Many small business owners are confused about the US tax code. That’s understandable as most people are generally lost when it comes to taxes. In fact, the US tax code has 75,000+ pages of rules and regulations. On top of that, the Trump administration changed many tax rules like limiting state taxes and mortgage interest deductions.
While taxes might seem difficult, there are a few small business tax mistakes that you can avoid. Some of these small business tax mistakes include making late/minimal payments, not recording business mileage, misclassifying employees vs. contractors, and not separating personal vs. business expenses.
1. Late/insufficient payments
The tax code is very different when it comes to the “Self-Employed” vs. “Employee.”
- “Employee:” Most employees get paid on a bi-weekly or semi-monthly basis and their employer withholds all necessary taxes out of every check.
- Employees generally have fewer deductions than the Self Employed.
- Employees don’t have to make quarterly payments, unlike the self-employed. The only exception is high earning employees that receive large bonuses and employer stock.
- Employees only pay half of the 15% tax with the employer paying the other half. This tax funds Medicare, Social Security and is also known as FICA or payroll tax.
- “Self-employed:” Conversely, self-employed people don’t have an employer and are responsible for withholding their own taxes. The US tax code is a “pay-as-you-go” system, which means that you must pay taxes in quarterly installments, also known as estimated tax payments.
- Self Employed people have more responsibility as they have to organize their own books. They also have more deductions available to them.
- They have to pay the entire 15% FICA tax. They do receive an adjustment of half of the FICA tax, or self-employment tax, on their tax returns.
- They also must pay quarterly taxes on all income.
Self-employed people must pay the federal and state governments each quarter, or be subject to penalties. Conversely, employees generally don’t have to worry about this as the employer withholds their taxes for them. The only exception is highly compensated employees that receive large bonuses and stock payments. In this case, they would likely have to pay estimated payments. They also have to pay the correct amount each quarter or risk being subject to under-withholding penalties. These might seem small but can compound over time, which results in a larger tax bill. You might be asking yourself, “How can I prevent small business tax mistakes like under-withholding and late payments?
Check out these simple methods:
- Use tax software like the Bloomberg Income Tax Planner to calculate estimated payments. This planner helps estimate payments and avoid any penalties.
- Be sure to withhold or pay at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller. This is also known as the safe harbor and will determine the amount of (if any) estimated taxes due.
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2. Not recording business mileage
One of the most commonly overlooked small business tax mistakes is not recording business mileage. For example, some small business owners like real estate agents frequently drive for business purposes. This includes driving buyers around the neighborhood to show them open houses. There are some other ways small businesses can deduct miles especially if they travel for medical, moving or charitable purposes.
- 58.5 cents per mile (Jan thru June) and 62.5 cents per mile (July thru December) for business miles driven
- 20 cents per mile (Jan thru June) and 22 cents per mile (July thru December) driven for medical or moving purposes
- 14 cents per mile driven in service of charitable organizations
These might not seem significant but makes a difference if you frequently travel for work. You can also deduct driving fees like tolls, parking fees, and more if you can prove they were business related. It’s tempting to declare that each mile or traveling expense that you incur is business related. Yet, this wouldn’t be wise as this could lead to a high audit risk.
To prevent small business tax mistakes, it could be prudent to use an app like Mile IQ. Mile IQ is a new platform that allows you to accurately calculate business miles. It can also segregate miles based on purpose as well as create weekly reports. Mile IQ can take the stress out of calculating this tax reduction and make tax time more streamlined without clunky spreadsheets.
Besides using an app like Mile IQ, you should also know when miles can be classified for business vs. personal reasons.
Here are a few business mileage scenarios:
- Traveling between client appointments.
- Getting supplies related to your business. For example, going to the arts and crafts store if your business is arts-related.
- Temporary job site trips, where you expect to conduct business functions for a year or less.
- Driving to and from the airport for business travel.
- Traveling between business meals or entertainment. On a related note, be sure to record receipts from all business meals as you can write off 50% of each one. Also, you could deduct up to 50% of business entertainment expenses, but this was eliminated during the Trump administration’s tax reform.
It’s very important to realize what you can’t include as business miles, which include the first and last trips to your work location. The IRS considers work commutes from your place of residence as a personal choice, which is why it’s not deductible. One simple way to work around this rule is to have a qualifying home office. A qualifying home office can help you uncover business miles, but be sure to follow home office rules to the letter. Having a home office can put you at a higher risk of being audited.
3. Misclassifying employees
As a small business owner, you likely work with a variety of workers. However, it’s imperative that you understand the difference between a contractor (paid with a 1099 form) vs. an employee (paid with a W-2 form) to prevent small business tax mistakes. This is a very tricky and highly scrutinized area of small business taxes as many businesses inadvertently classify employees as contractors. Sometimes this is an honest mistake; yet businesses frequently do this to avoid paying employee benefits like paid time off (PTO), health care and retirement.
Some companies that intentionally do this might think they’re saving money, but it’s a lose-lose situation. Employees are cheated out of their rights and morale is lowered. This causes employee turnover and other repercussions like high fees or even jail time for the employer.
Per the IRS, not giving employees W-2 forms can subject an employer to back taxes of as much as 41.5% of the contractors’ wages. In addition, these penalties can apply to the previous 3 tax years. Uber, a large tech ridesharing company, settled a class action lawsuit brought by drivers in California and Massachusetts for $100 million.
So what can you do to avoid this?
First, recognize the differences between contractors and employees with these tests:
- Control: Does the company control the workers’ hours and what he or she does on the job? Many contractors set their own hours and work for many clients. Conversely, employees generally work in an office from 9-5.
- Financial: Does the company have power over any financial aspects of the worker’s job? These include how a worker is paid, possibly reimbursements (contractors generally aren’t reimbursed), and who provides the tools. Some salespeople work outside the office but are still considered W-2 employees since an employer would reimburse them for car and phone expenses.
- Benefits: Is there a written contract for employee benefits like health insurance, PTO, or a 401(K)? Employees receive these benefits, while contractors don’t.
- Is it an ongoing relationship at 40 hours a week? Many contractors do one-off projects with inconsistent work. Employees are in an ongoing relationship with the business and even high-level personnel like managers are considered employees. Contractors won’t be able to climb the ranks within your organization and usually have to attend to other clients. It’s also important to consider the hours worked as employees that work at least 30 hours a week are eligible for healthcare benefits per the IRS.
4. Not separate personal vs. business expenses
As a self-employed person, you MUST be organized when it comes to separating personal and business expenses. It can be tempting to lump all expenses to save on your taxes, but this can put you at a risk of an audit and it’s one of the more easily preventable small business tax mistakes. A simple, but crucial step to separate personal vs business expenses is to open a business account or credit card with your financial institution. This will make it easier to segregate different expenses and keep yourself organized.
Another great way to keep your expenses separate is to consider using an app like QuickBooks Self Employed. Quick Books can help segregate business expenses by allowing you to take photos of receipts and store them within the app. This platform can also help you with estimated taxes, maximizing schedule C deductions and invoice management. Using the right tools is crucial to staying organized as a small business owner and will help you avoid small business tax mistakes.
Another simple way to separate business and personal expenses is to be organized throughout the year. Many businesses wait until tax time to do this and cause themselves unnecessary stress. It’s wise to systemize many aspects of your business which will eliminate most small business tax mistakes. Spending more time strategically planning how you will organize different types of expenses initially will save you TONS of time in the long run.
Lastly, if you’re very busy like most small business owners, consider outsourcing this task by hiring a quality bookkeeper. A bookkeeper can be a CPA, but doesn’t have to be. This person will help you organize your finances, but generally won’t prepare nor file your taxes. A bookkeeper should be honest, organized, and experienced. You can learn more about how to hire a bookkeeper here.
Taxes have a significant impact on all US citizens, especially small businesses. Most people feel lost and confused when it comes to taxes due to insufficient education and a long tax code with 75,000+ pages. Taxes are always in a constant state of flux since Congress can add changes. For example, President Trump’s administration changed many rules and deductions which makes it important to stay abreast of these changes. Small businesses can avoid common small business tax mistakes like untimely/insufficient payments, failing to record business miles, misclassifying employees, and not separating business vs personal expenses.