You might be committing tax fraud and not even know it.
3 bookkeeping mistakes that will cost you - big time.
You're working hard on your passion. You take good care of your clients and employees, and then one day - slap! - you're hit with bad news. You've been making mistakes you didn't even know you were making , costing you money and worse case - jail time.
If you're a small business owner, there's a good chance you started your business because you had a passion, a skill, a way to help others around you - and most likely that passion didn't include the administrative burden and legal responsibility of staying tax compliant...I know...shocker!
Today we're breaking down the 3 most common tax mistakes we see and the importance of proper bookkeeping for small businesses.
Mistake #1: Not Reporting All Income
We get it. Everyone wants to find ways to lower their tax bill. You work hard for your money - and then watch as it flies out the window -- 👋 💸
However, taking the advice of that "friend" who says he hasn't reported his full income in 7 years (yikes) isn't the way to save money on taxes.
Here are the consequences:
Big money fines -- you could be fined up to 75% of the total unreported income. Meaning, if you under report your small business income by $100,000, you're looking at a $75,000 fine. Remember the money you were trying to save...?
Possibility of criminal charges -- Jail time? If the underreporting is willful you could be charged with fraud and sentenced to jail. You would be shocked at the number of business owners who have been charged with jail time. All this to save money on taxes, when you could have hired a small business bookkeeper 😉
Slowed Business Growth -- there will be a time when your business looks to expand, open a new location, buy new equipment, etc. Most likely you'll want to utilize a small business loan or line of credit for this new growth. However, by improperly recording your income, your debt to income ratio will not be optimal for obtaining financing.
Short story -- your bank thinks you look broke and that's never a good look.
How do you avoid it?
Keep Accurate Records. To properly report your income, you have to know how much money you make -- I know, we're really smart. Seriously, you need a trackable way to know how much money is coming in and how much is going out.
Why? This will ensure you're maximizing your deductions, keeping track of your profitability, and accurately reporting your income to the IRS.
Using a system and bookkeeper to keep accurate records is the key to helping you remain profitable, reduce your tax liability, and of course stay out of jail.
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Mistake #2: Overstating Deductions
If you're like most founders and entrepreneurs you are looking for deductions for your small business. Why? The IRS allows you to take these deductions to reduce the amount of tax you owe. They're like little breaks that the government gives you to help your business keep more of the money it earns.
However, some small businesses overstate or get too greedy with the deductions they claim. You might do this because you want to pay less in taxes or think it's an easy way to save money. But the problem is, if you claim too many deductions that shouldn’t be claimed - it could lead to trouble.
Here are the consequences:
No Financing: If you overstate deductions that could leave you with a profit and loss statement that shows losses or little net income, any lender would read that as your company is not profitable and it will be very hard to obtain funds through financing.
The "A" Word: "Audit", yep we said it - Audit. Your small business could be at risk of an IRS audit due to overstating deductions. This is one of the big red flags of triggering an IRS Audit. Claim a lot of travel and entertainment? Claiming consistent losses due to expenses? Big charitable donations? You could be at risk. 🚩🚩🚩
Legal consequences and fines: Additionally, you could be at risk for big fines and legal consequences. If it's found that your small business deductions are invalid - you could end up paying more in taxes. Even worse, if it's found that your deductions are false, you could be looking at fraudulent charges, and you guessed it -- jail time.
How do you avoid it?
In addition to keeping good records as stated above, a certified small business bookkeeper can help you navigate which deductions you should be claiming. Your bookkeeper might even find new deductions you haven't taken advantage of yet.
Showing up to your local accountant with a pile of receipts isn't a good strategy for claiming deductions. Find a small business bookkeeper who is knowledgeable in your industry and has helped similar clients to you.
Mistake #3: Improper Classification of Employees & Contractors
It's always so exciting when you hire your first employee. You from solopreneur ton. a team of two, and eventually your small business grows to the team you've always wanted.
When it comes to scaling your business through hiring, I know there are so many questions running through your mind.
How much should I pay my first employee?
How should I run payroll for my small business?
Should I pay employees as W2 employees or 1099 contractors?
W2 vs 1099 vs Seasonal vs Part-Time?
It's so important to have a plan for these questions. This is how we will identify how your employee will be classified and paid.
Too often we see small business owners improperly classify workers as a contractor when they should be paid as a W2 employee.
Why? Sometimes this is due to misinformation. However, we often see small businesses misclassify employees to save money and avoid paying certain taxes or benefits that employees are entitled to. This can lead to serious penalties and legal issues.
So what's the difference? Here's a simple breakdown:
Independent Contractor: These individuals are self-employed and the income they make is subject to self-employment tax. They are in control of their time and must submit invoices for work completed.
Employee: Employees perform a service for a business. The business is in control of what is to be done and how it should be completed. Employees are subject to FICA Tax.
You can see more details about classification on the IRS website here.
Here are the consequences:
More Fine & Penalties: So, what if you misclassify an employee or contractor? It's a common mistake that can lead to penalties, back taxes, and legal issues.
If the IRS determines misclassification, you might be required to pay back taxes based on the number of W2s the company failed to file.
We’re not just talking about the IRS either. The state departments of revenue, state labor departments, and the federal labor department all have regulations regarding classification of employees and assess their own fines and penalties along with the IRS.
And More Legal Consequences: Because the IRS and other departments take this penalty very seriously, if found that the misclassification was willful you could face criminal charges per violation. Meaning, jail time, class action lawsuits, and wage claim audits.
Yeah, doesn't sound worth it, right? How can you avoid this? Consult with a bookkeeper and tax strategist and map out a plan for the type of employee / contractor you need in your business.
Conclusion
While all of these mistakes can feel overwhelming, that doesn't have to be the case. The right team can help you develop a strategy to ensure you are compliant, getting the maximum about of deductions possible, and help you grow your team
Looking for help? There are many options for finding a certified bookkeeper.
Run a creative business? Look for bookkeepers for creatives. Professional Services? Google search -- Professional services bookkeeper near me. You could ask around your industry contacts or even see if there are local bookkeeper recommendations.
Of course, our team is here to help you navigate your next step. You can schedule a free consultation with us by clicking here -- and if you aren't quite sure about pricing, be sure to look at our bookkeeping pricing here.