Common Tax Mistakes and How to Avoid Them
In the spirit of full transparency, I have to tell you that none of this is tax advice because while I may know enough to be dangerous to myself and others, I’m not a tax advisor.
I know that dealing with your taxes is a lot like dealing with your dental health. It’s kind of painful and may be costly. You can try to avoid it, but eventually it’ll catch up with you. So if there’s going to be some amount of discomfort anyway, the best we can do is at least minimize it by avoiding any costly mistakes.
In this article, I’ll review some of the most common tax mistakes I’ve seen over the years and tips for how to avoid them.
Mistake #1: Starting late or forgetting to file by the deadline
If you’ve ever filed taxes, you should probably know that they’re due right around the same time every year: April 15 and March 15 for S-corps and partnerships. Now that we know our filing dates, we also know that we should prep our stuff for our accountants as early as possible.
Doing your taxes is like being a part of a group project. It’s at least a group of two – you and your accountant. If you’ve got business partners and a spouse, that only expands the group. Everyone, including you, has to do their part. Nobody likes the person that turns in their part of the project late and unorganized.
Not being liked isn’t the only reason why timeliness matters. You have to give yourself ample amount of time to complete your taxes in order to avoid mistakes happening. Although it’s a daunting process, it's crucial that you do not procrastinate because it can bite you in the ass and cost you money!
Please note that it’s less expensive to pay late than it is to file late: there's a 0.5% fee for paying late versus a 5%-25% fee for filing your taxes after the deadline, so make sure that you file on time even if you cannot pay your taxes! Filing for an extension is always an option as well, but your tax payment is still due on the same day.
Mistake #2: Misclassifying workers (employees vs contractors)
Don’t try to avoid payroll taxes by hiring someone on as a contractor when they’re really an employee. This type of misclassification can lead to audits, back taxes, penalties and interest - on top of a headache for everyone involved. It’s important to know the difference between contractors and employees:
A contractor typically negotiates their time beforehand and is paid a flat fee per job rather than per hour. They make their own schedule and use their own tools and typically receive no training from their employers. They are paid a gross amount and that amount is reported on a 1099. The service they provide is not the same service your firm provides. For example, an interior designer can hire a web designer as a contractor, but they’ll likely need to hire a junior interior designer as an employee. When in doubt, check with your accountant or small business attorney.
An employee usually works for an indefinite amount of time, during hours set by an employer. They either earn an hourly wage or salary and are paid on regular intervals. They are provided training and tools by employers. They are paid a net amount reported with a W2, deductions for payroll taxes and federal and state withholding.
Keep in mind that even if someone considers themselves an independent contractor, it might not be the case from a tax perspective (the IRS has info to help you distinguish if you’re hiring employees or contractors). If you don’t want to navigate the IRS website alone, lean on your accountant or small business owner to help make sure that you do not break the law!
Mistake #3: Underreporting Income
Report all of your gross earnings, the IRS will be looking to match that number, not the net sales, so make sure that this is all accounted for otherwise expect to pay penalties. Every side job, gig, or sale paid in cash, barter or other method needs to be reported as income. Don’t forget about payments made through a different source such as Venmo or wire transfer! The best solution is to stay on top of all income sources with documentation to back it up - maintain organized bookkeeping on a regular basis. Also, don’t forget to treat anything you’ve received for goods or services - including bartering, an exchange of services or virtual currency - as income.
Mistake #4: Mixing up personal and business
Separate your business and personal finances by using separate accounts. When they’re in separate accounts, it makes it easier to organize and record keep. You’ll reduce the likelihood of errors, like missing out on possible deductions. Accurate records can help you reduce your chances of being hit with penalties from over or understating business expenses and income as well.
In order to keep a clear record of all business transactions, consider opening up separate accounts for your personal and business entities. Also, be mindful of personal assets used for business such as your vehicle, home office and utilities, i.e. cell phone or internet.
Mistake #5: Not saving for taxes
There are wonderful, amazing benefits to being self-employed. You have a lot of autonomy over your day-to-day work schedule. You determine who you work with and in what way, and you generally have a lot more control in your ability to increase your income. However, all these wonderful, amazing benefits come at a cost. For one, you’re taking on all the risk as an employer. Another cost is being responsible for paying your own taxes and having the burden of learning what taxes you’ll be responsible for.
The kind of business you have set up will determine the various types of taxes you’ll owe. For example, partnerships and sole proprietors will need to pay self-employment taxes based on their net self-employment income. There's a 15.3% additional tax for self-employment owners in addition to regular income taxes on their business. Owners of s-corps will pay for their payroll taxes on the individual-level and at the corporate level (so as the business owner, you’re technically paying all of those taxes).
Consider putting money into a savings account that’s solely for tax obligations. You can work with your accountant on coming up with a number that works, but a good rule of thumb for income taxes and self-employment taxes is to save 10-30% of everything your business earns.
Mistake #6: Not reviewing your tax return
Please review your tax return to make sure there aren’t any mistakes that jump out at you or a correction you forgot to relay to your accountant. It’s a simple mistake with a simple solution: don’t assume all details in your tax return are correct, review everything before you submit! Entering in any incorrect business information - i.e. name, address, or tax identification number - can slow the whole process down, and even incite an audit by the IRS.
Mistake #7: Using messy or incomplete recordkeeping
Build a strong foundation and get your record keeping cleaned up before tax filing, by getting all of your information together in one, single space. Keep in mind that the best record keeping system is one you’ll actually use, so use one that’s easy or even automates part of the process. Lasty, know when to bring on help - the cost of hiring a professional will save you time, stress and money in the long run. Don’t hesitate, reach out to us at Hell Yeah Bookkeeping to get you started now!