Starting a business is significant work and may feel daunting. With any new endeavor we may have so much to do we overlook the basics. Our focus may be on marketing our services and generating revenue, rather than the behind the scenes business aspects. Here are top 10 common business mistakes and how to avoid them so you are not frustrated and dealing with a big headache at the end of the year.
#1 Not having a separate business account
Many first time business owners begin by paying expenses and even deposit payments from their business into their personal account. This is a mistake. IRS Publication 583: Starting a Business and Keeping Records states "One of the first things you should do when you start a business is open a business checking account. You should keep your business account separate from your personal checking account." Having a separate business bank account makes yours and your accountants life easier for many reasons.
Keeping transactions separate allows you to link your bank account to an accounting system and to easily ensure you've captured all business transactions. The audit process is also simpler if your business bank statements match your accounting records in detail and in total.
#2 Not intentionally choosing your form of business
There are four choices for form of business and three are pass-through entities commonly chosen for small businesses. Many people choose their form of business because "my accountant said..." This is your business, make sure you are educated on all the options. Each has pros and cons and our preference once you know all the options may not be the same as your accountant might choose. Check out the free Simple Profit Form of Business Webinar to learn more.
#3 Not having an accounting system, at least a spreadsheet
An accounting system is a method of tracking revenue and expenses. Whether kept on a spreadsheet or using accounting software, having an accounting system provides a process for recording transactions, reports to review, can help with tax estimates and will be used for your year-end tax return.
#4 Not keeping detailed receipts
It is equally important to keep accurate records to support your accounting statements. Proper documentation helps prove to the IRS your tax deductions are legitimate if you are ever audited. Keeping receipts and records electronically is allowed. Check out the blog post Documentation & Receipts: What you Need to Know.
#5 Not having a budget and not review your business results
A budget does not need to be a lengthy or overly complicated process. It is important to set goals for yourself and your business. A budget gives you a measuring stick to evaluate your results as the year progresses and plan for the upcoming year.
Do not wait until the end of the year to see how your business performed. An important step in owning a business is regularly looking at your business results. At least once a month, look at your results for the current month and year-to-date to see how you are doing, revise your expectations or make business decisions based on the results if necessary.
#6 Failing to pay estimated taxes
Unless you have payroll withholding and are over contributing your payroll withholding or you are operating at a loss, you may owe estimated taxes.
The IRS expects you to pay estimated taxes if you will owe more than $1,000 for the year. The rules are described on the form 1040 ES. An underpayment penalty of 0.5% can be assessed if you pay less than you paid the prior year or less than 90% of the tax owed this year. Another penalty can be assessed if you do not pay enough estimated tax in each quarter.
The IRS the deadlines are April 15th, June 15th, September 15th and January 15th. If the date falls on a weekend or holiday, the deadline moves to the next business day. To learn more check out the Simple Profit Quarterly Tax Mini-Course.
#7 Not knowing when to issue 1099-Misc forms
We are expected to issue a 1099-MISC form at year-end to anyone we have paid more than $600 in the year for business including rent to your landlord or any service.
There is a list of exceptions to this rule, including that we do not need to issue a 1099-MISC form for payments made via electronic payment, because the credit card processor will fall under the 1099-K rules. We also do not need to issue a 1099-MISC for payments made to an S-Corp or C-Corp. However, payments to attorneys and for medical and healthcare still need to be reported on the 1099-Misc even if they payee is a corporation.
Collect a Form W9 from anyone you expect to issue a 1099-MISC form to, the W9 will help determine if a 1099-MISC is needed and if so, provide information needed to issue the 1099-MISC. See IRS Form 1099-MISC: Rules and Exceptions for more details.
#8 Spending cash and not recording it
The IRS expects taxes to be based on all revenue collected, this includes cash collected from clients. It is a myth that it is safe to take cash payments from your business and spend it on yourself without recording the cash. This is tax fraud. The best way to ensure all cash receipts are recorded is to deposit them in your business account, but if not deposited they can be recorded separately.
Another reason to record all cash receipts is to ensure the reports you use to make business decisions are complete and accurate.
#9 Taking on too much debt
When starting a new business we hopefully have big dreams. We do not, however, need to reflect all our dreams in our first budget. We can start small and keep expenses low until we are generating enough revenue, and then grow at a reasonable pace. Taking on debt, or more debt than we need, creates unnecessary pressure and cost. Being mindful of what we are spending and minimizing where we can, without compromising our ability to generate revenue, will help create a financially healthy business.
#10 Not saving for emergencies and PTO
Companies are able to pay employees for time off because they plan for it. You can also plan by setting side money in savings when you have it or by purchasing appropriate insurance.
If you are self-employed and your income is generated mainly from your own work effort, you are keenly aware you do not get paid if you don't work. Even if you have employees who generate a significant portion of your business revenue, it is still a good idea to plan for emergencies. Having a contingency plan for weather-related disasters, unexpected illness or family emergencies protects employees, you and your business.
The IRS does not allow deduction for disability insurance that will replace lost income. IRS Publication 535: Business Expenses, nondeductible premiums #2 says, "You can’t deduct premiums for a policy that pays for lost earnings due to sickness or disability." However the section on deductible premiums #8 states that, "Overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness" is deductible as a business expense. Other insurance premiums are also deductible including business interruption insurance.
Further, health insurance premiums are deductible as long as 1) the policy is established in the name of the owner or the business, 2) the owner is not eligible for employer provided coverage for themselves or through a spouse and 3) the deduction does not create a business loss.
If you have developed the skills and the motivation to start and run a small business you are completely capable of avoiding all these common business mistakes. If you have made some of the mistakes listed above now is the perfect time to take corrective action. With some planning and work, the business side of your small business will be running smoothly.
Questions: email [email protected]
Jennie Schottmiller, LMFT, CPA is a licensed marriage and family therapist who practiced as a CPA prior to becoming a therapist. She has an active solo therapy practice and runs a facebook group for clinicians and offers courses to help small business owners with accounting, tax and financial analysis matters.
Disclaimer: This blog is for education only. Please consult with a qualified professional when you have any questions about your personal accounting, tax or legal situation. Information contained in this post is for informational purposes only and not intended to replace professional advice.