Taxes can be complex for startup founders juggling multiple responsibilities at once. But investing early in proper tax planning can save time and money by helping founders avoid common filing mistakes.
Mistakes such as mixing personal and business expenses, overpaying taxes or not taking full advantage of Section 179 can have serious repercussions for startups. Here are five things they must remember in order to avoid such errors.
1. Not Keeping Track of Expenses
Launching a startup requires creating financial accounts and records from day one. Doing this prevents an embarrassing transition at tax time while protecting founders against legal violations that might threaten company status or cause legal violations to arise.
Entrepreneurs should keep meticulous records and receipts to document all payments both made and received, including one-off expenses such as equipment purchase or hire of logo designer as well as permits/licenses/fees due. Receipts/records will allow for accurate reflection of expenses as well as provide evidence should you ever face an audit.
If you employ contractors or consultants, make sure to submit 1099s by the end of every tax year in order to enable the IRS to track who is receiving payment and who is paying them; failure to do so could incur costly penalties.
2. Misclassifying Employees
Employee misclassification can be an expensive mistake startups make in an attempt to avoid payroll taxes. If a startup is caught misclassifying an employee, they could face liability for back payroll taxes, worker’s compensation insurance payments and unemployment insurance payments as well as fines and penalties imposed by authorities.
Determining whether an employee is exempt or non-exempt depends on how much control their employer exerts over their time. If a company directs employees where to be and when, then they likely fall within its definition as employees rather than contractors.
Misclassifying contractors intentionally or not can be an extremely costly mistake without professional accounting and tax support. A single mistake could cost your business hundreds of thousands in fines and back wages as well as valuable time and productivity losses.
3. Not Keeping Separate Financial Accounts
No matter the legal structure chosen for a business–whether an LLC, partnership, S corporation or C corporation–it is vital that personal and business finances remain distinct. This helps safeguard owners against liability risks while making tax filing simpler and easier.
To accomplish this goal, startups should open an individual bank account immediately for their business and never mix funds between accounts. Furthermore, using a chart of accounts – an organizational tool which records cash coming in and going out – it becomes much simpler to file accurate tax returns.
One way to avoid making this error is through accrual accounting, which involves recording income and expenses as they’re earned or incurred rather than when cash arrives at your business’s bank account. Investors tend to favor accrual accounting as it provides them with a more accurate picture of your startup’s financial health.
4. Misclassifying Equipment and Supplies
Misclassifying equipment and supplies is a common tax mistake that can lead to incorrect financial reporting and missed deductions. Equipment refers to tangible assets with long useful lives used for earning income or operating a business, while supplies refers to consumable products used regularly within an annual cycle and eventually used up.
Classifying assets correctly allows for proper deduction claims and ensures compliance with accounting standards, while also aiding inventory management and improving decision-making capabilities.
Though hiring contractors may seem like an easy way to save money, startups should carefully weigh all available options and assess the tax consequences before making their selection. One mistake could lead to substantial fines and unpaid taxes down the line; taking time before company launches to address these concerns will pay dividends later.
