In the face of business pressures, keeping up with IRS rules and regulations can be difficult. But the consequences of noncompliance can put a small enterprise out of business just as easily as poor economic conditions can. While you can’t control the economy, you can avoid the most common tax mistakes made by small businesses. BORROWING EMPLOYMENT TAXES Social Security and income taxes withheld from employees’ pay may sit in a small business’ bank account for days before it has to be sent to the IRS. So, the owner might rationalize “borrowing” that money to pay other bills. Then, when the time comes to convey the employment taxes to the IRS, the money is not available. The IRS audits the payment of employment taxes frequently. A business owner who is responsible for withholding and transmitting employment taxes, and who willfully fails to do so, is personally liable for a 100% penalty tax, even if the business is incorporated. INDEPENDENT CONTRACTORS Some small businesses treat certain workers as independent contractors so they don’t have to pay employment taxes for them or provide them with employee benefits. Misclassifying workers as independent contractors is a common — and costly — mistake. If the IRS discovers that you misidentified employees as independent contractors, you may owe back employment taxes for those individuals, plus interest and penalties. Before you decide to classify a worker as an independent contractor, check with us to make sure the classification is appropriate. INADEQUATE EXPENSE RECORDS Another mistake small businesses often make is not keeping adequate records of business travel and entertainment expenses. Even if all your expenses are legitimate, deductions for those expenses may be disallowed if you haven’t kept certain receipts and records. The records must be created at the time the expense is incurred — not two years later. UNREASONABLE COMPENSATION Another troublesome issue may arise when an owner of a regular C corporation pulls all of the profits out of the business as the owner’s compensation. The corporation is entitled to a deduction for employee compensation — but not for dividend distributions to shareholders. The IRS will examine whether the owner’s compensation is reasonable, given the business, the work the owner does, and the compensation similar businesses pay for similar work. Compensation that exceeds “reasonable compensation” can be recharacterized as a nondeductible dividend. IGNORING TAX CONSEQUENCES The biggest mistake some business owners make is not recognizing that their business decisions may carry tax consequences. In the rush to close deals and conduct business, taxes aren’t necessarily a high priority. However, almost every business transaction may have tax consequences. Ask your tax professional what they might be before the deal is done.
Small Businesses, Big Tax Mistakes
