As a small or new business owner, you may be a tad clueless on how to manage the tax side of your business. Most business owners don’t think about taxes, until April 15th, and by then, it could be too late to save yourself from potential risks.
I fully understand you got into business with the intention of making the world a better place with your products and/or services, but that doesn’t mean the IRS isn’t watching. There is a tax gap of $406 billion dollars that must be made up, and they are starting with small business owners, like you.
Because we are living in a digital world, most items are being tracked and reported to the IRS, especially your income. You cannot use the excuse “I didn’t know” when they come knocking at your door for those extra tax dollars, so I want to share with you 3 reasons they would look your way, in the first place, and the solutions to make sure they don’t (or if they do, you are ready to flash them your pretty white smile).
Problem 1: Commingling funds
Most small business owners mix business with pleasure, and that includes mixing business income and expenses in the same banking account with personal transactions. The IRS calls this commingling, and they will use this as an excuse to exclude potential deductions you would, otherwise, be eligible for. They will say they can’t determine if your expenses were for business use if your bank statement shows your office supplies charge from the same account as your weekly mani/pedi.
Solution 1: Open a separate bank account
The best way to avoid this issue is to open separate bank accounts (this includes credit cards and PayPal accounts) that you use exclusively for business. The keyword here is exclusively! Put all the income you receive for your business in this account, and again, I’ll reiterate; you should only use it only for your business expenses. No personal transactions allowed! The new account need not be a business account per se, but using a formal business account has the upside of showing you are treating your solo-business as a “real business.” Yes, I know, having business bank accounts can mean extra fees, but the bonus is those fees are tax deductible.
I also know you will need the income you bring into the business to pay your personal bills, so I recommend setting up a monthly or bi-monthly transfer from your business account to your personal account of the same (or very similar amounts) to act as sort of a payroll system. Having this system in place means the IRS can’t judge your ShoeDazzle obsession. They won’t see it, because that spending is in your personal account, right?
Problem 2: Not filing your taxes
Small business owners get overwhelmed when it comes to filing taxes, because they have no system in place to record their business income and expenses timely. This leads them to put off filing taxes, until they have had “time” to gather and organize this data. In my professional experience, these same business owners have, sometimes, taken years to compile this info, and the only reason they decided to finally take action is because they got a very scary letter from the IRS.
Not filing your tax returns for a few years, usually triggers a big, red flag with the IRS, especially if you have any income reported by your clients, customers, and/or a merchant processor (Square, Stripe, PayPal, etc.). The IRS will wait a couple of years before they send you that scary letter, if you haven’t filed, but if you wait until it comes, then they will have prepared a return for you that won’t consider any expenses you may have for your business.
Solution 2: File your tax returns on time
To avoid receiving this letter, you should file your tax return the year it is due, which in the US is normally by April 15th. If you need more time, a 6-month extension can be requested by using Form 4868, giving you until October 15th to file the return. Filing an extension doesn’t excuse you from paying any taxes due by the original due date, so if you think you will owe taxes, send in a payment, with your extension request.
Problem 3: Multiple year losses
Now, it’s not uncommon for small businesses to show a loss on their taxes, especially during the initial start-up year; however, having losses multiple years in a row can indicate a reporting issue to the IRS. To them, it could look as if you aren’t reporting all your income or you are inflating your expenses.
Worst case scenario, the IRS will try to treat your business as a hobby and disallow any losses you have previously taken, meaning you will owe money back, plus interest and penalties, for not filing correctly and paying on time. Now, there’s nothing wrong with having a hobby and making money off it, but for tax purposes, you can only write-off expenses equal to the total income for the year. So, that means -0- tax benefit.
Solution 3: Keep accurate records
There is nothing to worry about if you have all your ducks in a row by accounting for every last business transaction. Make sure you are reporting all income, including cash transactions that may not make it to the bank, and all of your business expenses, making sure they are ordinary and necessary for you to run your business. Having accurate records will help ease your worries. Click here to download a worksheet that will help you manage this process.
Keeping your business out of tax trouble can help your business flourish. It’s one less thing keeping you up at night, especially if you have a system in place that works. These are just a few ways you can help minimize that stress. For more specific and personalized matters, speak with your tax professional, well before April 15th, so he/she can help you craft a well-thought-out tax plan that’s tailored just for you.
Have you had any run-ins with the IRS? Do you think these tips could’ve saved you from the trouble you were facing? Let me know in the comments below.