Small businesses are usually so fixated on making money and keeping everything running smoothly all year long that keeping track of anything tax-related tends to wall at the wayside. However, making tax errors can have some major consequences, including not taking out enough tax deductions, having to pay a lot more money than what was accounted for, and maybe even having to deal with penalties. That’s why it’s vital to not ignore taxes and make sure you’re keeping up with them all year long and not scrambling to put everything together at the last minute.
Entrepreneur recommends using tax-filing software such as TurboTax or H&R Block because not only does it offer protection, it makes it easier to do taxes.
While this recommendation may be a no-brainer for the small business owner interested in avoiding headaches, it's applicable to even the tax-savviest entrepreneurs; it offers protection a small business owner may not be able to afford otherwise.
Platforms like TaxSlayer, TurboTax and H&R Block can help you prepare and file your tax return online while backing up that filing with accuracy and maximum-refund guarantees. Having a shield that ensures the accuracy of your return — and guaranteed reimbursement of any fees or penalties you've been charged — makes every other tax hurdle easier. I've personally used each one. I tend to prefer them in the order I've listed them.
Similarly, Inc. also mentions that it’s better to rely on the experts to do your taxes because it’s their job to help you sort things out and stay up to date on your finances.
This is something I cannot stress enough, and it can save you time, headaches, and–more importantly–money. Going to a CPA or other certified financial professional who is familiar with you, your finances, and your business goals is always an ace up your sleeve.
These people know the rules and are trained to keep themselves up to date. Getting some professional advice can only help.
Taxes are rarely a fun experience, or something that small-business owners and entrepreneurs look forward to, but that does not mean you should give them short shrift. You work hard for your money, and doubly hard for the money you earn through your entrepreneurial activities, so why not take advantage of all the options available?
Perhaps you’re thinking that your side business is just a hobby, but if you’re making money regularly and aren’t keeping track of everything you could get into some serious trouble. Magnify Money mentions and explains how the IRS takes several factors into consideration, which you should also keep in mind:
You know you’re in business to make money, but would the IRS agree? If your company is operating at a loss, the IRS could reclassify your business as a hobby, resulting in some serious tax consequences.
A business is allowed to offset taxable income with business expenses, but hobby expenses cannot be netted against hobby income. Instead, they are deducted as miscellaneous itemized deductions on Schedule A and limited to the amount of hobby income reported on Schedule C. This means a hobby business can never result in a net loss, and you may be prevented from deducting hobby expenses entirely if you don’t itemize deductions.
If you’ve been making money in your business for a while and just have one bad year, you don’t have to worry about the IRS reclassifying your business as a hobby. If you’ve been losing money for a while and especially if your business involves some element of personal pleasure or recreation (such as horse racing, filmmaking, or restoring old cars), you’ll want to make sure you’re treating your business like a business in case the IRS challenges your losses.
The IRS takes several factors into consideration:
Does the amount of time you put into the business suggest an intention of making a profit? Side projects are more likely to face scrutiny because you’re spending the majority of your time at another full-time job.
Do you depend on the income you receive from the business?
Were any losses beyond your control or occur in the startup phase? Losses due to poor management and overspending are less likely to hold up under examination.
Have you changed operation methods to improve profitability? Many business experience setbacks. If you learn from mistakes and try to correct your course, the IRS is more likely to agree that you have the intention of running a profitable business.
Do you have the knowledge and experience necessary to be successful in your field?
If you are concerned about an IRS challenge of your losses, there are a few steps you can take to treat your activity as a business:
Keep thorough business books and records.
Maintain separate business checking and credit accounts.
Obtain the proper business licenses, insurance, and certifications.
Develop and maintain a written business plan.
Document the hours spent working on your business, especially if it is a side project.
Now that we’ve established that it’s important to keep track of your finances how important it is to keep track of your money-making hobbies, you should also make sure you’re keeping good documentation of the money you’re making and spending. Don’t forget the expenses as well. Forbes summarizes this all below:
Part of being IRS-compliant is “The Money Habit.” It’s the 15 minutes a week you spend documenting your business-related transactions. Don’t make the mistake of putting off “the numbers” for later. Later won’t happen.
Here’s an example of putting “The Money Habit” to work. If you take your spouse, a client and his wife to a meal to discuss business, you can deduct 50% of the cost of the meal, but you need a copy of your receipt and information about what the meal was about, who it was with, what was discussed, etc. Are you going to remember what you discussed over dinner six months ago? Doubtful. So start a weekly “money habit.”
It’s also important to keep your accounts separate because otherwise things get all muddied up and it may be hard figuring out which cards your expenses are on and everything else. That’s why CEOWorld Magazine recommends making it a priority to keep business and personal accounts separate from one another.
If you want to make your taxes and accounting easier later on, make it a priority to keep your personal and business accounts totally separate from one another.
“This is a key piece of advice,” tax attorney Jessie Seaman says. “The business bank statements should be solely used for business expenses, and no personal charges or withdrawals should occur. If business and personal funds are commingled, the owner/shareholders/members could find themselves personally on the hook for business tax debts.”
With a rising number of free online checking accounts for small businesses and entrepreneurs, there’s no excuse for not opening up a separate account.
Yes, you should keep your accounts separate, but it’s also vital to document all that you’re spending. This includes when you pay out contractors. Keep it all logged and well documented so that it’s easier to get everything together for taxes when it’s that time.
Businesses that outsource specific jobs to contractors are required to file 1099-MISC form with the IRS when payments of $600 or more have been made to the contractor throughout the year. Dave Du Val, VP of Customer Advocacy at TaxAudit.com warns that “without proof of payment these amounts are unlikely to be allowed in an audit.” In addition, “if the required 1099-MISC forms are not issued, penalties are likely.”
The flipside to this is worker misclassification. While classifying an employee as 1099 can have advantages to the business owner, they should be classified as a W-2 employee if the worker is an actual employee with set hours. Failure to classify workers correctly can leave the business liable for past taxes and penalties.
Do you have an Employer Identification Number (EIN)? Accounting Today says that it’s important to have one and if you don’t you just make it a priority to get one soon.
Many businesses will need to apply for an Employer Identification Number, or Federal Tax ID Number, to identify themselves as a business entity in their interactions with the government – and not just new businesses: Those that have changed their ownership or structure often need to get a new EIN, too. The IRS aims to make it relatively easy to apply for them online.
According to Entrepreneur, forming the right type of corporation is also vital when you have a business. Perhaps you would benefit from forming an S Corp, as explained below:
Many entrepreneurs would benefit from forming an S Corporation or choosing S Corp taxation rules for their LLCs. For an S Corp, you set up a regular payroll and make monthly payments to the IRS, with significant tax advantages. “With an S Corp, you'll technically become an employee of the LLC,” Piper says, “and that salary will be subject to payroll taxes. But any company profits are subject only to income tax.” Depending on how much you pay yourself, you could save thousands each year.
Build your own Passive Income-Generating business in this new 10-day challenge!
Join us and participate to get the Tools, Training, and Support you need to produce predictable, passive income. It's easy!