We’ve already posted several recent blogs about taxes. The reason is simple: every dollar you pay in taxes is a dollar you can’t use for business expansion, employee compensation and benefits, and investor remuneration. Legally minimizing your tax bill is just good business.
Not counting poor record-keeping, the three biggest mistakes we see that entrepreneurs make are—
Classifying employees as independent contractors
There’s a temptation for small business owners to hire “independent contractors” to avoid minimum wage and overtime pay rules. It’s also a way to circumvent unemployment insurance, payroll taxes and workers’ compensation expenses.
You’ll have a hard time convincing the IRS that an “independent contractor” isn’t actually an employee if that individual is critical to running your day-to-day business . . . or if you set mandatory work hours and provide a work space.
If your “independent contractor” isn’t free to hire his or her own staff or accept work from other clients, he or she will almost always be considered an employee.
Confusing a personal loan and an equity investment
We’ve seen it happen many times: the company has a cash shortfall and the small business owner writes a personal check to infuse cash into the company. Is it a loan or an equity investment?
For the IRS to consider it a loan, there needs to be supporting documentation: a formal loan agreement (similar to one you’d sign with a bank) with a fixed schedule for repayment and an applicable interest rate.
Then, if the company repays the loan, it can write it off as a legitimate business expense. Or, if it fails to repay the loan, you can write it off as a bad debt on your personal income tax return.
Mixing personal and business finances
Unfortunately, comingling funds is fairly common with entrepreneurs, especially in the start-up phase. You need something for the business and buy it with cash in your pocket or with your personal credit card.
Or you don’t have room on your personal credit card for an emergency expense and use company funds or the company credit card, figuring it’s all your money anyway.
Mixing personal and business funds impacts control of your business expenses, as well as determining your business’ true profit and loss, ascertaining your personal income, and appropriately filing your business and personal tax returns.
Your bookkeeping can become chaotic leading to errors on your tax returns, exposing you to IRS fines for errors. Even worse, the IRS might conclude that your business is actually a hobby, nullifying all your business expenses.
As soon as your business becomes an entity, you need to open a company checking account and company credit cards. You should also obtain a bookkeeping software program to separately keep track of both your business and personal income and expenses.