When you’re a teeny, tiny startup, you’re more concerned with things like finding the right investors, than you are with preparing for tax season. The problem is, if you wait until the last minute, you’ll probably end up making some common tax mistakes. At best, these mistakes are a missed opportunity to lower your tax bill. At worse, these mistakes could saddle you with some expletive-inducing fines or even legal penalties.
Luckily, it doesn’t take an expert to avoid some of the most common tax mistakes. With a little bit of extra planning and the advice of a few trusted professionals, you can make sure you don’t repeat the kind of mistakes that landed your fellow entrepreneurs in hot water with the IRS.
1. Filing as the Wrong Legal Entity
When you first started your company, you probably didn’t give much thought to what type of business entity it would be. However, deciding on your business’ legal structure is one of the most important decisions you’ll make because it not only affects how you file your taxes, but also how much you pay.
In the US, businesses fall into one of five categories: limited liability companies (LLCs), partnerships, S corporations, C corporations, and sole proprietorships. Prior to 2017, filing as an LLC was often (though not always) seen as the best option for entrepreneurs because it held significant tax advantages. However, the Tax Cuts and Jobs Act (TCJA) has lessened the advantages of filling as an LLC. Moreover, the tax advantages of filing as an LLC come at the cost of additional tax reporting complexity.
To avoid filing as the wrong entity and creating more problems for yourself down the line, it’s important to carefully research the advantages and disadvantages of each legal structure. If you’re not very tax-savvy, it’s an even better idea to ask your accountant for their take.
2. Not Registering In Every State You Do Business In
The virtual nature of startups means these companies often have employees and customers across the country. But what many startups fail to realize is that having business in multiple states means they may need to file a return for each of those states.
On the one hand, the Supreme Court recently clarified that a company is legally obligated to pay taxes in every state in which it does business, even if the company has no actual property or employees located within the state. So if your startup shipped products or carried out services in multiple states, you may owe sales tax in each of those states.
Startups must also file returns for states in which their employees (full-time, not contractors) are located. So if your company has a couple of developers working in another state, you’ll need separate state forms. While the rules vary from state to state, the general rule is that if you have property, payroll, and sales in a given state, you probably need to file a return for that state.
3. Combining Business and Personal Finances
While the concept of mixing business finances with personal finances seems like an obvious no-no, in reality, it can be tricky to keep the two entirely separate. In fact, nearly one in five business owners admit that they do not even have separate personal and business bank accounts.
The problem is, mixing business and personal finances can make it nearly impossible to tell which expenses are business related and deductible for your taxes. Over time, failure to account for reimbursable expenses can result in lost money, as well as lost tax deductions. Commingling finances also removes a layer of legal protection in the event that your business is ever audited.
Of course, the easiest way to avoid this problem is to establish a financial account for your startup business from day one and to maintain separate records for all business transactions.
4. Not Sending 1099s
As a startup, you’ve likely had to hire contractors to help with everything from coding to legal consultation. However, if you paid any of these contractors more than $600, you’d better make sure to issue Form 1099-MISC to both the individual and the IRS. Copy B of Form 1099-MISC should be sent to contractors by January 31st, 2019, while Copy A should go to the IRS by February 28th, 2019.
If you used a contractor and did not file Form 1099-MISC, you could be fined $100 for each type of form (with no maximum). Moreover, if you miss the deadline and file late, the fines are determined based on how late you file, as well as the size of your business. In other words, make sure to send your 1099s to your contractors or you could be facing a major bill (and some frustrated contractors) when tax time rolls around.
5. Not Amortizing Pre-Revenue Expenses
Launching a startup usually takes a lot of up-front investment. This can include everything from a dozen laptops to research and development costs. Where many startups get into trouble, is choosing to report all these expenses at once.
A much better way to handle these expenses is to offset the costs through amortization. This means writing off its initial tax burden and then paying it back incrementally. This method allows you to capitalize on the expense and then pay a percentage of taxes on it over the next couple of years. If your company is in the pre-offering period, this strategy can help to reduce your tax liabilities
6. Not Deducting Your Business Expenses
If you’re running a startup and you’re not deducting your business expenses, you’re essentially leaving money on the table. While the general rule is that you can deduct all “ordinary and necessary” business expenses, there are a number of key deductions that startups should be taking advantage of.
In addition to things like meals and bank fees, startups should also be deducting the cost of training programs, research and development, and home offices. The best way to make sure you’re capturing all the important startup tax deductions is to do your research well ahead of tax season.
7. Not Keeping Proper Records
Of course, it’s important to keep in mind that a deductible expense is only good if you can actually prove that you spent money on what you said you did. This is where many startups go wrong. Entrepreneurs often neglect to keep proper expense records throughout the year and end up scrambling to fill old shoeboxes with receipts when tax time rolls around.
The easiest way to avoid this situation is to go paperless. Make things a little easier for yourself (and your bookkeeper) by scanning and uploading copies of your receipts to the cloud. You can even use dedicated apps to transcribe the information from each receipt for you. Keep in mind that the IRS requires businesses to keep receipts that support business expenses for a minimum of six years from the date you filed your return, and this is far easier to do with digital receipts than paper ones.
8. Not Talking to the Experts
While all of the above can get you into some trouble around tax time, one of the biggest mistakes that startups make is trying to go it alone. Many founders believe that an easy way to save money is to simply do back-office tasks like bookkeeping and accounting themselves. However, without the proper training and expertise, the DIY approach often ends up costing more in the long run.
It’s no surprise that one of the best ways to make sure your business is tax-ready is to talk to an accountant who specializes in tax planning and tax filing. You should also consider finding a bookkeeping service to keep your books organized and compliant from tax-time onwards. You’ll be especially thankful for your bookkeeper if you find yourself in the midst of an audit.
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