Five Small Business Tax Blunders You Don’t
Want to Make... and How To Avoid Them.
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Stephen L. Nelson, a CPA and author of QuickBooks for Dummies, describes five of the most common tax blunders small businesses make and some easy tips to help protect your business.

New or inexperienced small business owners sometimes make terrible, easily avoidable tax blunders. And that's a tragedy. These missteps can cripple or even kill a new business that might have otherwise succeeded. Fortunately, in most cases, avoiding trouble only requires simple steps and common sense.

1. Deducting Startup Expenditures

You know what the first small business tax blunder often is? Thinking one can deduct business expenses even before the business starts operating.

This sounds nonsensical. But let me explain using the example of a restaurant.

Think about the expenses a restaurant has before that first night the establishment throws open its doors. Commonly, the restaurant might pay for advertising, employee recruiting and training, development of tasty menu items, and so forth.

You might think these expenses are all deductible as incurred. But they’re not. Rather, you only get to deduct startup expenditures after your business starts. And even then, the rules are tricky.

After your business does start, you can immediately deduct the first $5,000 of startup expenditures. But amounts in excess of $5,000 need to be deducted evenly over the first fifteen years of business.

The tax planning trick to deal with startup expenditures should be obvious:

Minimize your pre-opening expenses and try to accelerate the date you officially start operations.

2. Skipping Setup of an Accounting System

By law (federal and state tax law, that is), you need an accounting system that lets
you clearly measure your income.

If you don’t maintain such a system and you get audited, federal and state examiners can do your accounting for you. And you know what? When they do the accounting for you, they don't choose accounting methods that minimize your taxes. And they don’t select procedures that keep your bookkeeping simple. Quite the opposite.

What’s more, even if you don’t care that ultimately it’ll be an IRS agent or state examiner “doing your books,” you still shouldn’t skip setting up a good accounting system. You need a decent accounting system to track your business tax deductions and estimate taxable profits.

You need a tool like QuickBooks Simple Start, Pro, or Premier, or, if you’re truly not ready yet, a workable manual system. Enough said.

3. Incorporating Too Soon

Incorporating a small business often delivers wonderful tax benefits to profitable small businesses. Incorporating also minimizes the legal liability of the business's owners.

But in spite of all the good parts of incorporating, you should know that incorporating often greatly increases the tax accounting for the business. An un-incorporated one-person sole proprietorship often gets to do his or her tax accounting by including a single extra page (a Schedule C form) with his or her annual income tax return.

In comparison, a one-person corporation needs to file a complicated annual corporate tax return with both the federal and state authorities. The corporation typically needs to file at least a couple of quarterly payroll tax returns. And the corporation also needs to file at least a couple of annual payroll tax returns.

In summary, incorporating a small business just explodes the workload associated with doing your taxes. And incorporating means more paperwork for you—and bigger bills from your accountant.

After you get your business up and running, you probably will want to look carefully at the incorporation option. But don't rush to incorporate. Consider waiting until you're solidly profitable.

Related tip: If you are concerned about your legal liability, look at the limited liability company option. An LLC gives you legal protection but often without complicating your tax accounting.

4. Failing to Make Quarterly Deposits

If you’re an employee, you often don’t have to worry much about paying your taxes. Your employer withholds a bit of money from each payroll check. And if the total is off a bit at year-end, you either pay a little more or receive a little refund at tax time.

Small business owners, by comparison, do need to worry about paying their taxes. Specifically, the self-employed small business owner needs to pay his or her tax bill in even chunks four times a year (April 15th, June 15th, September 15th, and January 15th right after the year ends.)

If a business will owe $20,000 in income and self-employment taxes, for example, a
$5,000 quarterly payment needs to be made four times over the course of the year.

This seems like such an obvious point, but you need to make these quarterly estimated tax payments. (You use the 1040-ES forms and instructions, which are available from the www.irs.gov web site.)

The big problem with not making the quarterly deposits, by the way, isn’t the modest interest and late-payment penalty that the IRS charges when you make the payments late. The big problem is getting to the tax return deadline and finding out, “Oh my gosh, I need $20,000 to pay my taxes...”

Bottom line? Do estimate your tax bill for the year. And do pay the tax bill (or most of it) in quarterly chunks.

5. Failing to Collect or Remit Payroll and Sales Taxes

While on the subject of tax deposits, let’s cover a quick point. You need to both collect and then promptly remit any payroll taxes or sales taxes you collect for the federal or state government: employee taxes you withhold from paychecks, sales tax charged customers, and so forth.

The awkward fact about these taxes—called trust fund taxes—is that the money is never yours. You’re simply holding it in trust for the employee or the government.

The surest way to be certain you have the cash to pay these taxes is to create a "reserve" just for payroll liabilities. Transfer funds into the reserve each and every payday, just as if it were another employee. When it's time to pay liabilities, transfer the required funds back into your disbursement account.

When you are planning cash for payroll expenses, the cash required is Gross pay PLUS Employer's liabilities - all of them including taxes, insurance and so forth.

If you fail to remit a trust fund tax related to a business you operate, you’re toast. You have to pay the tax. Period. And, by the way, whether the business is incorporated or not makes no difference. You have to pay the tax—even if it means liquidating personal assets like a house or closing down your business.

Final Suggestion for anyone who’s already in trouble with trust fund taxes: Start thinking now about how you’ll raise cash to pay your trust fund debt and then talk to a local accountant about getting straight with the IRS or the state government.


More information on taxes and other important business topics can be found by visiting the Intuit Community Website. To learn more about QuickBooks products, please visit
www.quickbooks.com.
About the author: Seattle CPA Stephen L. Nelson is the author of QuickBooks for Dummies and an occasional adjunct tax professor at Golden Gate University graduate tax school. Nelson, who holds an MBA in finance and an MS in taxation, is also the editor of the Limited Liability Company Explained

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Dangers of Commingling
The IRS may not be your biggest worry if you commingle funds, i.e., you do not absolutely separate your business and personal finances. You may lose the "limited liability" protection of your LLC or S Corporation. This is referred to as "piercing the veil". Part of your corporate status is that it has the legal stature of an individual. If the corporation becomes your "alter ego", you are on dangerous ground. Avoid the dangers from the beginning.

1. Use separate bank accounts. If you are a sole proprietor or an LLC taxed as a sole proprietor, account for monies you take as an "owner's draw". If you put monies into the business, account for it as owner capitalization or if it is a loan, make sure you have documented it like any other loan.
2. Use software designed for personal or business finances. People do sometimes use QuickBooks for personal finance, but for a reasonable investment you can use Quicken, designed for personal finances, and avoid one more commingling pitfall.

For more info: Google for "commingling", "piercing the veil", "alter ego" Tax Almanac discussion about commingling Nolo.com for resources to establish your LLC

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Other Tax Information

Small Business and Self-Employed Tax Center (from IRS.gov)
This section offers a broad range of resources across federal and state agencies, as well as industry/profession specific information for self-employed entrepreneurs, employers and businesses.

Small Business and Self-Employed "Filing Season Central" (from IRS.gov)
Filing Season Central is your one stop assistance center for filing your business returns. This includes Highlights of Tax Law Changes, Tax Tips, and more.

Forms 1120 and 1065 and Related Schedules and Instructions for 2008 (from IRS.gov)
Forms 1120 and 1065, and several related schedules and instructions, released July 2008 for public comment, are now final. Changes to the forms increase the transparency of the relationship between entities that make up complex business enterprises.

Industry Issue Focus (from IRS.gov)
The Large and Mid-Size Business Division (LMSB) of the IRS is implementing an Industry Issue Focus (IIF) approach to compliance as part of its overall issue management strategy. Under this approach, issues are identified and prioritized based on industry impact and level of compliance risk.