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Avoiding Tax Pitfalls of Small Businesses

There are many tax advantages available to small businesses, but year after year, business owners and officers fall into the same tax pitfalls.   The Internal Revenue Service (IRS) audits thousands of corporations and small business annually, often finding severe and damaging errors.  Below are some of the more common mistakes small businesses make on their tax obligations, and how to avoid them.

Not paying or withholding enough tax

The most obvious, but most common pitfall businesses face with regards to their tax payments is simply not paying or not withholding enough tax.  Businesses that deal in cash transactions are often more susceptible due to a lack of record keeping on cash payments.  This can result in underreporting of revenue and over reporting of expenses, leaving the business susceptible to noncompliance.

Another area where businesses can get into trouble is not withholding or paying the requisite taxes.  This includes, but is not limited to, income taxes, Social Security and Medicaid taxes, and unemployment taxes for employees.  Most businesses will be affected by cash flow problems at some point.  Failure to pay the withholding taxes due to cash flow problems can lead to substantial tax liabilities and penalties for the company.

Employee Classification

Properly classifying your employers is both a tricky and risky business.  Business owners must pay employment taxes for employees, but none is required for independent contractors.  This often leads to confusion because owners and officers may label a worker as an independent contractor when they should actually be classified as an employee for tax purposes.  The IRS looks at a variety of factors to determine the type of relationship between worker and business for tax purposes.  Check out IRS publication 15-A, Employer’s Supplemental Tax Guide, for more on employee classification.

While hiring independent contractors can save expenses for business owners, it can actually cost the business owner more in the long-run if this is not done properly. Still unsure on the difference between an employee or contractor?  Contact our office to help sort it out.

Co-mingling of Business and Personal Funds

 When starting a business, co-mingling of funds is the easiest way to get into tax trouble.  Co-mingling of funds means treating business funds the same as personal money, or transferring money from business accounts to personal accounts without proper documentation.

It is very important for small business owners to have separate bank accounts for personal and business expenses.  In addition, the owner should document all income and expense transactions flowing in and out of the business account.

Proper Corporation Formation

There are many different ways to form a business: limited liability corporations, professional corporations, sole proprietorships, etc.. Each has its own unique set of tax implications.

When starting a small business, it is important to form the business properly to ensure sufficient protection of the owner’s personal assets, as well as taking advantage of the unique tax incentives.  The most popular business formation for small businesses is a limited liability company (LLC).  LLCs are easier to set-up and administer than other types of business formations.

No matter what type of business formation, every type of business structure has specific filing requirements with the IRS.  Failure to file the proper tax forms for the small business can result in late filing fees and penalties from the IRS.

These small business tax pitfalls can be prevented or mitigated with the advice and help of a knowledgeable tax attorney.  If you are an owner or officer of a corporation and are concerned that you may fall into one of these small business tax traps, feel free to contact our firm for a complimentary consultation.  The attorneys at JDKatz, P.C. can assist small businesses from formation and structuring to worker contracts and tax controversy.

For more on our business services, visit:  http://www.jdkatz.com/practice-areas/business-transactions/

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At JDKatz: Attorneys at Law, each of our attorneys brings a unique set of experiences and perspectives to bear on our clients’ legal problems. For each case or task we take on, we assemble a team of lawyers ideally situated to our client’s specific needs and goals. Our managing partner, Jeffrey D. Katz, founded our firm in 2000 after starting his career in the tax department of Big Four accounting firm KPMG Peat Marwick. To learn more about our attorneys’ backgrounds and qualifications, please review their individual profiles.

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