12 tax mistakes to avoid with a side business -- Page 2
By Dana Dratch • Bankrate.com

6. Failing to designate a business credit card.
Another good way to keep personal and business funds separate is to use one credit card exclusively for your side business. Credit cards also are great for creating a paper trail. With most, you get an end-of-the-year statement that will track all of your purchases, a great log of your business expenses.

"You'll be able to [document] expenses that you'd never be able to recall a year later," says Slott.

He remembers going into an audit with one client, armed with the year-end credit card statement as well as the other necessary paperwork. "The IRS agent loved the fact that he had it all in one statement."

7. Keeping bad, or no, records.
That nicely ordered year-end credit card statement is a good first step, but don't forget your other records. If your filing system is a shoe box, the pocket of the coat you wore last winter and various envelopes in your office, you need to get organized.

Traditionally, small business owners keep "horrible" records, says Slott. "They're busy running their businesses."

Most people will forget expenses or underestimate, Slott says. But better records mean more deductions, which equals more money in your pocket.

Record keeping can be simple and cheap. In his own practice, Slott gives his entrepreneurial clients a manila file folder sealed on three sides on which he's written "tax info" and tells them to just throw every receipt in there. "You have it all in one place, and it's so simple."

It works so well that clients clamor for the special folders every year, he says.

So what about sorting through the receipts? Get a decent bookkeeper, Slott counsels. "It doesn't cost that much, and frees you to do what you're best at."

8. Refusing to consider tax preparation software.
If your business is too small to justify a bookkeeper, at least consider prepackaged help, especially at tax time. There are a lot of good programs out there, says Sorkin, and they can make your overall tax preparation a lot easier.

"Look for a package that prepares the individual Schedule C properly," he says. "Once you do that, you can run your own projections anyway."

9. Forgetting to adjust your withholding.
If you're making extra money through your business, chances are you also have to pay more taxes. The two simplest options are either filing estimated taxes for your side business or adjusting the payroll withholding on your day job to cover the extra tax you owe, says Sorkin.

But if you've established a corporation, you can't simply adjust your salary withholding. Instead, you'll have to pay withholding monthly or quarterly, depending on your situation, says Sorkin.

10. Passing on employing your kids.
If you have kids and can do it, putting them on the payroll is a great tax strategy, says Slott. You get some extra help, show them the value of hard work and your small business gets to deduct their salaries. Plus, the youngsters can get a nice head start on their own retirement funds.

The big factor here: It has to be real work. "You can't just put them on the payroll," says Slott. "But if you have work that you would otherwise pay someone else to do, the amount you pay [the youngsters] is a tax deduction."

It's an especially great situation for the self-employed because the money "comes right off their income," he says.

In 2004, children could make up to $4,850 before they had to pay taxes; the inflation-adjusted amount this year is $5,000. If the job is just for the summer, youngsters likely won't make that much. What they do make, they can use to invest in a Roth IRA, Slott advises.

11. Referring to a hobby as a business.
You know the difference between a vocation and avocation. So does the IRS.

With a bona fide business, you can prove you're out to make a profit. In that case, go ahead and take every deduction you're entitled to because you've earned them.

But if you take pictures for fun and just want to write off the cost of film and developing, forget it, says Picker.

"The real rule is that a business is operated as a business," he says. "In terms of marketing it, in terms of the effort put into it, to show that your intention is to make a profit."

12. Deciding you don't qualify for certain deductions.
If you have a question about a deduction, talk to a tax pro before you decide you don't qualify.

"If you're making your own decisions, you [could be] cheating yourself out of deductions that could be allowable," says Slott.

Slott regularly sees small business owners who buy office equipment with a credit card and carry the balance for a few months. They're savvy enough to know that finance charges on personal purchases are not deductible. What they don't know, he says, is that they can deduct finance charges on business expenses.

So collect the paperwork, put in for the deduction and let your tax pro tell you if you don't qualify.

"For a lot of people, depending on their inclinations and time, this is a case where if you're making a decent outside income, it's probably worth it to have an accountant," says Farrell.

"Not only will your accountant be able to advise you on deductions, but you can also get some good advice on when you buy, or don't buy, things for your business so that you can maximize your money."

Dana Dratch is a freelance writer based in Atlanta.