Common Tax Planning Mistakes Small Business Owners Should Avoid

Among the other areas that must be taken into account to ensure that a small business survives are those of tax planning. Although business people might have more to worry about such as their income, expenditure, payroll, and business expansion, there is no denying the fact that taxes might greatly affect cash flow and profits.

It is hard to take into account deductions and taxes if one waits for the tax season to come. Proactive tax planning can help in knowing the tax obligations and financial planning ahead of time.

Following are some of the common tax planning mistakes made by small business owners.

1. Waiting Until Tax Season to Start Planning

The one thing that is most commonly overlooked is tax planning as a yearly process. Tax planning at the end of the year might not give enough time to analyze the financial situation including revenue, expenses, deductions, and tax liabilities.

Regular reviews of the financial condition can assist business people in analyzing their probable tax liability. Whenever profits are increasing during the year, doing an analysis might give insight into whether the estimate for the tax liability needs to be changed.

Tax planning should always be regarded as an essential element of financial planning.

2. Mixing Business and Personal Expenses

Transactions that are mixed for both personal and business purposes will make it hard to keep track of financial transactions.

When mixing of transactions takes place, then it becomes difficult to distinguish between what is a valid business expense and what documentation needs to be provided for the transaction.

It is easy to keep track of business transactions through maintaining separate banking and credit facilities for business purposes.

3. Failing to Track Deductible Business Expenses

Businesses that operate without keeping up-to-date accounting records are prone to ignoring many expenses that are indeed tax deductible for their business.

Qualifying expenses will differ from company to company; however, there could be some common qualifying expenses like those associated with advertising, professional service fees, insurance premiums, supplies, rents, salaries, and more.

Instead of trying to piece together their expenses months down the road, businesses should always record their expenses at the time of transaction.

4. Assuming Every Business Expense Is Deductible

The other error is thinking that all expenses related to the business qualify as deductions.

There are criteria in tax laws regarding the deductibility of expenses. Some may have restrictions or special treatment. Generally, personal expenses cannot be considered business expenses merely because they happen in a time when the individual operates the business.

The business owners need to assess their expenses thoroughly and make sure that they are documented for business purposes.

5. Ignoring Estimated Tax Payments

A great number of small business owners, especially those who are self-employed and those that run pass-through businesses, do not have taxes withheld from their income as it happens for wage earners.

The latter will be based on how each individual’s situation is and might have to make estimated tax payments throughout the year.

Failure to meet these estimates means one will owe additional tax at the time he files his return, and there is even the possibility of incurring fines. Projections of income should be done regularly.

6. Choosing a Business Structure Without Considering Tax Implications

A business structure may influence how earnings will be reported and how tax will be paid.

There are various structures of businesses that include sole proprietorship, partnership, LLC, S corporation, and C corporation that may result in different tax consequences and compliance. It is not always good to choose a structure only because it is easy and popular.

One may need to look at several aspects when assessing a business structure such as income, ownership, liability, paperwork, and taxes.

Professional assistance will be quite beneficial before creating or altering an existing business structure.

7. Overlooking the Difference Between Tax Brackets and Tax Rates

Some business owners have been under the misconception that being in a higher tax bracket means that all their income will now be subject to the higher tax rate.

Taxation is done progressively in the United States where portions of income may be subject to varying tax rates.

An understanding of marginal and effective tax rates will assist business owners in evaluating the tax implications of income from different sources.

8. Neglecting Recordkeeping

In addition to problems completing tax returns, poor financial record keeping can lead to additional issues when it comes to accounting for one’s income, expenses, and deductions.

Some examples of important documents that you may require include: invoices, receipts, bank records, payroll records, expense accounts, and other financial documents.

Good bookkeeping makes the process of following the progress of your business simple.

9. Missing Tax Deadlines

There might be many deadlines for tax during the year. These can include the filing of estimates taxes, payroll tax returns, information returns, and business annual taxes.

Failure to meet this deadline will lead to unnecessary penalties, interests, and administrative hassles.

Firms should maintain a tax calendar that includes all the deadlines, federal, state, and local, depending on the circumstances.

10. Forgetting About State and Local Taxes

Federal income tax is just one type of tax liability that businesses might be facing.

Based on the geographical area in which a business functions, there may be state or local obligations regarding taxes related to income, sales, payroll, franchise, property, or any other type of tax liability.

If a business functions in more than one state, there will be some additional considerations for compliance. It is important for the owners to be familiar with all tax liabilities relevant to them.

11. Failing to Plan for Changes in Business Income

However, the income of a business can differ quite significantly from one year to another depending on new contracts, expansions, rising prices, hiring more people, among others.

If all of the tax planning relies on the data from last year’s figures, then the business owner will end up either underestimating or overestimating his/her liability.

Through constant examination of their revenue and expenditures, the business owner can be able to notice any changes and thus make better estimates.

12. Treating Tax Planning as Only a Cost-Reduction Strategy

Lowering a tax bill is certainly a worthwhile objective, but tax planning should not concentrate only on reducing tax.

A business decision which leads to a tax deduction may not be a sound financial decision at all if the cost incurred does not add any value to the business itself.

Tax planning should take into account the overall picture of finances of the organization.

13. Overlooking Available Tax Credits

A difference exists between tax deductions and tax credits. The reduction in the amount of taxable income through tax deductions is common. However, qualifying tax credits may result in a direct decrease in tax liability.

Based on the ability to satisfy the criteria, businesses can be eligible for tax credits in various activities, such as hiring employees, conducting research, providing employee benefits, or investing.

It is important to consider possible tax credits that could apply to the business, rather than concentrating only on tax deductions.

14. Not Reviewing the Tax Strategy After Major Business Changes

That tax strategy that proved successful with a small company will not prove sustainable as the company grows.

For instance, becoming a partnership, hiring employees, operating in another state, purchasing capital goods, and transferring ownership will be a change that will affect taxes and regulations.

A business change, hence, must trigger a reassessment of the firm’s financial and tax strategy.

15. Trying to Handle Complex Tax Matters Without Professional Guidance

A business’s tax situation might get increasingly complicated as it develops. Though accounting software and the Internet can be of assistance to you in managing your finances, there are situations in which you need to seek professional advice.

It would be better for a business owner to consult a tax professional regarding complicated deductions, changes to the nature of the business, operations across several states, business transactions, and other complicated tax situations.

How Small Businesses Can Improve Tax Planning

Avoiding common mistakes starts with establishing consistent financial habits. Business owners can take several practical steps to improve their tax planning process:

• Check your financial performance during the year.
• Separate your business and personal transactions.
• Organize your receipts and financial records.
• Accumulate your business-related eligible expenses.
• Check your estimated taxes payments.
• Review federal, state, and local requirements.
• Evaluate your business structure if needed.
• Keep your calendar for your tax deadlines.
• Check your eligible deductions and credits.
• Consider consulting professionals if tax situation is complicated.

These practices will help organize tax preparation and give the business owner an insight into their financial standing.

Conclusion

It is necessary to take steps not to make mistakes during tax planning, in order to prevent further difficulties for the organization both financially and administratively. The tax planning mistakes may comprise, but are not limited to, postponing until tax time, combining personal and business expenses, overlooking tax deductions, forgetting about the estimated taxes, as well as not considering the state/local taxes.

Tax planning may help the owner of a business to manage his or her income tax liabilities, prepare for them, keep records, and make wiser decisions regarding finances. Tax planning may help the business adapt to the changes related to its income.

According to the structure of the business, its location and income, and individual circumstances, the tax planning consultant may be needed for the business.

FAQs