When you’re a business owner, you can’t afford to ignore proper tax and income reporting for your business, lest you fall unwittingly into one of the following tax traps. Luckily, all of these traps are easily avoided with some due diligence and—when needed—a little extra guidance from a tax professional. 

1. Incorrect startup cost deductions

New businesses can deduct expenses related to starting their operations as first-year tax deductions. However, there’s a common misconception that these expenses can be deducted right away, leading many business owners to overestimate their deductions. In the first year, you have to make your first sale, and then the IRS allows up to $10,000 in deductions from startup costs ($5,000 for startup and $5,000 in organizational costs) if total expenses do not exceed $50,000. If your startup costs are more than $50,000, but less than $55,000, there are still deductions available, reduced by the dollar amount beyond $50,000.

2. Improper entity selection

You may start your business as a C-corp or LLC because it seems straightforward; however, there may be tax advantages or disadvantages for doing so. Selecting the wrong tax entity can affect your tax obligations and your personal liability, so it’s important to get things right—and that’s where the help of a tax professional can be invaluable. 

3. Misclassifying employees vs. contractors

Trying to classify an employee as a contractor (or vice-versa) can have serious consequences. If you hire independent contractors to save money, but you set expectations that they work certain hours or meet other employee-like conditions, you may be on the hook for payroll taxes. Failure to pay or heed IRS regulations in this situation could result in severe tax penalties.

4. Late tax payments or filing

Running a business is a full-time endeavor—and then some. While it’s easy to understand how a tax filing or payment can slip through the cracks in a busy schedule, the IRS isn’t quite as understanding and will assess fees and fines for delinquent taxes accordingly:

• Penalties for late tax filing are equal to 5 percent of the tax owed for each month, or part of a month, that your return is late up to five months (25 percent). If your return is more than 60 days late, the minimum penalty for late filing is the smaller of $100 or 100 percent of the tax owed.

• If you file on time but don’t pay all amounts due on time, you’ll need to pay a late payment penalty of 0.5 percent of the actual tax owed for each month, or part of a month, that the tax remains unpaid from the due date, until the tax is paid in full. There is no maximum limit to the failure-to-pay penalty.

5. Poor records for tax information and accounting

If keeping tax and financial records isn’t your strong point, you may want to outsource this function to an accounting professional to ensure your records are up to date for tax season and your estimated tax payments through the year. Precise records will also be invaluable in case you’re faced with an IRS audit. While it may seem like a lot of work now to keep on top of your records, the real tax trap is not having access to the receipts, invoices and income tracking that will be required should the IRS ask you to substantiate your tax deductions or filing information. 

Avoid tax traps with professional guidance 

It’s vital to avoid these and other business tax traps, since they can cost you a lot of money and time. Many self-employed individuals are so focused on running their business that they don’t have time to address or learn about these issues—and this poses a significant risk in terms of their tax liabilities. To avoid dealing with these issues, enlist the help of a tax professional who can conduct due diligence to catch these and other potential problems before the integrity of your business’s financial infrastructure is compromised.