Just because your business is small doesn't mean the IRS and state taxing authorities won't be keeping an eye on you. Many small business owners make the assumption that they can get away with tax evasion because they are too small to be noticed, and other small business owners don't take the time to keep good records or pay taxes when due, just because they are overwhelmed and busy. In both cases, these tax issues can result in huge problems. Here are 6 mistakes made by small businesses (in no particular order):
1. Auto/Travel Expenses. Failing to keep good records for travel and auto usage. This includes failure to differentiate business and personal use of your car, especially if you have only one. The IRS scrutinizes auto expenses closely, and if you have only one car and you are claiming lots of travel and auto expenses, they will probably want to see your records.
2. Backup Withholding. Not withholding taxes on independent contractors. I talked about this last week - it's called "backup withholding." If you don't have a valid taxpayer ID number for an independent contractor, you must withhold 28% from your payments to this individual. Before you send out those 1099-MISC forms, ask all independent contractors for their tax ID numbers and start withholding if you don't get them.
3. Contractor vs. Employee. Speaking of independent contractors, one of the most common mistakes businesses make is to treat a worker as an independent contractor when the person is really an employee. I know companies don't like paying FICA taxes on employees, but they don't want to treat these workers as independent. You can't have it both ways. If you aren't sure, file Form W-8 and get a determination from the IRS.
4. Sales and Payroll Taxes. Failing to pay state sales taxes and payroll (FICA) taxes. Both of these taxes are "trust fund" taxes, meaning that you must turn them over to the state (sales tax) and the IRS (payroll taxes). Using these funds to keep your business running, as I have discussed recently, is a dangerous way to play the cash flow game.
5. Cash Transactions. If you have many cash transactions, you may be tempted not to record or report them. But the IRS knows that businesses like to hide behind cash, so they look closely at businesses that have many cash transactions. For example:
- Paying employees in cash
- Accepting income in cash
- Barter transactions
I recently discussed your obligation to report all large cash transactions of over $10,000, but even smaller transactions might raise a few eyebrows over at the IRS. And the IRS looks closely at the difference between your lifestyle and the profits of your business. If your business is only marginally profitable and you are living high, they are going to take a closer look.
6. Keep Business and Personal Separate. I just talked about this one, but I wanted to mention it again. If you fail to keep your business and personal financial data separate, you risk having the IRS disqualify your business as a separate entity, and having all your business expenses wiped out as legitimate business deductions. Set up a separate business bank account and keep separate records.
As tax time nears, take a few minutes and make sure you are not making any of these mistakes. Playing by the rules not only helps you stay out of the gaze of the IRS; it allows you to sleep at night.