How to Avoid Tax Penalties as a Business Owner

The Bay Area is not just a great place to live, it’s also an excellent destination to do business. Access to top talent, funding, modern infrastructure, and affluent residents makes it an attractive hub for thriving businesses.

Despite the undeniable appeal, it also imposes some of the highest taxes and penalties in the country. In fact, Bay Area business owners deal with more tax penalties than those in most other areas of California. These penalties can add up to a substantial amount over time and erode your profits and personal wealth. But many of these are avoidable, and you can easily sidestep them with a few effective strategies.

Common Tax Penalties for Business Owners

From missed deadlines to incomplete tax returns, there are multiple ways you can face tax penalties as a Bay Area business owner. The most common reasons for paying penalties include:

1. Underwithholding

By underestimating your tax liabilities, you may unknowingly withhold less tax that what is required withhold less tax than what is necessary. This leaves you with a penalty at the end of the tax year, calculated as a percentage of the unpaid amount.

2. Income Fluctuations

As an entrepreneur, there are several ways you can draw an income from your business. It is not uncommon for income to fluctuate, especially at the early stages of the business or during periods of severe market volatility, such as the global pandemic that we’re experiencing today. This can lead to underestimating taxes when paying quarterly installments—the result of which is usually an underpayment penalty.

3. Personal Retirement Account Withdrawals

Business owners turn to their personal retirement savings in search of capital to invest in their business or to supplement funds needed for expansion. Not only are you invading funds saved and invested for the sole purpose of retirement, premature withdrawals before the age of 591/2 will incur penalties of 10% as well as an ordinary income tax liability on the distributed amount.

4. W-2 Mistakes

Each year, you need to hand over W-2 forms to all your employees and submit your copies to the Social Security Administration (SSA). Missing the submission deadline, forwarding inaccurate information, or failing to submit required details can all lead to a penalty.

5. IRA Audits

Discrepancies in tax return filings can trigger an IRS audit. For example, a sudden increase in deductions compared to revenue could raise a red flag and cause IRS officials to pay you a visit. The consequences of such an audit can range from penalties to even criminal charges.

6. Not Applying Deductions

Many business owners don’t fully take advantage of tax deductions available to their business. How and when you spend on business purchases and investments has a notable impact on your tax returns. For example, machinery and equipment you purchase for manufacturing or R&D activities can provide significant tax advantages. Without making use of these deductions, you incur unnecessary tax expenses. This simple mistake is equivalent to a self-imposed tax penalty.

7. Not Using an Accountant

Qualified accountants are expensive, so some business owners forgo their services to keep costs low. However, as your business grows, tax filing becomes more complex. Without an accountant, the possibility of making errors inevitably increases. The result is usually a costly penalty.

Strategic Best Practices to Avoid Tax Penalties

As a business owner, avoiding tax penalties should be a priority to protect your bottom line and personal wealth. Here are some essential strategies to adopt.

Understand and Comply With Tax Return Regulations

Providing accurate and complete information, maintaining and furnishing detailed records, and filing your returns before the IRS deadline can save you from a penalty or even an audit. To avoid an underpayment penalty, apply a tax safe harbor provision of 110% on your previous year’s tax liability.

Mark your calendar with all important IRS deadlines. If a third-party service provider is handling part of your tax-related activities, ensure that it abides by the given deadlines, too. For example, if you have outsourced payroll-related activities, follow up and confirm that all W-2 forms reach the SSA before the due date.

Optimize Deductions

Whatever the stage, scale, or structure of your business, there are various tax deductions that you can benefit from. For instance, when you’re setting up a new venture, you can deduct qualifying start-up expenses of up to $5,000 during the first year of operation. This applies regardless of whether you have commenced selling your products or services. A regular business would be eligible for deductions such as advertising, licenses, and supplies. Advancing these to the current tax year can help lower your tax liability. Therefore, planning qualified purchases, expenses, and investments and appropriately timing them is critical to avoid unnecessary tax-related costs.

Keep in mind, however, that too many deduction claims may also set off an IRS audit. Therefore, it’s essential to understand deductions applicable to your business.

Rollovers for Business Start-Ups

Rollovers for Business Start-Ups (ROBS) is an excellent option for you to invest part of your retirement savings in a business venture without incurring early withdrawal penalties. It allows you to roll over funds to a new 401(k) plan and use it to purchase stocks in your business.

Besides helping you avoid penalties and taxes associated with a traditional IRA withdrawal, ROBS has other advantages, too. For instance, it enables you to access capital without interest-bearing loans or collateral. However, it involves a lengthier process that includes establishing a new C Corporation and setting up and administering a new 401(k) plan.

Future-Focused Tax Planning for Your Bay Area Business

As your business expands, the process of filing taxes will grow in complexity and so will tax hurdles, such as penalties and fees. You can minimize or avoid many of these penalty-related challenges with the help of an experienced financial advisor. After all, applying optimizing strategies and best practices should always be a  forethought. It’s best to address them before the tax year begins.

This is why Summitry has adopted a holistic, future-focused, and localized approach to tax planning and wealth management. Our financial advisors help Bay Area business owners with customized tax planning strategies to avoid costly penalties and minimize unnecessary tax liabilities.

Contact us today to speak to a Summitry financial advisor on how you can avoid tax penalties and protect your business and personal wealth.