Business Taxes

It isn’t just individuals who must file taxes. Businesses must also pay income taxes by filing a tax return annually. Large corporations typically have an accounting department or outside service to prepare the required tax forms. A small business owner must either file their taxes on their own or hire a tax professional to prepare their taxes for them.

Because the tax code can be complicated, taxpayers make several common mistakes when paying business taxes. Learning about what they are in advance can help you avoid these common pitfalls with your business venture.

Eight Common Tax Mistakes That Businesses Make

The IRS tax code is lengthy and potentially confusing. Many taxpayers struggle with filing their own tax returns, let alone filing taxes for a business. Many of the common mistakes are easily avoidable with awareness and preparation.

1. Inadequate Record Keeping

The most common mistake entrepreneurs and business owners make is failing to keep adequate records. Many people do not know or realize that they need to keep records. Others know they should keep records but do not maintain adequate detail or accuracy. It isn’t until tax preparation that they find out they should have kept records. Correctly filling out tax forms is difficult to impossible when you don’t have records to reference.

Avoid the Mistake

To avoid this mistake, do not wait to keep records. Document financial activity and keep it separate from your personal finances. Save quotes, invoices, and receipts for anything you spend money on that is related to the business.

2. Selecting the Wrong Business Structure

When forming a new business, you will need to decide what type you want to form. There are several types, and not all will be appropriate for every entrepreneur. The type of business formation that you choose will depend on several factors, one of which will be state and federal tax liability.

• Sole proprietorship
• Partnership
• Limited liability company (LLC)
• Corporation (C-corp and S-corp)
• Cooperative
• Nonprofit corporation

Once you register your business, you will receive an ID number. You will use this number to pay your corporate income taxes. Even though a nonprofit corporation qualifies for a nonprofit- exemption, it must still file a tax return.

Avoid the Mistake

Taxpayers can avoid this mistake by doing the necessary research before they form their new business. Speaking with a tax professional or tax attorney can help you understand the potential consequences of each business formation type. Doing so before you form your business is crucial for avoiding unexpected tax liability. Changing a business formation type is also more difficult than choosing the correct one the first time.

3. Failing to Separate Personal and Business Taxes

Most people start their small businesses part-time or casually. At some point, their side hustle becomes a full-fledged business. However, they never change how they manage their finances. They continue to combine their personal finances with those of the business. When it comes time to file their tax return, they either incorrectly file or spend hours sorting through financial records.

Avoid the Mistake

To avoid this mistake, keep all side hustles and business activities separate from personal finances. Open a separate checking and savings account into which you put business income. Then, pay yourself from that account. You can then submit a separate electronic filing (e-file) for yourself and your fledgling business.

4. Not Understanding Deductibles and Credits

IRS tax credits and deductions help reduce total tax liability. However, taxpayers often fall into the trap of claiming the wrong ones or too much, resulting in lower tax liability than it should be. This may not be an issue right away. However, if the business gets audited, it can result in a significant tax bill.

Avoid the Mistake

To avoid this mistake, speak with a tax accountant before filing your taxes. They can review your records to determine what you qualify for and help you verify that you have adequate documentation for the deductions and credits you claim.

5. Falling Behind or Failing to Pay Estimated Taxes

Businesses and self-employed individuals must pay quarterly estimated taxes. The IRS publishes these due dates for the following year annually. If they fail to make this tax payment, penalties will be added to their total tax payment due for the tax year. They may discover they owe more than they can afford by the due date. Falling behind on paying owed taxes will increase the IRS’s tax debt and collection activities.

Avoid the Mistake

Businesses and self-employed individuals must take a proactive approach to paying their tax debt. This means making quarterly estimated payments based on the income generated for that quarter. It could also mean accounting for the self-employment tax to ensure the quarterly payments are enough to cover tax liability.

If a business falls behind on paying its taxes, requesting a payment plan is a must. This will ensure the business can pay its tax debt without continuing to accrue interest and penalties.

6. Improper Employment Tax Payment

Once a business begins hiring employees, there are an additional set of laws and tax regulations that must be followed. One of the most common mistakes made is misclassifying workers. Doing so will result in labor law violations and potential additional taxes owed. “The number one snafu that people get themselves into has to do with something called employment taxes,” says David C. Gair, a tax attorney at Locke Lord LLP in Dallas, Texas.

Employees require a business to pay a withholding tax from the employee’s paycheck. This isn’t a requirement for independent contractors. In addition, new business owners often do not realize or neglect to pay employment tax. This is the money withheld from an employee’s paycheck. Unlike income taxes, employment taxes must be paid quarterly. Not paying this tax can but the business and the individual in significant trouble with the IRS.

Avoid the Mistake

To avoid misclassifying workers, speak with a tax professional or tax attorney. These professionals know the law and can help determine your workers’ qualifications. You must pay withholding tax, Social Security, and Medicare taxes if they are employees.

Gair explains how a business owner can avoid further tax issues when they neglect to pay their employment taxes. “The first thing they should do is make sure that they’re paying the current employment taxes so the problem is frozen and not getting worse. Then you want to go back and get into a payment plan with the IRS. You also want to make sure that you pay what’s called the Trust Fund portion of the taxes. That’s the portion that the government can go after people individually for if they don’t pay it”

7. Overlooking Taxes

Depending on the state in which your business is formed and operating, you may have to pay additional taxes. Small business owners can easily overlook city, county, and state taxes, which can result in a surprise tax bill.

Another common overlooking tax mistake is when someone closes a business. You may still need to pay taxes despite the business being no longer in operation.

Avoid the Mistake

Research potential applicable taxes in the state, county, and city where you operate your business. Talking with a tax professional can assist with this. There may be applicable taxes that you are not aware of. Each state has a department of revenue that oversees the enforcement of taxes in its respective state. For example, you may have to pay a property tax if your business owns real estate. You may have to pay sales tax if your business sells goods or services. You might have to pay a use tax for items that you bring in from another state. You may have to pay an excise tax if you are importing goods.

8. Ignoring Tax Law Changes

The tax law code changes from year to year. What you know now may or may not be correct one, three, or five years from now. Business owners make the mistake of learning the laws once and never looking into them again. Without staying current on the law, they can easily file their business taxes incorrectly.

Avoid the Mistake

To avoid this mistake, make it a priority to review any changes to the tax law. You could do this annually before filing your taxes. That way, the new tax information is fresh in your mind. It is also smart to work with a tax accountant and tax attorney. Their profession requires them to stay up to date on the law.

Tax Issues in Entity Formation and Restructuring

Choosing the correct business formation type is important when starting a business. This legal structure will govern several aspects of the business, including taxes. Once you decide on a particular type, develop a financial and tax management strategy. That way, you have the adequate amount set aside for when your taxes come due. This is a much simpler approach than changing your business type later.

Benefits of Working with a Business Tax Lawyer

Working with a tax attorney can provide a valuable resource to help you avoid these common mistakes. By working with an attorney, you have attorney-client privilege that protects your communications. Your attorney can provide legal guidance during planning and strategy formation. They can assist with identifying potential risks and liabilities and creating an action plan to avoid them. Should you be subject to an IRS audit or other action, you already have an attorney familiar with your business who can represent you during the audit or in tax court.

Find an Experienced Business Tax Attorney

Understanding potential tax liability is crucial if you have already formed your business or are planning to open a business. Knowing your potential tax liability will help you plan for your annual tax debt. This financial responsibility will help you pay your business taxes and make your business a success.

Visit the Super Lawyers directory to begin your search for an experienced tax attorney. For more information, read our guides on tax law.