For most Americans, the idea of owning their own business means taking control of their finances and attaining a sense of accomplishment, as well as a valuable legacy that can be passed on to their families. The work involved in starting and maintaining a small business requires the kind of passion and commitment to detail that comes from a desire to map out your own future, and there are problems that can arise. Because most small businesses don’t make a profit in their first year, it’s important to pay close attention to tax laws when reporting your earnings to the Internal Revenue Service (IRS). Establishing a good track record with the IRS from the beginning is a way to ensure that your earnings remain penalty free and can be reinvested into your future.
The most obvious oversight also turns out to be the most common. Failure to withhold income taxes for your employees can result in what is called a 100 percent Payroll Penalty, meaning the IRS will pro rate the entire amount owed and hold not only the business owner accountable, but everyone with check signing or accounting privileges.
While all small businesses are entitled to write off operating expenses, misrepresenting yourself by making unauthorized deductions can cause IRS problems in the form of penalties and interest fees. You should be prepared to prove all business deductions made on your tax return and keep your write-offs within a reasonable range. Excessive deductions are a red flag that could provoke an audit and result in small business tax problems.
In an effort to maintain productivity, small businesses sometimes turn to contract workers to temporarily add to their labor force, and can legally avoid withholding taxes. However, classifying permanent employees as independent contractors in a effort to avoid a tax responsibility is a major mistake, and the IRS imposes steep penalties for each infraction. Federal form 22-8 “Determination of Employee Work Status for Purposes of Federal Income Tax Withholding” provides clear distinctions between permanent and contracted employees.
