penalties and accumulated interest for the whole year’s worth of income.
Those things add up, and there’s not a wide margin for error when you’re a new business owner.
Tax-Related Business Problem #2: How many deductions are too many?
While business ownership means more complicated taxes, it can also mean getting to take advantage of deductions that a regular taxpayer can’t. You can claim deductions that are an “ordinary and necessary” part of running your business, including phones, home office, travel, and entertainment – to name a few. But there are rules to doing so and not every expense in those areas can actually be deducted (see IRS Publication 535).
It’s amazing the things business owners try to claim as a deduction or claim incorrectly. (A jet ski as a work vehicle? Really?)
Now, something else a lot of new business owners miss is keeping detailed records of those business expenses. Because, if you’re gonna claim to Uncle Sam that you should get a deduction for an expense, you better have proof of it.
Claiming deductions erroneously or in too great of measure is an invitation for the IRS to slap you with an audit – and, again, this can mean penalties. Even if you have legitimate deductions, if they’re not proportionate to your income or to the claims of other businesses in your industry of similar size, you could find yourself in the IRS’s crosshairs.
Tax-Related Business Problem #3: Mixing business with pleasure
Books can get messy really quickly if you’re not separating out what constitutes a business expense. And if your books are messy, your taxes will be too.
For example, if you’re a sole proprietor and you decide to use one credit card for all expenses it can be extremely difficult to differentiate between legitimate business expenses and those of a personal nature. And that can pose a problem for claiming deductions. And, as I mentioned before, in the case of an audit as well.
Think about traveling for a business trip but stopping to visit family for a day or two. The parts of the trip that were for business (within certain parameters) can absolutely be deducted. The personal detour to see Aunt Susan and Uncle Joe, not so much. The IRS wants to see that anything you claim on your taxes as a business expense when you’re on a trip is actually in its entirety for your business.
Some proactive solutions for those tax-related business problems…
If you’ve found yourself in tax traps like these or you’re wanting to avoid them altogether, there are some simple solutions to keep your business on track:
- Keep business and personal finance things separate. Separate accounts and separate credit cards.
- Keep detailed records of all your business expenses and do it regularly.
- Organize your tax records to make all tax activity go more smoothly.
- Set aside money for taxes and do it monthly, placing them in their own account that you can pay directly from when payments are due.
- BONUS: Rely on a professional you can trust to help you think all this through and plan in advance for it all. (We know someone 😉 )
If you want that someone in your corner to help you get a handle on these things in your business, let’s talk:
We can help safeguard you from IRS trouble and be ready to help if you ever fall afoul of an audit. As a business owner, there’s a lot to face, so this is one area you’ll want to be well-equipped for.
Helping you succeed,
Emelia Mensa, CPA