It is that time of year again, tax time! Many people like this time of year because they are excited to receive their refund. Others dread it because they know they will owe more taxes. Whichever camp you fall into, you still have to file your taxes. The tax rules can be confusing, especially if you are new to owning a business.
I am an enrolled agent and have been doing accounting and taxes for individuals and businesses for almost ten years. I have seen a lot of different tax situations. It is inevitable that some of the same questions and situations continue to come up every year. Here are several tax tips for small business owners that will help you get on track.
These tax tips for small business owners and the self employed are easy to follow and can have many benefits for you. They will help make your life easier and keep you on track all year. The tips will also ultimately help your CPA or accountant too!
Tax Tip #1: Don’t Be Afraid of the IRS
We have all heard someone who has a horror story involving the IRS. You might have someone you know who claims the IRS garnished their wages or seized their property without any warning.
I am here to tell you that the IRS does not simply garnish your wages or seize your property without notice. You receive several letters and have a chance to negotiate or appeal before this step occurs.
The IRS will work with you if you have trouble paying your taxes. The most important thing to remember is not to ignore any correspondence from the IRS. Always respond in a timely manner by the date listed on the letter. File your taxes and tax extensions on time. Set up arrangements for a payment plan if you cannot pay all your taxes right away.
If you ignore the correspondence the IRS sends you, then you are opening yourself up to bigger consequences. While you will not get out of paying your taxes completely, you can keep yourself from the more severe steps the IRS can legally take against you.
Tax Tip #2: Track Your Mileage
When you are a business owner, you are able to deduct some expenses related to you car. You can choose to take mileage or you can choose to take actual expenses. Actual expenses includes things like gas and repairs. You cannot take both types of expenses. Parking and tolls are able to be taken separately, regardless of if you use mileage or actual expenses.
Most of the time, mileage ends up being the bigger deduction. The mileage rate changes each year, but is 57.5 cents per mile for 2020. You can get a mileage log or simply track it on a notebook or spreadsheet. Write down all your business related mileage. Make note of your starting mileage and ending mileage for the year. This way, you can properly calculate which portion is business related and which portion is personal.
It is important to note that commuting to and from a regular workplace do not count as mileage. Contractors that drive to different job sites can count that mileage.
Save yourself some time and get into the habit of tracking your mileage from the start. You will then easily be able to calculate if mileage or actual expenses is more beneficial for you at the end of the year.
Tax Tip #3: Have a Separate Account if Possible
Keeping your business and personal expenses separate is easier for both you and the person doing your taxes! Starting out, you may not have a separate business bank account. You could use a specified credit card or other account if you have one.
As someone who has done my share of reconciling the books for businesses, please keep the expenses separate if you can. It takes a lot more time to have to go through all of your personal expenses to weed out the business ones. It also saves time going back and forth asking you questions about which ones are actually business related.
If you are not able to separate them into different accounts, it is very helpful for you to go through your statements and highlight or mark the ones that are business related. Saving your accountant some time also saves you money in the tax preparation or accounting fees. You might think you only have a few transactions that will not take long to reconcile. The time your accountant spends on this can quickly add up if you are not organized or have a lot of personal expenses mixed in with the business ones.
Tax Tip #4: Draws Are Not the Same as Payroll
As a small business owner, you likely take money out of your business account and use it for personal reasons. This could be through a regular withdrawal, ATM withdrawal, or even a personal purchase at a retail store. It is fine to take withdrawals, but you must understand that this is not the same as payroll.
Payroll involves running an actual paycheck and having payroll taxes (social security and Medicare) taken out of your check. When you simply make a withdrawal from your bank account, no payroll taxes are being paid. Therefore, it is not payroll. Some businesses, like S-Corps, require you to run a yearly payroll. If you are not this type of business, you are probably not required to take a salary. Always check with your CPA or accountant to make sure you are not required to take a salary due to your business structure type.
Speaking of draws, try not to take out more than your profit in draws. This causes an issue and you may end up having to pay tax on the excess money you withdrew. This typically happens when someone has a loss and takes withdrawals or when they take out large amounts of money. This is a subject all on it’s own, but I wanted to briefly mention it here.
Tax Tip #5: The Balance in Your Bank Account Does Not Equal Profit
There seems to be a lot of confusion surrounding this topic. I have had several people who are surprised at their actual profit number. They think that since the profit is more than what their bank balance is, that it cannot possibly be correct. “If I made that much in profit, why do I not have any money in the bank??”
There are a lot of factors that influence your actual profit or loss amount. Remember the draws vs payroll that we talked about earlier? The draws are usually what explains the difference here. Taking money out of the account for personal reasons does not count as a deductible expense. You still have to pay taxes on this money. This means that the money you draw out lowers your bank account balance, but does not lower your profit number. Knowing that these are different will save you a lot of headache later on!
Tax Tip #6: Make Estimated Tax Payments
This likely will not apply to you until you are making a good profit. Estimated payments are important for those who are making a large enough profit. There is no set amount for what your profit should be before making these payments. It can depend upon a variety of factors including other sources of income and withholding that you may have. You can work with your CPA or accountant to figure out if you should be making estimated payments.
Estimated payments are important for many reasons. First, making timely estimated payments help you avoid underpayment penalties. No one wants to pay penalties that could have been avoided! The payments are due four times a year (January 15, April 15, June 15, and September 15).
Making estimated payments also helps you avoid a large, unexpected tax bill on April 15. This is especially important if your business is your only source of income. If you are not receiving a W-2, you are not paying in any withholding tax. The estimated payments serve the same purpose as if you had been paying in through your W-2. If you make a large profit, and have not made any estimated payments, you are going to have a large tax bill at the end of the year.
Taxes do not have to be stressful. They can be confusing for some, but taking a little time to understand the basics will hopefully help keep your stress levels about taxes down.
Also make sure you are following Journey for Jasmine on Facebook and Instagram. I am posting weekly tax tips aimed at helping small business owners and the self employed every Friday through the tax deadline.
Hopefully you found these tax tips for small business owners helpful! Let me know in the comments if you have any tax related questions you would like to see answered in future posts or in our weekly social media tax tips.
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