Now that the 2013 tax filing season is behind us, the temptation for many small business owners is to try to avoid thinking about taxes until April of next year rolls around. This is unfortunate, because with a little advance planning, a small business owner can reduce his tax burden and keep more of his hard-earned money. Accordingly, for this blog I asked my colleague Ryan Cole of Integrity Financial Partners, an accounting and wealth management firm, to discuss some of the most common mistakes they see small business owners make.
Underpaying Estimated Taxes
According to Ryan Cole, one of the most common mistakes for the small business that operates as an S-Corp or as a limited liability company is the failure of its owners to properly account for and pay estimated taxes.
As an owner of an S-Corp or limited liability company, you are responsible for paying the taxes due on your income, as the income of the business is passed through and taxed at the individual level. Although it may be difficult to estimate what taxes will be due for a growing business, the tax code provides a safe harbor that will allow you to avoid penalties for underpayment. So long as you pay the lower of 90% of your current year income or 110% of prior year income through quarterly estimated taxes, you will not be subject to interest and penalties. If you pay less than these amounts, you will be subject to underpayment penalties, which is extremely wasteful in a near zero interest rate environment, where the benefits of borrowing money via underpayment of estimated taxes are negligible.
Even more damaging is the failure to budget sufficient money to pay the taxes, potentially leaving owners cash-strapped come tax time. Ironically, this problem often occurs when the business is growing and has a good year because the owner fails to increase his estimated payments to account for the increased profits of the business.
The problem typically occurs when a business owner mechanically sends out estimated tax payments for 110% of the prior year income in accordance with the tax vouchers provided by his accountant, without recalculation if the business is particularly profitable. The solution, of course, is to meet with your accountant throughout the year, or at the very least to have him do a projection at year end.
Choosing the Wrong Small Business Retirement Plan
Another common mistake many small business owners make is failing to take advantage of the many retirement plan options available to them. A good retirement plan not only benefits you in the future, but substantially reduces your taxes today. As a business owner you have many more options than an employee who is limited to their workplace 401k. An owner of a profitable business could contribute up to $51,000 to a Sep IRA, take a tax deduction and benefit from tax free growth. By contrast, a workplace 401k limits you to $17,500.
There are also a range of other small business retirement plans that can be appropriate based upon the number of employees and the cash flow needs of the business. These small business plans can also be supplemented with Roth or Traditional IRAs.
Poor Organization and Bookkeeping
This may sound simple, but business owners should use bookkeeping software and ideally a good bookkeeper. Without consistent and organized records, it is impossible to assess the after tax cash flow of the business. This is essential to determine how much to pay in estimated taxes as well as how much you can afford to contribute to retirement plans. According to Ryan Cole, accounting software, like Quickbooks or Peachtree, are the most effective at tracking streams of income and expenses in one centralized place. They are very intuitive programs to use and typically work right out of the box with minimal setup. But if you do not want to learn the ins and outs of the program, you can always hire a bookkeeper.
In sum, the key takeaway for the business owner is to take the time to do some tax planning now. Thinking about taxes only at tax time can lead to the mistakes outlined here. Make sure you sit down with your accountant throughout the year to review your cash flows, retirement planning options and to stay organized.
Frank J. Monteleone – Monteleone Law
Address: 11 Broadway, Suite 615 New York, NY 10004