Being a small business owner can be tough, especially when tax season rolls around. The deadline for filing taxes is April 15th, and this applies to individuals, sole proprietorships, partnerships, and many limited liability companies. It can be a steep learning curve to file your business taxes, and you might find yourself scrambling to find the right forms and missing receipts.
If you’re a sole proprietor, you’ll need to fill out the long form 1040, along with Schedule C and Schedule SE. It’s important to get this right, as you don’t want to miss out on any money or risk an audit from the IRS. Here are some common tax mistakes that sole proprietors often make:
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Not Paying Your Quarterly Taxes: As a business, including sole proprietorships, you’re required to pay estimated taxes on a quarterly basis. You get a pass for the first year of your business, and there are certain exceptions based on your income. But it’s important to keep up with these payments to avoid penalties or surprises come April 15th. Many sole proprietors set aside a percentage of each payment they receive, like a self-imposed tax withholding. When it’s time to make a quarterly payment, they review their profit/loss statement and estimate their bill. If you need help with this, a tax advisor can assist.
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Under Reporting Your Business Income: The IRS found that sole proprietors under reported business income by $68 billion in 2001. If you’re a sole proprietor and earned more than $600 during the tax year, the business you worked for should send you a 1099-MISC form stating your compensation. The IRS will receive the same form, so they’ll know if you didn’t report the income. Even if you don’t receive a 1099-MISC, you still need to report that income. If you receive a 1099-MISC and the reported income is incorrect, you’ll need to contact the issuing business to correct it. Wait to receive the amended 1099-MISC before filing your taxes.
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Problems with the Home Office Deduction: Many sole proprietors are hesitant to take the home office deduction because they fear it will trigger an audit. But if you’re entitled to the deduction, you should take it. To qualify, your home office needs to be used exclusively for business purposes. The IRS introduced a simplified method for calculating the home office deduction in 2013, which involves measuring your home office space and multiplying the square footage by $5. This method is quicker, but it might not give you the biggest deduction. It’s worth calculating the home office deduction using both the actual expense and simplified method to see which is more beneficial.
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Over Deducting Your Gifts: Business gifts can be deducted as a business expense, but only the first $25 per recipient is deductible. If you gave a client a $75 gift certificate, you can only deduct $25. If you report $2,000 in deductible business gifts for the year, it means you gave gifts to at least 80 different people. Make sure you can back this up.
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Mixing Equipment and Supplies: Many sole proprietors get confused about which business expenses are considered equipment and which are supplies. Supplies are things that get used up during the year, like printer ink, paper, and envelopes. Equipment is typically higher-value items that last longer than a year, like computers, software, and office furniture. Supplies are reported on Schedule C, but equipment needs to be reported on Form 4562. If you deduct your equipment as supplies on Schedule C, the IRS might determine that you incorrectly reported the expense and you’re not entitled to the deduction.
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Not Reporting All Your Expenses: From the moment you start a business, there are many deductible business expenses you can take advantage of. These include big expenses like equipment, mobile phone plans, health insurance premiums, and travel expenses. Sole proprietors should also keep track of any miscellaneous expenses, as they can add up. Examples include books, online courses, mileage to meet with clients, web hosting, stamps, etc. The biggest mistake is failing to track these expenses throughout the year, and trying to gather every receipt or remember every trip when April 15th rolls around. Remember, you can’t deduct what you can’t document.
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Choosing the Wrong Legal Entity: Depending on their tax bracket and amount of self-employment taxes, sole proprietors may end up paying more in taxes than owners of a corporation. In this case, creating a C Corporation, S Corporation, or LLC that’s taxed like an S Corp could help lower their tax bill. If you’re wondering if you should change your business structure for 2014, a quick discussion with a tax advisor or CPA can help you determine what’s right for your situation.
