As a small business owner, you probably know that willfully avoiding paying taxes will lead to severe problems with the IRS. However, IRS problems aren’t always a result of a business owner’s intentional actions. Here are five ways a small business owner can get in trouble with the IRS — often unintentionally.
1. Under-Reporting Income
All business income must be reported to the IRS. Even if you are a freelancer, receive contract payments, or are paid in cash, you must let the IRS know or risk hefty fines and penalties on top of the tax you owe on that income. Some individual self-employed people fail to pay taxes — either due to lack of knowledge about tax laws or tax evasion — and do not realize they are responsible for up to six years of back tax returns. Take note: if you do need to file back tax returns, many deductions are not claimable on more than the most recent three returns. Unclaimed income, up to six years prior, must be filed; however, the benefit of deductions is lost beyond three years ago. It’s always to your advantage to keep current with income reporting, to allowably match all of the deductions against that income.
2. Over-Reporting Expenses
Keep business expenses separate, preferably paid from a separate account and with a separate credit card, so that your personal expenses do not get mixed in with those for your business. The most common over-reported expenses are private travel being claimed as business travel, and private miles driven and claimed as business miles. If you’re not sure what qualifies as an actual business expense, consult with your tax preparer or accountant. At Baum CPA, we’re always ready to help answer your questions — just call us at 719-493-9499! For a business expense to be deductible, it must be ordinary and necessary. An “ordinary” expense is common and accepted in your business; a “necessary” expense is helpful and appropriate for your business. Expenses like the cost of goods sold (what you spend to acquire or produce what it is you sell) and capital expenses (costs that are part of your investment in your overall business) are figured separately from business expenses — but they all legitimately deduct from income to calculate “the bottom line.”
3. Failing to Report and Pay “Trust Fund Taxes”
As an employer, you must withhold taxes from employee earnings. These are income tax, Social Security, and Medicare taxes (aka “withholdings”). These taxes are not paid to employees as net wages, but are held “in trust” until paid to the U.S. Treasury (or state Comptroller, for state income tax withholdings). These withholdings are money that belongs to the Government as soon as the employee receives their remaining net pay. Thus, the name “trust fund taxes.” Sales tax is also considered a “trust fund” tax since it is collected from someone else like a customer or client and held until paid to the recipient Treasury. All trust fund taxes must be paid and reported to the proper taxing authority and cannot be used for operating or financing a business. If they are, it is a criminal violation of public trust, and if also not reported, it is criminal tax fraud.
4. Forgetting the Self-Employment Tax
Just like an employer must withhold Social Security and Medicare taxes from employees (and pay a matching contribution to each, on top of the withheld portion), if you are self-employed, you must pay self-employment (SE) tax, consisting of Social Security and Medicare taxes, to the U.S. Treasury. The SE tax is 15.3% — 12.4% for Social Security (old-age, survivors, and disability insurance) plus 2.9% for Medicare (hospital insurance) — of net self-employment income, in addition to income taxes. Net income means it is calculated after business expenses are deducted. Note that SE tax does not include any other taxes that self-employed individuals may be required to file, so these individuals must consult their tax preparer or accountant to be sure they are paying all the required taxes. Baum CPA is experienced and helpful with all small business and self-employment tax issues. Click here to schedule an initial consultation with us today.
We can help explain how self-employed individuals can deduct the employer matching contribution portion of the SE tax when calculating their adjusted gross income (AGI), for example. Also, keep in mind that the tax is paid only on net self-employment earnings, that is, income after business expenses are deducted.
5. Not Paying Estimated Quarterly Taxes
As a small business owner, you are not required to pay yourself with a formal paycheck that has taxes withheld, like your wage-earning employees receive from you. However, this does not mean there are no taxes due to the IRS. If a small business owner anticipates a personal tax liability of $1,000 or more, they must send estimated quarterly tax payments to the IRS. Not doing this can lead to a whopping end-of-year tax bill with penalties, too. (For some instant help on this topic of estimated quarterly taxes, take a look at our blog from Feb 28, 2022!)
As mentioned above, always consult your tax preparer or trusted accountant to help you make sure you stay in the clear with the IRS. Why not treat yourself to extra peace of mind by making Baum CPA your trusted accountant and professional tax preparer? We know how small business owners can stay out of trouble. To schedule an initial consultation with us today, click here.
This blog and its authors provide this content strictly for informational purposes. No content herein should be misconstrued as financial advice. Everyone’s specific circumstances vary — Always consult with a qualified, licensed financial advisor, legal counsel, and tax professional before venturing into any investment or business activities.