10 Common Tax Planning Mistakes Service-Based Business Owners Make
When running a service-based business, tax planning can often be a source of confusion and stress. Unfortunately, many business owners make costly mistakes simply due to lack of understanding or focusing on the wrong strategies. In this article, we'll explore ten common tax planning mistakes service-based business owners make, so you can avoid them and focus on what's really important—creating a business that lets you have the lifestyle that you want, while making a positive impact on the world.
1. Focusing on the Wrong Tax Strategies
One of the most common mistakes is putting too much time and energy into tax strategies that provide little, if any, tax savings, while missing out completely on strategies that might be easier and more profitable. Prioritizing tax planning opportunities by their potential impact could help you reach your goals much faster.
2. Starting Too Late
Tax planning is not something you should leave until April 1st when filing your return for the previous year. By waiting, you severely limit your options to save on taxes. Tax strategies work best when planned well in advance, and you have the most choices when you start planning before a taxable event occurs. The earlier you start planning, the more leverage and flexibility you’ll have to reduce your tax liabilities. Be proactive and make tax planning
3. Using Someone Else’s Tax Strategy
Just because a tax strategy worked for someone else does not mean it will work for you. Tax planning is highly personalized based on your specific financial situation, goals, and timeframe. Blindly trying to copy a strategy that worked for a different business than yours might not yield any tax savings for you, and could even end up increasing your tax bill.
4. Putting Too Much Money in Retirement Accounts (aka “Retirement Jail”)
While tax-advantaged retirement accounts can offer significant benefits, locking too much money away can lead to liquidity issues. If you need access to funds before retirement, withdrawing from these accounts can be very costly due to penalties and taxes. Business owners often make the mistake of contributing every available dollar to retirement accounts, only to find themselves strapped for cash when they need it most.
5. Forgetting About Cash Flow
Focusing solely on minimizing your tax bill can be shortsighted if it compromises your business’s cash flow. Having enough liquidity to cover business expenses, invest in growth, and maintain personal well-being is essential. Don't make the mistake of sacrificing cash flow or your emergency fund just to save a small amount on taxes.
6. Buying Things You Don’t Need, Just for a Tax Write-Off
Many business owners believe they should buy expensive equipment or vehicles every year just to get a tax deduction. However, buying things you don't need just to reduce taxes is almost always counterproductive. For example, spending $1 just to save $0.40 in taxes means you're still out $0.60. Make sure your purchases align with your business goals and strategy. If you don’t need or want something, don’t buy it—tax write-off or not.
7. Getting Peer-Pressured Into Tax Fraud
Your personal and social media networks could be filled with "tax hacks" and advice that tempt you into cutting corners or even committing tax fraud. Whether it’s inflating business miles or writing off personal expenses, these tactics can lead to severe consequences. You’ll have to make the choice of whether to follow the law, or follow the crowd.
8. Ignoring the Compliance Costs
Advanced tax strategies often come with additional paperwork and compliance requirements. If you don’t have a dedicated accounting department or professional handling your taxes, these tasks can fall on you, taking valuable time away from running your business. The cost of compliance, in terms of both time and money, can negate the benefits of certain tax strategies. Make sure to factor in these costs when deciding which tax strategies to implement.
9. Failing to Follow Through on Implementation
Creating a solid tax plan is only the first step. You must also follow through on implementation to benefit from the strategy. Whether it's keeping accurate records, maintaining a mileage log, or ensuring you’ve completed payroll correctly, failing to meet the necessary requirements can result in the IRS disallowing deductions and credits. The time and energy spent crafting a tax strategy could be wasted if you don’t execute it properly.
10. Not Knowing Your Key Numbers
Many small business owners, especially those new to entrepreneurship, don’t have a clear understanding of their business’s net profit. For self-employed taxpayers, changes to this number often make the most significant changes to your tax liability. Businesses that track their profitability throughout the year often find it easier to reduce their tax bill than businesses who only look at profit after their tax returns are done.
Key Takeaways for Service-Based Business Owners
Start tax planning early: Don’t wait until tax season. The earlier you plan, the more options you’ll have.
Focus on the right strategies: Tailor your tax strategies to your specific goals and business needs.
Keep an eye on cash flow: Avoid draining your liquidity just to save on taxes.
Avoid tax fraud: No short-term gain is worth the long-term penalties.
Understand your numbers: Monitor your business profit and other key metrics to avoid surprises during tax season.
By avoiding these common mistakes, you can create a more efficient and profitable business while still managing your tax obligations responsibly.
Click here to learn more about how Joshua Jordan CPA Inc helps service-based business owners use tax planning to reach their goals.
