From trying to take on too much by yourself to overlooking crucial elections, here are nine answers to the question, “What are some unhelpful tax mistakes that every startup founder should know and avoid?”
- Not Getting Professional Help
- Not Building the Habit of Quarterly Tax Payments
- Overlooking the Advantage of Section 179
- Failing to Report Foreign Accounts
- Not Documenting All Expenses
- Failing to Collect and Remit Sales Tax
- Not Separating Business and Personal Finances
- Misclassifying Workers as Independent Contractors Instead of Employees
- Skipping the 83(b) Tax Election on Equity
Not Getting Professional Help
One of the largest mistakes I’ve seen colleagues and myself make for taxes is not asking for help. It can be tempting to think that you can get away with doing your own tax returns, but the reality is that not fully understanding deductions, foreign trade regulations, or other factors could end up costing you significantly in the long run.
Not having a professional in your corner to review before filing could cause unforeseen fines and penalties. That’s why I always suggest to those just starting out to remember the importance of seeking an experienced accountant for their taxes!
Not Building the Habit of Quarterly Tax Payments
You must pay quarterly taxes after running a business for one year. That being said, if you are a new business owner, you might as well pay quarterly taxes as soon as you launch your business to get into the habit. Furthermore, this will allow you to avoid a larger tax payment down the line.
Overlooking the Advantage of Section 179
Startup owners should take advantage of Section 179, a tax code that offers an extraordinary opportunity to write off the entire cost of certain kinds of business equipment in just one year. Startups often need expensive equipment such as computers, servers, and other technology to run their businesses effectively.
Section 179 allows entrepreneurs to write off the full cost (almost up to $1 million) of eligible purchased or financed business assets of tangible property—meaning physical items like machines and office furniture—in the same year they buy them rather than depreciating.
That’s right; you can deduct the entire purchase price from your gross income for taxable purposes! The deduction is currently capped at $1 million annually, so make sure you’re getting every penny out of Section 179 before hitting that cap limit.
This could be a vital hack for startups looking to place investments where it matters most—personnel hires and marketing initiatives.
Failing to Report Foreign Accounts
If you have foreign accounts or investments, you must report them on your tax return. Failing to do so can cause severe penalties. The IRS has strict reporting requirements for foreign accounts and investments, and failure to comply can cause significant fines and penalties.
Not Documenting All Expenses
Startups often incur many business expenses in a relatively short time, so founders need to keep accurate records of all expenses related to their business. This includes purchases made with company funds and any costs that may have been covered by the founder out-of-pocket.
Accurately documenting these costs will help the startup take full advantage of available write-offs and deductions, which can lead to significant tax savings. Additionally, if an audit or other IRS review occurs, having accurate records will ensure that no unnecessary penalties or fines are incurred as a result.
Failing to Collect and Remit Sales Tax
Many startup founders often try to make their products appear more affordable to potential buyers and won’t collect sales tax on their sales. While this helps your business gain customers quickly, it will hurt you during tax season.
Ensure you disclose taxes applicable to each purchase a buyer makes, then collect and remit the sales tax appropriately to avoid further issues down the line.
Not Separating Business and Personal Finances
It’s crucial to separate business and personal finances to maintain accurate records and avoid potential tax liabilities. Mixing business and personal finances can make it challenging to track expenses and result in missed deductions. It’s important to keep separate bank accounts and credit cards for business and personal expenses to avoid any confusion.
Misclassifying Workers as Independent Contractors Instead of Employees
This mistake can cause serious tax consequences and penalties.
When a worker is classified as an independent contractor, the startup is not required to withhold payroll taxes or provide benefits such as health insurance or paid time off. However, the IRS has specific rules for determining whether a worker is an independent contractor or an employee.
Startups must ensure that they are correctly classifying their workers to avoid penalties for failing to withhold payroll taxes, as well as potential lawsuits from workers seeking benefits or back pay. The IRS uses a variety of factors to determine whether a worker is an independent contractor or an employee, including the level of control the startup has over the worker’s work, the worker’s investment in equipment and materials, and the length of the working relationship.
Skipping the 83(b) Tax Election on Equity
Avoiding the 83(b) election can be a costly tax mistake for startup founders. This election lets individuals pay taxes on equity at the time of grant, avoiding higher taxes when the equity is vested or sold.
When a startup founder receives equity, it is typically granted over a vesting period of several years. If the founder does not make an 83(b) election, they will have to pay taxes on the value of the equity at the time it is vested, which may be significantly higher than the value at the time it was granted.
Failing to make the election could lead to higher tax bills and cash flow burdens when equity vests. Making the election locks in the equity value at the grant date, potentially avoiding larger tax bills in the future. Startup founders should consult with tax professionals to make informed decisions and avoid costly mistakes.