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Avoid Common Tax Penalties With a Little Foresight

2 minutes Read

Tax-penaltiesEach year, small businesses pay the IRS an extra $4.5 billion beyond what they owe in taxes, and this isn’t due to faulty accounting or missing out on deductions. The reason is far simpler. That $4.5 billion comes from penalties charged for late payments. Depending on how late those payments are, the IRS can leverage penalties ranging from 2 to 15 percent of the original amount due.

Another fine many small business owners will face has to do with inaccuracies. The IRS can lay a 20 percent penalty if they find you have been negligent with reporting your income. This most often occurs when you can’t prove certain deductions or if you substantially under report taxable income.

Now, these two penalties are nothing new, and the clauses that allow them aren’t exactly hidden in the tax code. It’s safe to say that someone who’s capable of managing all of the details that go into running a small business probably knows that taxes need to be paid on time and that under reporting is risky. Nonetheless, the IRS continues to make a bundle off simple mistakes.

Rewire how you think

No small business owner likes to see their money sent off to the IRS. Unfortunately, many respond in such a way that they ultimately pay a penalty and owe more than they did originally.

One of the best ways to avoid these penalties is to plan ahead and make sure you are financially and psychologically ready to pay taxes. This idea calls for a simple strategy, which basically involves setting aside money as you make it. This will ensure you always have money in your account to pay your taxes.

If this sounds surprisingly easy, that’s because it is.

A simple solution

Think back to the time when people budgeted their expenses by putting cash into separate envelopes: one for groceries, one for transportation, another for the house payment and so forth. This admittedly primitive technique is one that small business owners should follow.

All you have to do is divide your revenue into separate accounts for taxes, salaries, rent, accounts payable and retirement. This way, you’ll always be prepared to pay what you owe.

How much should you allocate for taxes?

It’s recommended that you put 15 percent of every payment collected into a tax-reserve account. You may discover that you need to set aside a larger percentage, especially if you’re behind in your payments. The real power of setting this money aside is that when it comes time to pay taxes, you won’t be pulling money out of your revenue fund. As a result, that sting that comes each April won’t be as strong. After all, you set aside money for just this payment.

Finally, in order to fine-tune this system, meet with your accountant every quarter.

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IMPORTANT INFORMATION: This is not investment, tax, or legal advice. Should you have questions, please consult your own attorney, tax accountant, or other appropriate expert having expertise in the area of your question or before making important decisions in these areas.