Accountants see their small and midsize business clients making plenty of mistakes once tax season rolls around, but tax season may be too late to warn them.
Taxes typically take a backseat for small business owners compared to the other headaches associated with running a business every day. Nevertheless, it’s important that day-to-day business tasks don’t interfere with filing returns, as simple mistakes can lead to businesses overpaying or underpaying their taxes. If they underpay, that can trigger tax penalties or an audit courtesy of the IRS.
Jonathan Barsade, CEO of the sales tax software company Exactor and a former tax attorney at the law firm Akin Gump, talked last week about some of the most common tax errors that small businesses make and how to avoid them.
“One of the biggest-ticket items we see is the failure to make allocations of funds to be able to cover taxes when they come due,” he told me. “All types of taxes—whether they're corporate taxes, franchise taxes, payroll or sales taxes—come due at different times of the year, and sometimes extended times, so they could be quarterly, annual or even monthly. They are calculated based upon different factors, whether it's revenue, sales, or payroll, and they tend to be large chunks of payment, a large outflow. If you don't make the proper allocation, it's going to have a significant impact on cash flow.”
If the money has not been put aside, it's going to be difficult to make those crucial tax payments.
“What we've seen time and time again is where companies don’t set aside the funds for the taxes,” said Barsade. “Even though they know the taxes are going to be coming due or collected, taxes need to be factored in as part of their revenue. There are always pressing operating needs, so they use those funds to cover the ongoing daily operations, and then when the time comes for the payment and the filing, they basically just don’t have the cash. I'm not talking about situations where people are intentionally trying to avoid taxes. It's just literally mismanagement of cash flow.”
He doesn't advise the business owners to make estimated tax payments, though.
“They don’t necessarily have to make estimated taxes,” said Barsade. “Obviously nobody wants to pay the taxes before they’re due. While that does definitely help with cash flow management, another alternative that I oftentimes recommend to small business owners is to set up a different bank account. It's easy to set up a bank account and transfer funds from one account into another. You set up another bank account that is dedicated to your tax payments, and every time as money comes in, you take whatever portion of that money that should be used to cover all the different types of taxes, and you transfer it immediately into that other account. That way it's not there in front of you. That way you're not tempted to use it for daily operations and that way you've got the cash flow. The bottom line is that when the due date comes, the government is not sympathetic. They're not going to postpone your due date just because you mismanaged your cash flow.”
Another mistake Barsade has seen is the lack of awareness of the nexus rules for companies that do business in different jurisdictions.
“If I’ve got a small retail store that’s located on Second Avenue in the city, it’s pretty simple and straightforward,” he said. “I would owe New York City taxes. But let’s say it’s a pizza delivery store, and people are raving about it. All of a sudden I start to get orders from New Jersey, and I get a delivery person who's using my vehicle to deliver that pizza into New Jersey. People don't realize it, but they actually are now subject to New Jersey taxes as well. A similar situation, but not as clear cut, is when people cross county lines. If you've got home delivery, oftentimes you're going from one county into another without realizing it, and you're creating exposure. That means you're subject to that new county’s taxes and reporting requirements.”
Barsade believes accountants should advise their clients about these kinds of issues during tax season and beyond.
“For the accountant, what’s really important is to be proactive and talk with your client,” he said. “Talk with him about his business. Get to know what their business is, how they're doing their business. Have some checklists, sort of like a decision tree of items that would be covered of how they managed their business, things that could not necessarily be gleaned just from from looking at the books. For example, if your client is a small pizza shop, ask them how do you deliver your pizza? Do you cross the George Washington Bridge? It’s a decision tree because if they don't deliver, then you don't have to ask how. Get to know the client and overall that will help them understand. If you know what they’re doing and how they’re doing it, it will help you provide practical, preventative advice. You want to address issues upfront rather than wait to be responsive when the notices and assessments start to come through.”