10 New Business Mistakes That Can Spell Trouble
10 New Business Mistakes that Can Get You Into Trouble
Thinking of starting your own business? Are you self-motivated in such a way that you’ll put in the long hours necessary to succeed? If so, you may have what it takes to prevent new business mistakes from becoming a bad habit.
Unfortunately, some individuals have the misconception that becoming financially independent can be accomplished in a short period of time. Well, I suppose its possible, but for most, they quickly learn the business facts of life.
Operating your own business can be very rewarding such as being your own boss, but there are a number of things that you have to comply with if you want to stay in business. The primary one is paying the various taxes that are required.
This is one area where a new business owner needs to consult an experienced, qualified accountant before setting up a business entity. A lot depends on the type of business and how to structure it so that overall taxes can be minimized.
In my state, a few years ago, the LLC designation was added to the state level types of organizations. Practically every new business was using that because it looked “nice”. Little did they realize it involved paying more in taxes for certain types of organizations.
In my many years of experience as a bank commercial loan officer and then as an accountant, I observed certain new business mistakes that a small business owner would make that were common to all. Generally, the primary reason for these mistakes wasn’t an intentional act, it was often just a bad habit or because he didn’t know.
I can’t emphasize enough how important it is to meet with an experienced accountant who can walk you through everything required in your state from the type of organization and taxes that you will be required to pay. Get educated before you take the next step and you will have an easier time of it.
In this article, we’ll cover what I believe to be ten (10) tax mistakes that a small business owner can make and how to prevent them.
- Selecting the wrong type of business formation – Many small businesses start as a sole proprietorship, the easiest type of formation. This may be fine for many of them as they simply file a Schedule C with their tax return. However, this type of organization has the least amount of liability protection to the owner.
A C corporation offers better liability protection unless you provide personal services, but you must pay income taxes at the corporate level.
An S-Corporation offers liability protection and also tax benefits to the owner. You must have a reasonable salary established, but the balance of the net income is not subject to self-employment taxes.
An LLC structure can be used, but a single member LLC reports the income and expense on a Schedule C like a sole proprietor and pays self-employment taxes on the net profit unless it happens to be a real estate rental. Two or more members usually operate as a partnership, and a corporate tax structure can be used also.
Your tax adviser will be able to tell you the best structure to use.
- Doesn’t maintain detailed records – This is one area where you want to excel. Sloppy and incomplete records can be your downfall. It is suggested to keep your income and expense records on a monthly basis. For a small business, Quickbooks can be used which will give you an approximate picture of your operations by month.
Don’t do as some do by throwing receipts in a box and waiting until the end of the year at tax time to sort it all out. It will be harder for you and your accountant doesn’t want to get the “shoebox” of records. It will only cost you more and this is one of the new business mistakes that many commit.
NEVER, NEVER, co-mingle your business records with your personal. Open a separate business checking account and get a business credit card if possible. If not, use one of your personal cards ONLY for business purchases.
- Delinquent taxes – When it comes to taxes, don’t mess up. One of the most common new business mistakes by a business owner is to spend the money withheld for payroll taxes from an employee’s wages. They may have a cash flow problem and fully intend to deposit the taxes when due. However, as it usually happens, they spend the money on other bills and have no cash to deposit the withheld taxes.
These are Trust Fund taxes and the IRS will come after the business owner to collect. This usually applies to payroll taxes, sales taxes, and even to some local taxes. Keep this current at all costs. Some business owners set up an escrow type of account and deposit their taxes there when withheld to avoid spending them.
- Misclassifying your workers – This is one of the first areas looked at in an IRS audit. Saying that an employee is an independent contractor to avoid paying payroll taxes, is a big no-no.
The IRS has a twenty point classification that they follow. You can read that, but I will tell you that if an individual is under your control as to time and direction of a job, they are an employee. Don’t gamble with this and hope that you’ll win an audit. Many make new business mistakes like this one.
- Not deducting startup expenses – Normally the IRS will allow you to amortize your startup expenses over a 15 year period. However, there is one exception. A new business can elect to deduct as much as $10,000.00 provided the total start-up costs are $50,000.00 or less.
Your accountant will be aware of this section of the code and can advise you accordingly.
- Correct home office deduction – If you operate your small business from your home, and that area is used exclusively for the business, you are permitted to deduct a certain percentage of the homes’ expenses.
This deduction can be done in one of two ways. Actual expenses can be used or the IRS will allow their simplified rate based on the square foot method.
This area used to be an IRS look at when doing an audit but has not been lately as the work at home economy has increased. They even simplified the calculation, but generally its less than using actual expenses.
This area is similar to the employee/independent contractor question. If you’re entitled to deduct it, do it, but make sure it’s proper and accurate.
- Not deducting auto expenses correctly – Often times, a small business owner does not have a separate vehicle for the business in the early years. In order to deduct auto expenses, you are required to maintain a log book for the business portion. This would include the date, customer seen, purpose, beginning and ending odometer reading, indicating total business miles.
Again, there are two methods that can be used to calculate the cost. The first is the actual cost including depreciation, fuel, insurance, repairs, etc.
The second method that can be used is the IRS mileage allowance. In 2018, the allowance is .545 per mile.
- Carry-overs and carry-backs – This category is a little complicated to discuss here. Some items that apply are operating losses, Sec. 179 deductions that exceed income for the year, and a few other items.
Your accountant who prepares your tax returns should have a schedule in your return that shows the amount used for the tax year and the amount not used that can be carried back or carried forward. He/she will advise you as to the procedure to take.
- Overlooking business deductions – If you can use one credit card to pay for most business purchases, it will be easier to identify them and you will have a receipt of payment. Also, if you need more expenses at the end of the year to reduce taxable income, you can charge them to your credit card in December.
This counts as being paid in that tax year even though you won’t pay the credit card bill until the following tax year.
- Don’t game the system – Everything you spend money for might not be all deductible. As an example, meals and entertainment expenses are limited to 50% and customer gifts are limited to $25.00 to each one.
Also, keep an accurate record of business miles used and don’t fudge. It’s not worth it.
To summarize, get a qualified, experienced accountant to set the business up. Keep detailed and accurate records, and most importantly, make sure all federal, state, and local taxes are paid when due. In doing so, you will be in compliance and have less stress to contend with.
It’s not that hard to avoid these 10 new business mistakes a lot of new business owners make. We welcome your comments below.