How Your Small Business Can Prepare for Tax Season

Steps you can take now to make completing your tax return easier and save on your taxes.

Of course, last year’s tax preparation season just ended. That’s the point.

The time to plan for the NEXT small business tax season is before the prior tax filing year ends. If you wait until the end of the year, it’s too late.

That’s right: There’s no such thing as tax season. You have to pay attention to your tax situation all year long.

What’s important is that you track everything, every day, ideally in one place. You should have every business income and expense recorded, whether or not you think it’s tax-critical or not. Keep track of all invoices, bank statements, financial records, receipts, and sales slips. It will keep you from having to search and scramble next spring, prevent costly tax errors, and get you all the deductions and credits you deserve.

Here are some other things you can do to prepare for the next tax year NOW.

• Set up an accounting system
• Update your accounting tools
• Choose an accounting method
• Plan for tax payments and filings throughout the year
• Separate personal and business expenses
• Consider hiring a tax professional
• Figure out the deductions you may qualify for
• Take advantage of tax credits
• Avoid audit traps
• Aim for a reasonable refund

Set up an accounting system

How do you maintain your books?

A spreadsheet can be enough to handle financial record keeping for some very small businesses and self-employed people. If it works for you, keep doing what you’re doing. 

However, a spreadsheet isn’t robust enough for companies that have grown out of the startup phase. There are many cost-effective accounting software and bookkeeping systems designed for small businesses, including:

• Freshbooks
• Quicken
• QuickBooks
• Xero
• ZohoBooks.

Each package offers different features, so you should be able to find one that will work for your business. Some even come with tax software capabilities, which include built-in tax forms for both your federal and state taxes. No matter which you select, if you use it consistently all year, you’ll be well-prepared to complete your taxes in the spring.

Update your accounting tools

If you already have an accounting system, ask yourself: Do you have gaps or inefficiencies in your financial tracking process? How could you make things better or more efficient? In short: Is your bookkeeping method serving you well or leaving you feeling frustrated? The time to get things right is now, not next spring. 

Choose an accounting method

Once you set up your accounting or bookkeeping software, you must choose an appropriate accounting method for your business type. The most common methods available to small businesses are cash and accrual.  

• Cash accounting is an accounting method where payment receipts are recorded during the period in which they are received, and expenses are recorded in the period in which they are paid. At its simplest, revenues and expenses are accounted for when cash is received and spent.
• Accrual accounting allows a company to record revenue before getting paid for goods or services sold, and expenses are recorded before the company has paid for them.

An accounting professional can advise you on the method better for your business.

Plan for tax payments and filings throughout the year

The IRS expects you to pay taxes as you earn income during the year. Payments can be in the form of estimated tax payments or withholding. The filing schedule for corporations and other types of business entities differ. The good news is that the IRS offers a tax calendar you can use on your desktop. You can also receive email notifications from it or sync it to your work calendar. It takes the guesswork out of when you need to make your tax payments.

Also, if you have employees, you must plan for your Federal income tax withholding, social security and Medicare taxes, and Federal Unemployment Tax Act (FUTA) taxes throughout the year. Finally, if an independent contractor works for you and earns more than $600, you also need to file Form 1099-MISC by January 31.

Separate personal and business expenses

On top of creating confusion at tax time, mixing your personal and business finances can prevent you from qualifying for a small business loan or building an independent credit profile for your company. 

It’s a wise move to set up a separate business structure for your organization, such as becoming a sole proprietor, corporation, limited liability company (LLC), or partnership. Then open business bank accounts and implement an accounting system. At the very least, use a unique credit card to track business expenses.

Failing to separate your expenses throughout the year could cost you many hours of sorting through bills and statements to determine which are personal and business transactions. 

While you’re at it, maintain a separate business calendar. It will help you recall meetings, travel, and other business activities and sync expenses up to them.

Consider hiring a tax professional

Many small business owners benefit from having a professional handle their taxes. A knowledgeable accountant can make the most of your deductions and credits, which typically change yearly and can be almost impossible to keep up with. Working with a certified public accountant (CPA) or other tax pro could decrease your stress during tax season and pay off by helping you minimize your tax burden.

Figure out the deductions you may qualify for

The worst time to determine what federal tax deductions you’re eligible for is when it comes time to use them in the spring.

Many small business owners don’t claim all the deductions they’re allowed because they don’t have the records to prove they qualify for them. Deductions you may be eligible for include: 

• Employee payments: Cash paid to part-time, full-time, or contract workers is deductible.
• Professional and legal expenses: Any money paid to your lawyer, accountant, and tax advisor is tax-deductible.
• Advertising expenses: This can include various things from developing websites to travel to conferences and trade shows.
• Property: Property deductions include expenses related to any facility used for business purposes. Land and investment properties are not deductible.
• Home office: You can write off a percentage of your rent or mortgage payment and some utility costs if you measure and document the exact dimensions of your office. If you prefer, you can choose to deduct five dollars for every square foot of home office space up to $1,500.
• Supplies: Office supplies, including paper, pens, and toner, are deductible if used for business reasons.
• Equipment: Equipment is anything that will last longer than a year, such as a computer or manufacturing machine. You can write off up to $500,000 of business-related equipment purchases because of the section 179 deduction.
• Phone: You can deduct phone expenses for business use calls. Be prepared to sort through your phone bill and determine the percentage used for business purposes.
• Interest: If you use credit or loan money to finance your business, you can deduct the interest you pay to finance companies.
• Travel: The IRS allows you to deduct one hundred percent of the cost of business trips from your taxes.
• Vehicle and mileage: If you use a car to conduct business, you can deduct either direct expenses or mileage used for business from your taxes. Use a tracking application to monitor business mileage throughout the year.
• Retirement: You can deduct any payments you make into a tax-deductible retirement plan.
• Insurance: Many insurance premiums are considered by the IRS to be business expenses and can be deducted. However, some vehicle and life insurance premiums may be disallowed. If you own a sole proprietorship, partnership, or S-Corporation, you may also be able to deduct your own and your family’s health insurance premiums.
• Startup costs: You can deduct many of the costs of launching your business because the IRS considers them capital expenses. 
• Educational activities: The cost of seminars, classes, and conventions can be deducted if they improve your business or work skills.
• Charitable contributions: Many businesses make donations to charity. You may be able to write them off if they’re properly documented.

A tax professional can help you plan now for the small business deductions you may be able to take in the spring.

Take advantage of tax credits

If you can, claim a credit rather than take a deduction for an expense. A credit will typically lower your tax liability more than a deduction. Check what credits you can get on IRS Form 3800 or with your CPA. Credits are rare and come with complex rules. Two popular credits:

• Healthcare: Use form 8941 to determine your eligibility for healthcare tax credits. They are offered on a sliding scale. If you employ fewer than 25 employees and pay 50 percent or more of their health insurance, you could earn a tax credit of up to 35 percent of the costs.
• Veterans: The IRS offers a credit if you hire certain unemployed veterans. 

IRS tax credits aren’t easy to qualify for, but they can pay off in a big way.

Avoid audit traps

Don’t make common mistakes that can get small businesses flagged by the IRS because it seems like you’re trying to break tax laws.

• Misclassification. Never classify employees as independent contractors. It’s a sure sign of tax evasion.
• Home office deduction. Be able to prove your calculations. Otherwise, you could get into tax trouble.
• Don’t deduct too much. If your deductions are higher than your income, it could seem fishy.
• Don’t mess with payroll taxes: If you use the taxes withheld from employees to fund your business, you will be personally liable to pay the IRS back along with significant penalties.

Aim for a reasonable refund

Did you receive a big tax refund this year? Taxpayers who do basically give the U.S. government a big interest-free loan. Adjust your withholding so you get a smaller refund next year.

Tax season really isn’t a season. It’s a year-long activity. Use these tips so you’re 100 percent ready to complete your income tax return next year well ahead of the due date while maximizing your deductions and avoiding red flags.