Plan Ahead to Avoid Tax Time Surprises 10 tips to make tax time easy and hassle-free
By Sujan Patel Edited by Dan Bova
Opinions expressed by Entrepreneur contributors are their own.
Self-employment can be so liberating. Being an entrepreneur and launching your own business provides tremendous freedom that you just can't get working for someone else.
At least until tax time arrives.
Related: When Starting a Business, Beware All the Taxes and Regulations
Entrepreneurs must take a totally different approach to taxes than the average worker. For example, when you work for someone else, your employer takes care of withholding taxes from your checks. But when you're self-employed, that tax requirement falls squarely on your shoulders.
For the uninitiated entrepreneur, not understanding these tax requirements could mean an unpleasant surprise at tax time. Follow these tips to help you plan ahead and avoid any last-minute tax time surprises.
1. Know your self-employment tax obligations.
As mentioned above, you have to pay self-employment tax if you work for yourself. That doesn't apply just to individuals working alone or sole proprietors: Members of LLCs and business partnerships are also subject to a percentage-based self-employment tax. Part of this tax goes to Social Security and part to Medicare. This is in addition to individual income tax.
2. Calculate your tax obligation.
If your business earns a net annual income of more than $400, you'll owe self-employment taxes. If this is the first year that you're in business for yourself, you'll need to estimate how much money you expect to earn by December 31st. Otherwise, you can use IRS Schedule SE, a worksheet to help you figure out your tax obligation based on your prior year's tax return.
3. Don't wait to pay
Because entrepreneurs don't pay taxes regularly from a paycheck, the IRS fully expects quarterly estimated payments.
The IRS has established fixed due dates for every quarter. If you don't pay, or you underpay, the IRS will charge a penalty, even if you're eligible for a refund at the end of the tax year.
In addition, know the absolute deadline dates to file your business tax returns.
4. Keep up on your numbers.
All too often, entrepreneurs wait until the end of the tax year to start gathering receipts and calculating expenses. But this just invites mistakes, which often lead to nasty surprises and even audits.
It's smarter, and safer, to use an accounting service like Indinero.com and automated payroll services like Wagepoint than it is to do everything by hand, with physical receipts and Excel spreadsheets. This eliminates the rush and makes it easier to complete quarterly payments and filings at the end of the tax season.
Related: 10 Year-End Smart Tax Strategies for Business Owners
5. Properly designate employees.
Entrepreneurs often hire contract employees such as freelancers, in addition to in-house employees. Freelancers are responsible for their own taxes.
If you make the mistake of mixing up employee designations and the IRS determines that a worker is an employee rather than a contractor, you could be hit with costly penalties and a huge tax bill from unpaid Social Security and Medicare taxes.
6. Keep separate accounts.
It's hard to know if your business is going to succeed when you first launch, but that's no reason to merge your business and personal checking accounts. From the moment you plan to start a business, you need to get a business checking account to obtain appropriate business savings.
These accounts should be used solely for business expenses, with no personal charges or withdrawals. If you commingle charges, then you could find yourself on the hook for business tax debts.
7. Know your deductions
This is another area where it pays to use an accounting service, so talk with certified tax accountants as necessary.
There are a lot of allowable deductions specifically for startups, and even more tax deductions for small businesses, if you know about them. A professional accountant can help you maximize your deductions. For example, you can deduct up to $5,000 for research and development as well as startup costs.
Just make sure you're claiming all of your available deductions; many entrepreneurs don't. For example, 7.6 million filers claimed a home office deduction in tax year 2011-- but that was just 32 percent of eligible filers.
"Many small businesses assume they can deduct all of their costs in starting a new busines, but they cannot until they have their first sale," says Gail Rosen, CPA. "Then, costs are deductible based on the laws for that deduction."
8. Save for liability.
Even if you think you've got your taxes covered, you need to set funds aside in the event that you have fines, penalties or a larger tax obligation than you calculated. The last thing you want is a tax debt that accrues additional fees and penalties due to being late while you scramble to put funds together.
9. Think about the future.
If you're going to seek funding in the next year, talk to an accountant about your reporting method (cash or accrual). This will impact your P&L. When a lender is underwriting a loan, or you're talking to a VC, less profit can have an effect on whether or not you're approved.
Related: The Top 4 Tax Strategies To Save Your Business Money
10. Get the tools and people you need now.
Richard Milam, CEO of EnableSoft, advised looking at your current systems to see where you can optimize before the end of the year: "Get the tools you need and get ahead of the year end rush so you're not playing defense at tax time," he said. "If something needs to be updated, take care of it, so when it's time to close the books, the data is in place and it's clean."
