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Kathy Pickering is the Chief Tax Officer for H&R Block and leader of The Tax Institute at H&R Block, a leading source for insights on federal and state tax laws affecting individuals and small businesses. With more than 20 years of experience in tax administration, Pickering oversees the enrolled agents, CPAs and attorneys who make up The Tax Institute and provide information and analysis on real-world implications of tax policy and tax proposals.
Pickering speaks about taxes and tax policy issues to policymakers, journalists, tax policy experts and tax preparers. She has appeared in broadcast and print news from CNN, CNBC, The New York Times, Wall Street Journal, USA TODAY, HuffPost, The Los Angeles Times and more. Recently, she spoke to a group of female entrepreneurs about small business taxes and received rave reviews for her insights on how to “keep the tax side of things” easy and headache free.
Brit Morin, founder of Brit + Co, writes an column for women entrepreneurs that runs every other Thursday. This week Kathy is stepping in to answer pressing small business tax questions.
Let’s all take a deep breath
Help! How do I conquer the anxiety of doing my taxes? I’m so overwhelmed with all of my business expenses, receipts, and the lack of organizing I did throughout the year. How can I make this less stressful now?
We hear this often, in part because most small business owners start their business to pursue a passion, not to crunch numbers. Taxes, bookkeeping and accounting — they can all be stressful, especially when you’re feeling unorganized and ill-prepared. Instead of worrying about what you should have done, change how you approach organizing your finances and documents going forward. For now, though, just get started. The simple act of getting started on organizing your finances, and not waiting until a tax filing deadline, can help reduce your anxiety.
As a first step, calculate how much income your business generated in 2020. How did you track that income? If you didn’t use invoicing or bookkeeping software, like Wave, you likely have bank account records. And those same bank records likely also show your business expenses. If you already set up a separate bank account and credit card for your business, well done! You won’t have to worry about untangling your personal and business finances when it’s time to file your taxes. Going back through your bank records to separate personal from business income and expenses is tedious and time-consuming, but sometimes necessary. Unfortunately, this is something many first-time small business owners learn the hard way.
Next, you’ll want to lower your taxable income by deducting some of your business expenses. Make a list of everything you spent money on to get your business up and running. Reviewing your online calendar, emails, and texts can be a great reminder of client appointments, projects, and agreements that you made. After that, try to find matching receipts and records of those expenses. If you made specific business-related trips, you can now use GPS mapping software to reconstruct your mileage logs. Going forward, you might also consider one of the many apps that make it easy to scan and save receipts through your smartphone, then automatically add them to your bookkeeping program that we covered in the first step. That way, you don’t have to keep track of all the loose paper receipts in your wallet, shoebox, or wherever else your receipts wind up.
To make things less stressful and more efficient, I highly recommend seeking the help of a small business tax professional. They can help you sort out your situation and set you up for success. Don’t be ashamed to admit that you haven’t kept the best records. You’re certainly not alone. Look for someone who will take the time to help you lay the groundwork for keeping good records, how to understand a profit and loss statement, and how much to set aside for taxes. If you’re not sure where to start, companies that specialize in small business taxes like Block Advisors can help small business owners like you succeed.
Whatever situation you’re in, you’re not the first to be there
What happens if I can’t afford to pay the taxes I owe?
My best advice is don’t panic, but don’t ignore the issue. Even if you can’t afford to pay your taxes right now, you should still file your taxes by the deadline. If you file your business tax return and can’t pay (or if your business still owes taxes from a past return), you do have options.
First, make sure the taxes you owe are accurate, because mistakes can happen. Hire a tax professional to look at your return to make sure you are filing correctly, and that you’re not missing out on any of the credits and deductions available to small business owners. If you don’t file your tax return or make a payment arrangement with the IRS, they can eventually force you to pay. The IRS can file a lien that would harm your credit, and they can levy your bank accounts and income sources, such as payments from customers.
Depending on your circumstances, the IRS offers payment options ranging from short extensions for businesses that just need a little more time to pay, to special agreements for businesses in financial hardship situations. A tax professional can help you find and evaluate which option will work best for your business, and your tax pro can even help work with the IRS to set up the agreement.
You are not the first (and certainly won’t be the last) small business owner in this situation. Take a deep breath, then take control. If you can start and run a small business, you can handle this too.
Getting audited is not the end of the world
I have an irrational fear of being audited. What are the most common mistakes you can make on your taxes that could get you in big trouble?
The word ‘audit’ is scary to a lot of people, but in many cases the fear of an audit is worse than the audit itself. It helps if you understand your rights as a taxpayer. When the IRS audits your return, it’s basically looking to see if you correctly reported your information and paid the right amount of tax. If you look at it another way, it’s just another level of IRS review, with the goal of keeping the whole system fair.
The chances of being audited by the IRS are relatively low, at nearly 2 percent for small business owners and 1 percent for individual taxpayers. If you’re confident that your information is correct and you kept good tax records, you have nothing to worry about.
Some common mistakes that can trigger small business tax audits include:
Misreporting income: If you forget to report income for which you received a 1099-NEC, you may draw the attention of the IRS. The IRS compares the amount you report on your return to any 1099s or W-2s it receives.
Disproportionate deductions: Claiming deductions that seem too high for your income level can also trigger an audit.
Home office deduction: The rules governing the home office deductions are stricter than many small business owners realize. You can only take this deduction if you use part of your home exclusively and regularly for trade or business purposes. “Regular use” usually means that the location is your main place of business. “Exclusive use” means that there can be no personal use of the space.
Even if you receive a letter from the IRS, it’s no reason to panic. First, open the letter right away — don’t set it aside in a pile of other mail. Second, review it for any actions needed or deadlines to respond by, and third, get some professional assistance.
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