The Most Common Tax Mistakes Made by SMBs
Tax mistakes have a far bigger impact on the sustainability & growth of an SMB than most entrepreneurs realise. Tax structuring, due diligence and best practices can keep an organisation financially fit. But trivial mistakes can cost companies in penalties, overpayment of taxes and countless hours with auditors.
While learning taxes is getting harder due to ever changing rules, it is easier to know what not to do. Here’s a look at the most common tax mistakes and how you can avoid them:
1. Missing Deadlines
As dull as it sounds, this is the one that matters the most. Yes, you cannot afford to miss deadlines for taxes. What makes it difficult is the huge number of forms and schedules needed for your business.
Companies and individuals for that matter need to know the dates for their annual federal income tax returns. If the IRS extends or changes the dates, you can register here to get reminders for important filing dates. By registering and staying up to date with the online tax calendar, your company can prepare and finalise accounts ahead of time.
Missing deadlines can incur huge amounts of penalties and lost waivers. So, companies have to religiously stick to the schedules and do the filing for all applicable forms and schedules. A tax compliance software can help companies to prepare and file their taxes conveniently.
2. Not Understanding the Impact of Penalties
The impact of penalties can be tough. Many new companies and even experienced ones are not aware of the penalties involved when returns are filed after due dates. Without a genuine and reasonable cause for filing late, 5% of the unpaid taxes for each month or part of a month that a tax return is late is incurred on penalty.
There are several other penalties incurred on non filing and have significant charges for a business. As rules and compliances become harder to manage, it is best to utilise automation and expert guidance for staying abreast with the regulatory needs of your business.
Sometimes, business priorities may render certain filing obligations impossible. In that case, you should be able to compute the penalties and fees due for payment to authorities. This will save you unexpected surprises and your fortune.
3. Hiring Wrong CPA and Financial Assistants
There are over 130,00 vacancies for auditors and accountants in the US every year. There is a shortage of tax professionals, the existing ones are overloaded and hard pressed for time, especially when deadlines are looming.
Choosing the right CPAs, financial assistants and automation is the key to sound financial reporting. It matters a lot if you have intelligent financial automation and accounting to track your business. The business accounting can be automated to prepare just in time reports. These reports can be vetted and submitted to authorities for compliance purpose.
Accounting software and use of technology reduces dependency on CPAs and financial assistants. For e.g. when all reports are prepared using software, your accountant or auditor will need to spend fewer hours to file your returns. It will save your business time, costs and valuable mind space too.
4. Missing Leverage
The federal and the state authorities provide SMBs and businesses with many relief measures. There are several schemes, subsidies and benefits for building a business that generates employment. There are tax breaks and allowances for R&D expenses. Governments also provides incentives for child tax credit etc.
As a company, your tax consultants and financial advisors should help you to identify critical levers for your business. It can help you structure your business in the most optimised way for long term growth and scalability. Many businesses miss out on availing the right benefits and credits from the IRS.
Companies can also use carryovers, tax credits, unabsorbed depreciation, losses in business etc. for subsequent years. These credits can be utilised by reducing the income taxes.
5. Filing Incorrect Forms
Businesses need to ensure that employees and contractors are separated. The independent contractors are not your employees. There are separate forms to be filled for employees and part time workers. So, the payroll tax penalties can create audit issues for companies when workers are classified wrongly.
The IRS tax rules make it clear on how workers need to be classified, the details can be found on the IRS portal here. All companies need to make a clear distinction on type of employees and file forms accordingly. Some of the forms related to employees and contractors are as follows
Forms 1097, 1098 and 1099
Forms 3921 and 3922
Forms W-2 and W-2G
Forms 1099
6. Wrong Filing Status
Is your company structured right for the type of business in which you operate? The IRS provides many exemptions to new organisations, for e.g. you can register as a tax exempt organisation under IRS. If your business is in the experimentation phase and doesnt make big profits, you can register it as a hobby business as per IRS guidelines.
The forms for filing annual taxes depend on the status and structure of your business. For e.g.
For small businesses i.e. a Single Member LLC (meaning it’s just you), you may file business taxes on your personal Form 1040 using a Schedule C.
If your SMB is structured as an LLC, & you have a business partner, you will need to file Form 1065 for a partnership return.
If your SMB is an LLC treated as an S-Corp for tax purposes, you will file Form 1120-S.
The right status and structure of your business has to be considered before filing the annual forms. Your company can benefit and avoid paying additional taxes with the right company structure.
7. Overreporting or Underreporting Income
A lot of SMBs tend to either underreport or overreport their business income due to lack of accounting knowledge. For e.g. when a client is invoiced with sales tax, the income does not include the tax part. The taxes are reported under different headers on the balance sheet and are not part of the income. In this case, overreporting income will lead to higher income taxes for the organisation.
The companies also need to report all income for the financial year according to the IRS norms. For e.g. there could be invoices raised to the clients, which have not been paid. But if you’re using accrual method of accounting, then it is treated as income. You’re also liable to pay taxes on it. So, underreporting or overreporting income can lead to tax implications that SMBs should be extremely careful about.
8. No or Incorrect Refund Information
The IRS reports that a vast number of taxpayers and companies don’t provide correct refund information. There are trivial mistakes in filing information that leads to no refunds for taxpayers.
SMBs can ensure that all information is correct and get the refunds after filing their returns using online softwares. The software automation enables organisations to double check any missing links. It is also advised that companies file their taxes in advance to avoid the last minute filing glitches due to overloading and poor response from tax portals.
The IRS mentioned that many refunds are not processed since the forms were not signed. SMBs can ensure that all the directors or partners sign the documents or opt for digital signatures to verify their returns.
9. Missing Documentation
Good documentation, bills, invoices and record keeping is crucial for tax and audit purposes. Many organisations fail to nail the documentation part. They’re left in a lurch when the IRS comes calling. For every purchase, there has to be a requisite bill and document to support your tax claims.
SMBs that do not have good accounting expertise often lack proper documentation. Take for e.g. meals at a restaurant can be expensed at 50% of their value. If your business claims 100% then it could create issues. When you have clear documents outlining all your expenses and claims made, things are more transparent. It can help you claim tax refunds with more confidence.
10. Not Using Automation
SMBs cannot afford to focus too much of their time in compliance and regulatory affairs, due to a globally competitive landscape. Use of automation and online accounting is the best panacea in dealing with financial reporting compliances. Tax reporting, structuring and bookkeeping can be automated to manage returns electronically.
The use of automation also organises the data and records for the organisation. The accounting softwares are also updated with the latest changes in the IRS, state and city wise tax authorities too. Entrepreneurs need not spend time like accounting clerks and use their time to build better businesses using accounting automation.