Owe the IRS more in tax than expected? These are the next steps for business owners
- Small business owners facing a big tax bill should have filed their taxes or, in the least, for an extension.
- Still, there are more important steps to take to limit the financial pain and risk to cash flow in the future.
Some small businesses may have received an unwelcome surprise at tax time.
As the U.S. continues to emerge from the pandemic, certain businesses might be seeing improved revenue and owe more taxes than they have in the past few years. Tax law changes in 2022 are also causing some shocking tax bills in the small business world. Meanwhile, newly self-employed often mistakenly equate gross pay and net pay, without taking taxes into account. "If you've been living as if the money that's in your bank account is your net pay, that can be a rude awakening," said Andy Phillips, director at The Tax Institute at H&R Block.
If owners haven't estimated appropriately, or have spent the cash elsewhere, it can create large problems. It can be especially vexing since the first estimate for the current tax year is generally due at the same time as last year's tax bill, a double-whammy.
But a larger-than-expected income tax bill doesn't have to sink the ship. Here are ways small businesses can handle unexpectedly high tax bills.
File even if you can't pay the whole IRS bill.
Some small businesses may not have filed their taxes by April 18 this year because they don't have the money to pay their bill. They should still file as soon as possible, however, to mitigate the IRS's "Failure to File" penalty, which applies to taxpayers who have a tax liability and don't file by the due date. The penalty is a percentage of the taxes you didn't pay on time.
If seeking an extension, you still have to pay.
Some business owners likely have sought an extension, thinking this will allow them to push off their payments without financial repercussions. "It's an extension to file, not an extension to pay," said Kimberly Wilkinson, senior tax manager at Wiss & Company.
Check for local disaster exceptions to filing.
Certain taxpayers may be able to benefit from IRS extensions for filing last year's taxes and 2023 estimated taxes due to disaster situations in their local area. To learn more, they can visit the section of the IRS's website specifically dedicated to this topic. "It's a tremendous relief for those that are impacted," said Michael Prinzo, managing principal of tax with CliftonLarsonAllen in Greenwood Village, Colorado.
Review payment plan options.
Owners who need more time to pay may qualify for a short-term or long-term payment plan. They can visit the relevant section of the IRS's website to see what's available, as well as potential costs and filing options.
Owners should keep in mind the IRS's "Failure to Pay" penalty based on how long their overdue taxes remain unpaid. Though future penalties may be reduced by setting up a payment plan, it's advisable to pay off the tax liability as soon as possible to limit the adverse effects of accruing interest.
Don't dip into payroll tax money.
Sometimes small business owners with employees try to tap money earmarked for payroll taxes to pay their personal taxes. That's not allowed and could result in a stiff penalty. "It's incredibly important that small business owners never borrow from their payroll withholdings to pay anything else," Phillips said.
Consider personal loans, credit even at higher interest rates.
A small business owner who needs cash to pay his or her taxes might consider a bank or credit card loan or some other type of short-term financing, such as tapping an existing line of credit if available. Interest rates may be high for some of these options — in many cases reaching into double-digits on a percentage basis after a year of Federal Reserve rate hikes. But owners have to weigh credit costs against the penalties and interest they'll accrue from the IRS, according to Anne Zimmerman, president and founder of Zimmerman & Co CPAs and co-chair of Small Business for America's Future, a national coalition of small business owners and leaders. "Don't use the IRS as your banker," Zimmerman said.
Consider filing an amended return.
It behooves small businesses to take a second look at their tax return and consider filing an amended return if they are able to eke out additional deductions.
"Often business owners aren't taking advantage of all the things they're entitled to," Prinzo said. "Make sure there haven't been any missed planning opportunities."
For example, there are favorable rules associated with taking accelerated depreciation, often referred to as bonus depreciation, which can help lower the tax burden.
In addition, there may be additional opportunities to deduct expenses, such as software, advertising or certain professional service fees, Phillips said. Small business owners may also be able to deduct home office expenses, if applicable.
For many small business owners, personal tax benefits can also reduce the taxes due. Owners may not have taken into account new life circumstances that could qualify them for a tax benefit or benefits, such as marriage, having children, caregiving for certain individuals or education expenses. "Life changes generally mean tax changes," Phillips said.
Work with a CPA to plan ahead, and potentially defer taxes.
Planning ahead with a CPA can help ensure owners aren't blind-sided in the future.
For instance, if an owner sees in the middle of the year he or she is making more money, estimates can be tweaked to minimize some of the impact at income tax time. "The goal is to have your tax paid by the end of the year," Wilkinson said.
Small businesses could also consider setting up a tax-deferred retirement plan for 2023, which can help with tax savings, said Cary Carbonaro, a certified financial planner with Advisors Capital Management in Winter Garden, Fla. A client recently did this mid-year and eliminated the need for a $300,000 estimated tax payment, Carbonaro said.
Thanks to recent passage of the SECURE 2.0 retirement savings legislation, there could be additional tax benefits for certain business owners who start tax-deferred retirement plans, so that's also worth investigating, Prinzo said. Secure 2.0 encourages small business owners to create retirement savings plans through starter plan options and tax credits for both administrative costs in setting up a plan and making employee match contributions.
Nevertheless, even if you take all these steps, it's still important to keep enough cash on hand for the next tax cycle, just in case there's another surprise.