When T. S. Eliot said April was “the cruelest month,” he was not referring to the fact that it was the time when taxes are due. Or was he?
For small business owners, getting ready for tax season can often feel like a cruel disruption in the midst of all of the other work that needs to be done. To make tax prep more manageable, I recommend working through these steps.
First, gather the paperwork
If you keep up with your filing, this step should not be too taxing. Most businesses keep this paperwork in electronic format, meaning it simply needs to be printed out. Some of the necessary documents that come from other institutions, such as credit card statements, may be available for download in electronic format or available to be imported directly into a spreadsheet in your accounting software.
For most businesses, the necessary paperwork will include:
- income statement,
- balance sheet,
- bank statements,
- credit card statements,
- business related receipts,
- payroll documents,
- mileage logs,
- 1099-INT forms,
- estimated tax payments,
- last year’s tax return.
Once you have gathered all of the documents related to regular business activities, take a minute to think about anything that might have been irregular during the prior tax year. Did you make any contributions to charity? If so, include the paperwork that they provided documenting the donation.
Second, review personal bank and credit accounts for corporate expenditures
As a small business owner, it is not uncommon to find yourself purchasing things for the business on a personal credit card or writing a check for a business expense from your personal account. It is also not uncommon to forget about those expenses.
Take some time during tax prep to review your personal financial records to identify any expenses that should be classified as business expenses. Perhaps you found yourself working from home for part of the year because of the COVID pandemic. Depending on your tax status, there may be some expenses that are typically charged to personal accounts that could be claimed as business expenses this year.
Third, review the 30 percent rule
An important part of annual tax prep is determining if the amount of money that you set aside for paying taxes will be a sufficient amount to set aside for the next year. Accountants typically use the 30 percent rule to determine the amount of taxes that should be anticipated; 30 percent of your business income should be enough to cover your federal taxes.
The amount that you set aside for this year was based on projections that were influenced by the amount of business income that you made last year. The impact of the COVID pandemic on businesses in 2020 made those predictions difficult, if not impossible. The same will most likely hold true for next year.
Experts are predicting that small business owners may see an increase in rent and payroll expenses next year. Those are two factors you may want to consider when predicting what your taxable income could be for 2022. Inflation is also expected to play a role in 2022, which would mean higher expenses for small businesses. Once you arrive at a possible number, it may be best to add 10 percent to account for the economy’s volatility. In a worst case scenario, you will have more than you need when the tax bill comes due.
Fourth, review tax reforms
The COVID pandemic made it extremely challenging for small businesses to stay afloat. To help, the government implemented a wide range of tax-related initiatives aimed at reducing the financial burdens businesses were facing.
New laws that contain provisions impacting tax practices include the Families First Coronavirus Response Act, the Infrastructure Investment and Job Act, the American Rescue Plan Act, and the Coronavirus Aid, Relief, and Economic Security Act. Initiatives that should be considered as part of small business tax planning include Paycheck Protection Program loans, Economic Injury Disaster Loans, Employee Retention Tax Credits, and business interest expense deductions.
If you find all of that confusing, you are not alone, which leads me to the fifth step that small businesses should be taking as part of their tax prep.
Fifth, hire a tax professional
Tax prep is not an easy task for small business owners during a normal year. And 2021 was not a normal year. Erin M. Collins, who heads the IRS Taxpayer Advocate Service, called 2021 “the most challenging year taxpayers and tax professionals have ever experienced.” For 2022, many of the challenges remain.
Rather than seeing the fees that you will pay to a tax professional as an expense, try to see them as an investment. Not only can a tax professional steer you clear of the kind of mistakes that could result in tax penalties, they also can make sure that you are benefiting from all of the deductions to which you are entitled. And they will do the bulk of the work while you get back to the business that you love.
Jay Jung is the founder and managing partner at Embarc Advisors, which brings Fortune 500-level financial consultations to middle-market, SMBs, and startups. Jay has nearly 20 years of experience in M&A, capital-raising, and corporate finance as a former Goldman Sachs Investment Banking Vice President and McKinsey & Company Engagement Manager.