If you’re just making the leap to self-employment, then preparing your own taxes can be quite confusing. Filing taxes as an employee is considerably different than filing as a business owner. Whether you hire a professional to help (recommended for many entrepreneurs) or you venture into things alone, here are some common tax mistakes to avoid.
This is a big one. You need to keep an accurate record of your income and expenses for tax purposes. If you don’t write it down, you’re liable to forget plenty of things. It’s also a bad idea to attempt to log this information on random post-its and napkins. Instead, you need to organize your records so you can find them. You can do that easily by using our tool, Money Pro. Alternately, you can use a spreadsheet, accounting software, or a dedicated paper notebook to track your income and expenses.
Every tax-deductible expense should be recorded on a timely basis. Keep all of your receipts and log everything at least once a week. ZenBusiness Money Pro can help track and tally tax deductible expenses for you, or you can manually enter them in a spreadsheet or other document. Make sure you enter the amount, date, and purpose of your expenses. Having everything logged, organized, and in one place will go a long way in making tax time easier and less stressful.
Many small business owners start off as a sole proprietorship and never consider incorporating or forming an LLC. Depending on the size and scope of your company, being a sole proprietor may be the best option. However, you owe it to yourself to at least research the benefits of incorporating.
Corporations and LLCs are legal entities that are separate from you, the owner of the business. Thus, operating your business as a corporation or an LLC helps insulate your personal finances and assets from loss if things go awry with your company.
In the tax arena, operating as an S corporation avoids the double taxation of C corporations and allows you to reduce the amount of money you pay for Social Security and Medicare taxes, also called self-employment taxes.
As a sole proprietor, you pay Social Security and Medicare through the self employment tax, which is assessed on all your business profit. Collectively, they add up to 15.4%. In a normal employment situation, the employer pays half of this tax, and the employee pays the other half. But when you’re self employed, you pay the full self employment tax rate of 15.4%.
It’s your personal responsibility to set those dollars aside based on your taxable income and pay them at tax time. You won’t have your Social Security and Medicare taxes withheld from your paycheck automatically, so make sure you do so yourself to avoid major headaches during tax season.
When you operate as a corporation, you can split your business income into two forms: salary and distribution of profits. Only your salary is subject to Social Security and Medicare taxes. The distribution is not subject to self employment or FICA tax (Social Security and Medicare for employees). Under IRS rules, you must pay yourself a “reasonable” salary for your self employment income, however. This requirement helps ensure that people still pay their share of taxes; without the requirement, people would pay themselves $1 salary and avoid employment tax altogether.
Although LLC members are usually taxed like sole proprietors, the LLC can choose to be treated as an S corporation for tax purposes. Making the LLC to S corp conversion does subject the LLC to additional regulations and paperwork, though, so the decision shouldn’t be undertaken lightly.
It’s also important to note that incorporating or converting into an S corporation doesn’t guarantee that you’ll have a lower tax burden at tax time. Corporations have additional tax burdens that sole proprietorships don’t, so one tax benefit (employment tax breaks) might not outweigh another (double taxation of business income).
If you think that changing your business structure might save you money on employment taxes, it’s highly recommended to chat with a tax professional. They’ll walk you through the calculations you need to make to see which approach is most beneficial for your unique tax situation.
Speaking of the self-employment tax, many sole-proprietors face a rude awakening at tax time if they fail to put money away ahead of time to fulfill this tax obligation. Estimated taxes are quarterly payments required when one expects to owe a significant amount in taxes. While half of your self-employment tax is deductible, it must still be paid. You also will be required to pay income tax on the income from your business. Failure to plan ahead for these taxes has resulted in plenty of tax-time anxiety and heartache for the self-employed.
As a self-employed individual, you don’t have an employer withholding taxes from your paycheck throughout the year. Instead, you’re responsible for making estimated tax payments to the IRS on a quarterly basis. These payments are designed to cover your income tax liability in advance, helping you avoid a hefty tax bill at the end of the year.
Estimated tax payments are usually due on April 15th, June 15th, September 15th, and January 15th of the following year. If you expect to owe at least $1,000 in taxes for the year, you’re required to make these payments. Failing to do so can result in an underpayment penalty, which is an additional cost you definitely want to avoid. By staying on top of your estimated payments, you can manage your cash flow more effectively and reduce stress when it’s time to file your taxes.
This is a very common tax mistake made by the self-employed. You don’t want to give Uncle Sam any more than you have to, do you? Make sure you research and take advantage of all of the tax deductions available to your business. Some commonly missed tax-deductible items are:
Make sure you take advantage of all the tax breaks you can. If you don’t, you might as well be throwing money out the window.
We get it: you went into business because you hustle, and you’re fine with a do-it-yourself approach for a lot of tasks. You don’t mind wearing all the hats. You might even enjoy it. And there’s no rule that says you have to hire an accountant for your taxes.
But for a lot of entrepreneurs, taxes are a complicated task would be better off entrusted to a professional. Part of being a good business owner is delegating tasks to the people best equipped to do them well, and taxes can absolutely fall in that category.
When you’re a “typical” employee, you might just have to file a W-2 and a few other tax forms. Those taxes aren’t too complicated. But when you’re self employed, you add so many “extras” to your tax return: business income, business deductions, employment taxes, state sales taxes, and more. With so many pieces to your tax puzzle, it’s all to easy to make mistakes during tax season.
Working with a qualified tax professional can help ensure you don’t overlook any tax liabilities and take full advantage of all the deductions available to you.
Navigating self-employment taxes can feel overwhelming, but avoiding common mistakes can save you time, money, and stress. By staying organized, keeping accurate records, understanding your tax obligations, and considering the benefits of incorporating, you can set yourself up for success. Don’t hesitate to seek professional guidance when needed — partnering with an expert can make all the difference in managing your taxes effectively. With a proactive approach, you can focus on growing your business while staying on top of your financial responsibilities.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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