By: Jennifer Babcock, Manager and CPA
Cordell, Neher & Company, PLLC
Many small business owners approach tax season with a can-do attitude. This entrepreneurial spirit is admirable, but when it comes to compliance, it is usually best to leave tax preparation to the experts. Being aware of common mistakes, like failing to comply with tax laws, violating tax codes, or incorrectly filling out forms, will help you avoid errors and unnecessary stress.
Underpayment of Estimated Tax
The Internal Revenue Service (IRS) requires business owners to make estimated federal income tax payments to account for the tax not recouped through a standard paycheck. Depending on how much you owe and your business type, you will need to make payments based on the amount of income you made from the business during the year and the amount of self-employment tax you owe based on that income. Failure to make the appropriate payment will incur accuracy-related penalties. Furthermore, business owners that do not substantiate their tax position or prove reasonable cause for their position will also incur a negligence penalty.
Employment Tax Deposits
What happens when a business owner yields their responsibility to meet employment tax obligations in favor of meeting payroll, debts of nonpayment, or trade obligations? Though it may not seem as important as other financial obligations, failure to comply with employment tax obligations will result in substantial penalties, and possible criminal prosecution. These fines are called Trust Fund Recovery Penalties (TFRP) because a portion of the employment taxes are withheld from employee paychecks, making them “held in trust” by employers until they are remitted to the government. TRFPs may be assessed against any person who is responsible for collecting or paying withheld income and employment taxes and who willfully fails to collect or pay them. A responsible person is someone who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. This person could be an officer or an employee of a corporation, a member or employee of a partnership, a member of the board of directors of a nonprofit organization, or a corporate director or shareholder, among other things.
Reporting your total payroll tax liability and determining your payroll deposit schedule depends on a variety of things, the most important of which is having the right information and being educated about payroll tax laws and how they affect your business. A good payroll software or outsourced payroll company can help you manage withheld employment taxes and ensure the electronic fund transfers are accurate and timely. It’s important to note, however, that while engaging an outsourced payroll provider could help mitigate the risk related to TFRPs, doing so does not completely absolve the responsible party within the entity of their duty to ensure that trust fund payments are being made fully and timely.
The IRS is a stickler for accurate and on-time payment. The latter is almost a rite of passage for many business owners that need more time to produce a precise return or take advantage of all their deductions. While it is ideal to file your return by the IRS due date when you have all the information, many instances prevent this. Late payments are acceptable so long as the IRS knows it will receive payment via an extension. The critical difference between a late filer and a negligent filer is their intention. Business owners that need to file their taxes after the April deadline should make an extension request with Form 4868 by the tax filing deadline. If you forget to submit the request, you will incur a penalty of 5% of the amount due for every month or partial months your return is late.
Keep in mind that with your tax extension also comes another deadline. If you fail to make the payment again, you will incur the 5% penalty above. And finally, when you pay later, you pay more. Even with the extension, the IRS will collect interest on any amount outstanding after the April deadline. In addition to this interest payment, you may also pay a late-payment penalty of 0.5% per month of the late, unpaid tax. If you want to minimize your total bill, consider paying at least 90% of your tax liability when you request the extension. Like we tell all of our clients, an extension request is just an extension of time to file, NOT an extension of time to pay. We can help make the right decision around extending versus filing timely. If you have questions about which is best for you, please contact us.
Failing to Separate Business from Personal Expenses
This step is the year-long headache that reaches maximum tension at tax-time. In an effort to simplify, many business owners will use one credit card, thus making it difficult to distinguish legitimate business expenses from personal ones. Overlooking this critical step results in more than just tax errors. The time an owner needs to spend categorizing expenses is quite costly to the business, and inaccurate financial information will result in inaccurate financial statements. It may feel like it’s too late, but it is never too late. Start categorizing your aging personal and business expenses and take the proper steps to begin tracking them better in 2021.
Working with a reputable tax preparer year-round can mitigate a lot of the stress that comes with tax preparation. Because we are constantly staying abreast of ever-changing tax law, it’s likely that we know of some deductions or credits that most people are not aware of. If you need assistance or would like to talk to one of the professionals in our firm, give us a call today at (509) 663-1661.