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Owning a small business is one of the most rewarding endeavors you can take on, but it can also be the most challenging. Especially when you are just starting out.
That’s why most new entrepreneurs look to friends, colleagues, and even professionals for advice about running their business and managing their finances and accounting. But how do you know if the advice you’re getting is good advice? Many seemingly well-intended people can give you advice that may sound good but could actually get you and your business into hot water.
It’s always a good idea to do your homework and make sure you are getting your information from a reputable source. If you hear the following four tidbits of small business accounting advice, you should think twice before taking it.
As an accountant, I’ve met many small business owners who were afraid to borrow money. They needed to grow their business because they had been told to avoid accumulating any debt.
But the reality is that all debt isn’t bad debt. In fact, passing on a potentially profitable business opportunity because you don’t want to borrow the money can be a very expensive decision.
It’s important to run the numbers and evaluate whether the cost of borrowing money in the short term will pay off for your business in the long term.
When considering whether to borrow money for your business, you need to think about your short- and long-term needs and goals. Many business owners opt to fund growth by selling equity in their business to raise capital. While this may be the appropriate choice in many situations, it can also be a long-term solution to a short-term problem. Giving away equity in your business to raise funds to fill an order, for example, is usually not the way to go.
You may be giving away future profits and reducing your own stake in the company to essentially put out a fire. In these cases, it may make better business sense to take out a short-term loan to fill the order and then use part of the profit to pay it back.
You might have heard your friend or neighbor down the street tell you that one of the benefits of owning your business is that you can reduce your tax bill by paying personal expenses with your business funds and treating them as deductible expenses on the tax return.
This is really bad advice because, according to the Internal Revenue Code, “Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.”
Deducting personal expenses on a business return is fraudulent and may result in penalties and even criminal prosecution. The penalty can be 20% of the amount deducted or up to $5,000 or 75% of the additional tax amount owed if it is determined to be fraudulent. Criminal prosecution can result in additional penalties and even prison time.
If you’ve been told that you can save money by paying your employees cash “under the table,” you’ll want to seriously reconsider this business practice.
There are stringent state and federal rules that must be followed when considering how to pay someone who works for you.
Many business owners struggle when trying to determine whether a worker should be classified as an employee or an independent contractor. If the worker should be classified as an employee, it is illegal to pay them without deducting the necessary tax payments from their wages and remitting them, along with the employer portion, to the IRS and other agencies.
You are also required to file periodic payroll tax returns. Failure to collect and remit these taxes due and to file the appropriate returns is subject to penalties and possible criminal prosecution. If you are unsure of how to classify workers, check IRS publication 1779 for guidance or consult with a tax professional.
One of the more common worst pieces of small business accounting advice is to delay filing your tax returns if you don’t have the money to pay the tax. Many people are under the assumption that if you don’t file a return, the IRS won’t know that you owe any tax. This is simply not true.
If you receive tax forms from your employer, bank, or other source, those amounts are being reported to the IRS, and they know that you have income. It may take a while for the IRS to contact you looking for a tax return, but eventually they will find you. Then you will not only be liable for the taxes you owe but will be assessed penalties and interest for failure to pay and failure to file.
If you can’t pay the total amount due on your tax return, you can generally request an installment agreement, which lets you spread the payments over several months or even years. You will qualify if you owe less than $50,000 and you have filed all required returns.
Keep in mind that the IRS will charge fees and interest on the amount owed, so you might want to consider finding a unsecured loan with a lower interest rate to pay the tax.
People love to give advice and share their own experiences to help you grow and be successful, but it’s so important to make sure that the advice you’re getting is coming from a reputable source and is accurate.
The next time your neighbor or relative offers you accounting advice, make sure you talk it over with a CPA or other qualified business advisor before you take it. You wouldn’t ask your accountant how to wire your house—you probably shouldn’t ask your electrician how to do your accounting.