This is a guest post written by Andrew Poulos, an Enrolled Agent admitted by the Department of Treasury to practice before the Internal Revenue Service and Principal of Poulos Accounting & Consulting, Inc. Poulos has been in practice for 20 years, working with small businesses and individuals on bookkeeping and tax matters. His writing also appears on Main Street Tax News (published by the National Society of Accountants), Intuit’s News Central and Blog, and elsewhere, and he has been cited as a tax expert in articles by American Express Open Forum, AARP, Staples, Regions Bank, and others.
If you’re running an IT business or operating as an independent contractor in an IT field, chances are good that you haven’t spent a lot of time studying accounting or bookkeeping. And yet, as the owner of your business (or maybe the only person in your business), you’re responsible for classifying revenue and expenses, paying taxes, managing loans, and more.
If you’ve already been through a tax season, you’re probably aware that there’s a lot that can go wrong. If you haven’t, you may be in for an unpleasant surprise this April (though I hope you won’t wait until then to start on your taxes).
Either way, there are some simple ways you can make your life easier by shifting the way you handle finances. Here are five common small-business bookkeeping mistakes and tips on avoiding them to prevent IRS-related headaches and fines.
Don’t Make These Common Small-Business Bookkeeping Mistakes
Aside from basic human mistakes like entering a wrong number or losing important invoices, these are some of the common accounting and bookkeeping mistakes that hurt small businesses.
1. Counting Loans as Deposits
It’s pretty common for owners of new startups to lend personal money to their business. Say you funnel $10,000 from your personal account to your business account so you’re able to pay a few invoices and buy software when you first launch. But many small-business owners don’t realize they should count this money as a loan for tax purposes. Why? Because the money isn’t revenue (i.e., it didn’t come from a paying client) and therefore shouldn’t be taxed. Loan money can’t be taxed. If you or other financial supporters lend your business money, be sure to tell your accountant. If you don’t, the loan amount will count toward your total revenue and increase your taxable income.
2. Waiting Until Tax Season to See Your Accountant
While we’re talking about accountants, let’s set one thing straight: you can’t treat the person handling your business taxes the same way you treat the person who handles your personal taxes. In other words, you can’t visit their office in March and dump the old shoebox of receipts on their desk and assume things will work out.
Why not? Because your business, even if it’s only you, functions more like a large corporation than a full-time employee from a tax perspective. That’s because, as a business owner, you need to consider…
- Which expenses are deductible and which are not. Some small-business owners assume everything they do for business (including entertainment and travel) is 100% deductible and use their business account for these things. That’s not the case. More significantly, deducted expenses that seem to have little or nothing to do with business operations are red flags to the IRS and can trigger an audit.
- Which legal structure will work best for your business. Your decision to operate as a sole proprietor, LLC, or S-Corp (or some other structure) will affect the way you pay yourself and the way you file taxes (among other things). [Editor’s note: among TechInsurance customers, 44% operate as LLCs, 37% as corporations, 18% as sole proprietors, and 1% as partnerships.]
- How you pay workers. While most small IT businesses don’t hire employees for a while, many hire contractors to help with specific tasks or projects. Classifying these workers correctly is essential to avoiding penalties at tax time.
3. Not Keeping (Good) Records
The hardest thing about keeping records is catching up when you haven’t done it from the start. The good news is that there are lots of options out there to make record keeping easier on small-business owners. QuickBooks and Xero are great software options for small-business accounting, and both can be managed from the cloud.
For processing customer invoices, I’d recommend Square, FreshBooks, Bill.com, and Chrometa – they’re all a little different, so you should be able to find one that works for your business.
But even an Excel spreadsheet can work for early-stage finance tracking. The important thing is to record expenses and revenue on a weekly basis. If you let it go beyond the weekly mark, it’s too easy to put it off indefinitely. And then it becomes overwhelming when you finally sit down to do it.
4. Deducting All Your Expenses
While it’s important to take advantage of the deductions that can reduce your tax bill, it’s equally important to know the limits of deductions. Some expenses are not deductible. Some are partly deductible. The IRS has a basic guide to deducting business expenses for self-employed people, but the important thing is to keep track of everything.
Your accountant can help you sort out deductions as you go.
5. Not Asking for Help
In a perfect world, small-business owners and independent contractors would sit down with an accountant as soon as they decided to start their business. They’d ask for tips on structuring the business, keeping financial records, and deducting expenses.
More commonly, small-business owners only realize after a disastrous year of filing taxes that they need an accountant’s help. If you want to avoid that (and you don’t yet work with an accountant), here’s what to do:
- Ask for recommendations of accountants from families, colleagues, and friends.
- If nobody can recommend one, visit a site like Thumbtack.com and look for accountants with small business experience and high ratings.
- Check in with your accountant several times during the year to ensure your books are in good shape when tax season rolls around.
For more small-business bookkeeping tips, visit the Poulos Accounting & Consulting, Inc. website: http://poulosaccounting.com/.