A common misconception among many entrepreneurs is that their startup will not face any tax filing requirements while in the early stages of the business.
However, this is not the case.
If you incorporate your business or form an LLC you have tax and other government filings that are due, even if you had little to no financial activity.
As a result, it is important to understand the tax laws associated with your startup’s legal entity as they may differ depending on whether you are a sole proprietor, a partnership, or some form of corporation.
There is no “right” type of entity that can be applied to all startups. Rather, there is the type of entity that is right for you and your startup.
Below are a few common startup tax related mistakes that can save you time and money in the long run:
1.Proper Record Keeping
It is important for a business, no matter how big or small, to have its own set of books. If the startup team lacks a solid bookkeeper or someone with financial expertise it can be very inexpensive to hire a bookkeeper on a part-time basis. You can also hire a consultant or accountant to help you setup a system that you can maintain going forward.
While you are exempt from paying quarterly taxes in your first year it is still a good habit to get into. First and foremost, you don’t want to get sticker shock when it comes time to pay taxes and you haven’t been setting aside cash every quarter. Secondly, you are going to have to start getting in the habit of paying quarterly taxes sooner or later so you might as well start now.
Additionally, set up separate accounts for anticipated taxes like self-employment and employee withholding. The biggest problem for many business owners when it comes to tax season is having enough cash on hand to pay for taxes.
3.Record Your Startup Costs
Almost every cost you incur when starting your business is eligible for a tax deduction – think market research, travel, customer surveys, prototypes, advertising, branding, etc. All startup costs up to $5,000 are deductible in full in the first year. Furthermore, if your costs go over $5,000, you
can potentially roll out the deduction for up to 15 years.
4.Track Expenses Correctly
While many of your startup costs are deductible be sure that you are recording these expenses correctly to ensure protection if audited. For travel and entertainment expenses over $75 you need to maintain receipts and a recorded reason for the expense. When using your personal credit card be sure to write an expense report to the business shortly after incurring the expense. Track your miles if you plan to deduct car travel to and from your office.
5.Know How To Classify Employees
Many startups think they can avoid paying payroll taxes by classifying their employees as independent contractors. However, the IRS is cracking down on this misclassification and this is one penny that is not worth pinching.
There are a lot of nuances surrounding the differences between an employee and an independent contractor. The biggest factor has to do with how you control this person’s time. If you are telling them when and how to work they are most likely an employee.
6.Blending Business and Personal Finance
Many entrepreneurs make the mistake of neglecting to claim certain expenses as business expenses, such as a home office. On the other hand, many entrepreneurs fail to separate their personal finances from their business finances and often get sued or are forced to pay additional taxes. Be sure to maintain a clear line between your business and personal finances.
7.The Difference Between Equipment and Supplies
Typically, equipment expenses are amortized over the lifetime of that piece of equipment and therefore face unique deduction eligibility requirements. Supplies on the other hand, such as pens, notepads, and printer ink, have a lifetime value that expires far more quickly. In order to get the most out of your deductions be sure to track your expenses accordingly.