New business formation has boomed, and that means more new business owners than ever are dealing with tax season and potential tax nightmares.
While there aren’t that many tax changes that will affect small businesses in the upcoming tax season, what is new — coupled with evergreen tax issues that tend to trip up small businesses — could cause headaches if owners aren’t careful.
For starters, there’s a big tax bill coming due for many business owners related to the pandemic, well ahead of the April 2023 federal income tax deadline.
Small businesses that took advantage of Covid provisions in 2020 to defer some of their Social Security taxes had to repay 50% of what was owed at the beginning of 2022. The other 50% is due on Jan. 3, 2023.
The IRS has been sending out notices reminding business owners to pay what they owe by the due date, but still it’s something that can easily fall through the cracks, especially if owners aren’t paying careful attention, said Eric Bronnenkant, head of tax at Betterment and an adjunct professor of taxation at Seton Hall University.
Here are a few more tips to stay ahead of the IRS this income tax season.
Expect a new tax form related to Venmo, PayPal income
For tax year 2022, many business owners may be receiving a form they haven’t in the past. That form is a 1099-K and owners who receive payment of $600 or more through a third party processor such as Venmo or PayPal should be receiving it. In past years, the form was only sent out if the payments amounted to more than $20,000 and if there were more than 200 individual transactions.
The obligation for owners to report their income hasn’t changed. However, owners who may have been lax in the past now have more incentive to report that income since there will be a record on file with the government, Bronnenkant said.
He also suggests owners check to ensure that all of the payments on the 1099-K form are actually for goods and services, as opposed to a gift from a friend that was mischaracterized. “You shouldn’t have to pay taxes on it just because someone issued you a 1099-K with erroneous information,” Bronnenkant said.
Keep business and personal income, expenses separate
Many owners don’t think to draw a hard line between business and personal income and expenses, but this can be a big mistake. Commingling funds may seem easier, but in reality, it creates extra work to compute the income and expenses of the business, and in the case of an audit could lead to potential tax headaches and may cost businesses more in the long run, tax professionals say.
The Wave State of Small Business Study for 2022 found that 35% of small businesses are blurring the lines between personal and business accounts. That’s even higher among microbusinesses, where slightly less than half, 48%, have a small business bank account.
The advice against commingling is true for bank accounts and credit cards. If a business is audited, owners need to be able to document that the expenses they paid were business-related. If they use a personal credit card and the business is examined, the IRS could deny those deductions and the burden of proof would be on the taxpayer to show it was a legitimate business expense, said Steve Rossman, a tax partner in the Philadelphia office of accounting and consultancy firm Armanino LLP. “This could result in penalties from federal, state and local governments for underreporting income,” he said.
File your tax return even if you can’t make payments
Business owners who can’t pay the full amount owed in taxes, should still file their federal tax return and get on a payment plan, said Brad Sprong, national industry tax leader for KPMG Private Enterprise. These owners will still pay interest on the money they owe, but they can avoid additional penalties for not filing, or for filing late, which can further cut into the profits of the business.
“It’s hard to get these penalties abated and penalties are nondeductible so it comes right out of the bottom line,” Sprong said.
Business owners who need more time to work on their returns beyond the original filing deadline of April 15 should file for an extension so they don’t owe the late filing penalty. That penalty is 5% of the unpaid taxes per month, capped at 25% of the balance due, Rossman said. Owners should then be sure to file the extension by the extended due date of Oct. 15, he said.
Even with an extension, however, owners will need to estimate what their tax obligations will be and pay that amount by the initial tax deadline. Owners who can’t afford to pay the full amount at that time should pay what they can to lessen any potential underpayment penalties, he said.
Set aside cash to cover tax liabilities
A good rule of thumb for businesses starting out — and for all business owners to avoid the situation in which they can’t foot the full tax bill — is to set aside 30% to 35% of net income, according to Sprong. Not setting enough aside could mean you have to scramble to find money to pay Uncle Sam. He offers the real-life example of an owner of a $100,000 real estate business who owed around $30,000 in taxes, but didn’t have the money to pay because she had used her available cash for advertising, open houses and other business expenses.
“Even if you go on a payment plan with the IRS or get a loan from a bank, you’ve soaked up some of your borrowing capacity,” he said.
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