Top 20 Small Business Tax Mistakes

Filing a tax return for your business each year is something you must do. But you don’t want to make mistakes that can result in higher taxes than you really owe, draw IRS attention to your return, or cost you interest and penalties. Here are 20 mistakes to avoid:

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Tax Mistakes

1. Misreporting Income

Income may be reported to you (and to the IRS) on information returns, such as Form 1099-MISC showing nonemployee compensation for 2019 (or 1099-NEC after 2019) if you’re an independent contractor or Form 1099-K showing credit card and certain other transactions, regardless of your entity type (e.g., sole proprietorship, C corporation) if you have a certain amount of transactions. IRS computers see what’s been reported to you, so it’s essential that you pick up the information correctly. If the forms are wrong and you can’t get the sender to correct them, report the wrong amount with a proper adjustment, and then attach an explanation to your return so you’re only taxed on the correct amount.

2. Failing to Report Income

If you barter for business goods and services, the transaction is taxable to you. This is so whether you trade one-on-one or go through a barter exchange. Similarly, if you use virtual currency to pay or get paid for goods and services, you also have to report the transactions appropriately. The IRS is looking closely at virtual currency transactions.

3. Overreporting Income

If you sell inventory items, you must factor in the cost of goods sold so that you don’t pay tax on the gross receipts from sales. Your income is only the difference between what you get for an item and what it cost you (based on how you value your inventory).

4. Not Applying the Limitation on Deducting Meals

Only 50% of certain business meals are deductible. Even though wining and dining a customer or paying for your own meals while out of town on business is a legitimate business expense, you can only deduct half of the cost.

5. Mixing Personal and Business Finances

If you don’t separate them, it’s all too easy to overlook a business deduction or erroneously treat personal income as business revenue. Keep a separate business bank account and use a separate business credit card to ensure you keep business income and expenses clear.

6. Not having a Mileage Record

If you use your personal vehicle for business driving, you are required to keep certain records. If you don’t, your deduction for business driving is lost. Recordkeeping requirements for this are in IRS Publication 463.

7. Thinking the Home Office Deduction is an Audit Red Flag

This is a common belief that probably should be dispelled. If you work from home and are eligible for the home office deduction, take it. Find information about the home office deduction from the IRS.

8. Tax Mistakes from Overlooking Pre-opening Expenses

If this is your first year in business, you may be able to take a deduction for startup costs incurred before you opened your doors. This can be as much as $5,000 in your first year, with excess costs deducted ratably over 15 years. Special rules apply if total startup costs exceed $50,000.

9. Not Utilizing Retirement Plans

Contributions from qualified plans cut your current tax bill while saving for the future. There are numerous retirement plan choices. For example, if you don’t yet have a plan, you can set up a SEP by the extended due date of your return and contribute to it for the year of that return. What’s more, you may even qualify for a tax credit for starting a plan.

10. Failing to Keep Basis Records

Business losses that pass through to partners and S corporation shareholders can be claimed on their personal returns only up to certain basis amounts. For example, an S corporation owner’s loss deduction is limited to basis in stock and loans he/she made to the corporation. Without such records, losses are lost. Similarly, gain on the sale of business property is not the amount of proceeds received; it’s the difference between those proceeds and the basis in the property. Basis is usually the cost of acquiring the property, reduced by depreciation and increased by capital improvements.

11. Overlooking Carryovers

Some business write-offs from prior years may have been limited then but deductible now. Check for carryovers of: net operating losses, capital losses, investment interest, the home office deduction, and the general business credit.

12. Not Obtaining Acknowledgments for Charitable Contributions

If you donate $250 or more, you must have a written acknowledgment in order to take a deduction. If you didn’t receive one, ask for it before you file your return.

13. Underpaying Estimated Taxes

If you are required to pay estimated taxes, be sure to factor in all of the taxes besides income tax. This includes self-employment tax if you’re subject to it and additional Medicare taxes (0.9% tax on earned income and 3.8% on net investment income). You usually can’t wait until you file your return to pay your taxes. Underpaying estimated taxes can trigger a tax penalty.

14. Not Claiming the Qualified Business Income Deduction

This personal deduction (also called the Section 199A deduction) for owners of pass-through entities is based on business income. It’s not a business deduction, but it’s a valuable way to reduce tax liability.

15. Fudging Worker Classification

Don’t duck employer tax obligations by labeling employees as independent contractors when they’re under your control. The IRS is continually on the lookout for this mistake, and it can cost you dearly.

16. Failing to File on a Time

Watch the filing due date. If you can’t file on time for any reason, just ask for a filing extension. You don’t have to give a reason for needing more time to complete your return. Just be sure that you then file by the extended due date.

17. Failing to Attach Required Forms, Schedules, or Election Statements

Your return isn’t complete unless you include all of the paperwork required. For example, if you rely on an IRS de minimis safe harbor to deduct capital items rather than capitalizing them, you need to attach an election statement referring to the safe harbor to make it valid.

18. Not Understanding the Differences in Federal and State Tax Rules

Some tax breaks on federal returns are limited or barred for state income tax purposes. For example, a number of states have different rules when it comes to the Section 179 deduction and bonus depreciation.

19. Not Staying Up on Tax Developments

Changes in the tax law may entitle you to new tax breaks on your current return. They can even entitle you to a refund if you submit an amended return. For example, dozens of tax breaks that expired at the end of 2017 have been retroactively extended for 2018 (plus 2019 and 2020). Learn which ones may apply to you and whether you want to file for a refund.

20. Tax Mistakes Because of Not Disclosing Everything to your CPA

Things happen and the IRS may disallow deductions or otherwise change what you owe in taxes. It likely will also impose an accuracy-related penalty that can only be avoided for reasonable cause. One way to do this is to show you relied on a tax professional, but you must have disclosed all relevant information to this person to have any chance of avoiding the penalty.

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