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Top Tips for Small Business Owners to Know About Their Taxes

4 Mins read

In financial management, education is more than a tool. It’s a pillar holding up your entire financial future. Professionals grounded in the philosophy of educating their clients know this to be true, even if it means going beyond the call of duty. Yes, it might backfire sometimes, but those who’ve traveled this path know why it is essential. Rewind to when I was 19 — a young mother filing my taxes for the first time. I couldn’t figure out why I was receiving a check for $1,000 when I was expecting $3,000. The lack of explanation and the indifferent attitude of the tax professional handling my case left me feeling undervalued and, quite frankly, cheated. This moment underscored what’s often missing from the tax-filing experience — care.

Tax returns shouldn’t be a solo venture; it is a partnership that demands trust and understanding. It’s not just about money. Sharing one’s most sensitive information, from the details about your children to your social security number, requires a relationship grounded in trust, support and guidance.

In the spirit of education, let me share top tax tips to help you build a strong foundation and empower you to make informed tax decisions.

Tip #1: Understand the Pay-As-You-Go System

Following the pay-as-you-go (PAYG) system offers many advantages for small business owners, most importantly preventing the “tax shock” that often comes at tax time for those making annual payments.

Following the PAYG system fosters financial discipline by encouraging regular reviews of your business’ financial status. This proactive approach promotes frequent financial check-ins, improving cash flow management. A U.S. Bank study found that poor cash flow management contributes to 82% of small business failures.

In addition to helping maintain a healthy business operation, PAYG reduces the likelihood of incurring penalties associated with underpayment of taxes by spreading the tax burden over several months. Consistently making PAYG tax payments can also increase a business’s creditworthiness as it reflects financial responsibility and regulatory compliance.

Finally, leveraging the PAYG system affords you a granular understanding of your financial health. You can lobby a more agile response when your financial situation changes, identifying new tax deductions and credits that can lessen your overall tax liability.

Tip #2: Choose the Right Business Entity Structure

One of the most important tax decisions you’ll make in your life is deciding on a business entity structure. This choice affects how you report income, pay taxes and file returns, and impacts your personal liability level.

There are several business entity types to choose from, each with its own set of rules governing taxation, liability and other legalities. The most common ones include:

  • Sole Proprietorship: This is the simplest business structure where the business and the owner are considered a single entity for tax and liability purposes.
  • Partnership: Here, two or more individuals share the ownership, and the business income is passed through to the individual partners to be reported on their personal tax returns.
  • Corporation (C-Corp): This structure creates a distinct legal entity separate from its owners, providing personal liability protection but with a potential for double taxation — at the corporate and individual levels.
  • S Corporation (S-Corp): While still a corporation, the S-Corp avoids double taxation by allowing income, deductions, and credits to flow through to shareholders’ individual tax returns.
  • Limited Liability Company (LLC): Combining features of corporations and partnerships, LLCs offer flexibility in taxation alongside personal liability protection.

This is an important step because your business entity significantly influences your tax liability and obligations.

For example, while corporations might face double taxation, they benefit from a potentially lower corporate tax rate and opportunities for tax-deductible business expenses. On the other hand, pass-through entities like S-Corps and LLCs avoid double taxation, potentially reducing the overall tax liability.

Given the complexity and the high stakes involved in choosing a business entity, seeking the guidance of a tax professional becomes almost indispensable. A tax advisor can provide personalized advice, taking into account the unique aspects of your business — such as its size, the industry it operates in and its financial outlook — to help you choose the most advantageous entity structure.

A tax professional also stays abreast of the latest regulatory changes, finding new opportunities to minimize tax liabilities. Leveraging their expertise can help you with compliance, shield you from personal liability and support the sustainable growth of your business.

Tip #3: Avoid co-mingling funds and its adverse effects

Keeping an immaculate record of your financial transactions is crucial for small businesses. One practice that is a colossal adversary to financial prudence in business is the co-mingling of funds. Let’s talk about what co-mingling of funds entails and why it should be consciously avoided.

Co-mingling of funds occurs when a business owner uses a single account for both personal and business financial transactions, effectively blurring the lines between business and personal finances. This includes a range of behaviors, from using business revenue to cover personal expenses to paying business expenses from a personal account to borrowing business funds without proper documentation.

Despite the seemingly innocent convenience it might offer initially, especially for solo entrepreneurs and small business owners, co-mingling funds muddies the financial picture and can have detrimental effects down the line.

For one, co-mingling funds make it exceedingly difficult to assess the accurate financial health of your business. When personal and business transactions are intertwined, deriving meaningful insights from your financial statements becomes a much bigger task, rendering planning and forecasting virtually impossible.

Not to mention, it creates a labyrinthine during tax time. Separating personal and business transactions retrospectively can be tremendously challenging and time-consuming. You’re also more likely to miss out on valid business deductions, consequently paying more taxes than necessary.

From a legal standpoint, co-mingling funds can potentially jeopardize the limited liability protection that businesses like LLCs and corporations typically offer. In legal parlance, it can lead to “piercing the corporate veil,” which means that the courts can hold you personally responsible for the business’s liabilities, including debts and lawsuits.

Worse yet, in the event of an IRS audit, having co-mingled funds can raise red flags, leading to more rigorous scrutiny and possibly resulting in penalties and additional tax liabilities.

The bottom line: when you aren’t sure what to do, contact a tax professional.

At the end of the day, for me and others in the profession who invest in their clients, what truly matters is the satisfaction derived from knowing that I have made a tangible difference in someone’s life. It gives me peace of mind and a clear conscience, affirming that I have indeed played a part in helping individuals make the most of their taxes with a little more understanding and a lot less stress.

Latoya Jackson, wife and mother of four, is the CEO of Professional Bookkeeping Plus and TaxBuzz contributor. 

Taxes stock image by Andrey_Popov/Shutterstock

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