Tax season can trip up even the most organized MSPs. From overlooked deductions to poor entity selection, many of the most common MSP tax mistakes stem from a desire to cut costs. However, be forewarned, that strategy may result in you eventually spending more.
Though the most-prepared service providers have already completed this dreaded task, several others likely will file for extensions to the April 15 deadline. “Taxes, a five-letter word no one likes. Ever,” said Wade Yeaman, former CEO and founder of Fluid IT Designs.
What Experts Say MSPs Get Wrong About Taxes
For those who haven’t gotten through the process yet, we talked with Yeaman and other industry experts to find out the biggest stumbling blocks. Here are three tax preparation pitfalls that they said MSPs should avoid.
1. Skipping Professional Bookkeeping
Kate Browning
Messy or incomplete financial records are a common tax-season troublemaker. Smaller MSPs that try to DIY their books often run into problems.
“Deductions are often left on the table because business owners have tried to save money by not paying to have bookkeeping done, costing themselves more in the long run,” said Kate Browning, owner of Liberty Tax in Auburn, MA.
When business and personal expenses aren’t properly separated, it can also delay tax prep and increase the risk of filing errors. Many business owners forget to make quarterly estimated payments, which often results in underpayment penalties from the IRS, she added.
2. Paying Too Much in Self-employment Tax
MSP owners often operate as single-member LLCs. Doing this means they miss out on a valuable tax strategy: electing S Corporation status.
Kent Fitzpatrick
“By electing S Corp status, you can pay yourself a reasonable salary — subject to employment taxes — and take additional profits as distributions (K1), which are not subject to self-employment tax,” explained Kent Fitzpatrick, managing director of Asset Strategy Advisors LLC in Natick, MA.
This move can significantly reduce the 15.3% self-employment tax burden. That said, MSPs’ salaries must meet the IRS’s definition of “reasonable compensation” to avoid scrutiny, Fitzpatrick cautioned.
Another tax-saving opportunity MSPs often overlook is solo 401(k) plans. These allow for much larger contributions than SEP or SIMPLE IRAs — up to $69,000 in 2024, or $76,500 for those 50 and older. This allows MSPs to better manage taxable income and save for retirement.
3. Ignoring Sales Tax Compliance
Many MSPs underestimate the complexity and risk of sales tax compliance across multiple jurisdictions. For MSPs, taxes come in many forms — federal, state, county and city — covering income, property, franchise, sales and more, Yeaman said.
Wade Yeaman
He learned this lesson the hard way with his former MSP in Texas. After undergoing multiple sales tax audits in Texas, one audit initially resulted in a $500,000 tax liability. It took more than six months to resolve, but he ultimately brought it down to under $1,000.
“What was the cost in lost productivity and focus on the business?” he said. “If you are reading this and unsure, you probably need to find a tax expert even if just to educate you on the requirements and risk exposure relative to your specific MSP.”
The Bottom Line
Cutting corners during tax season may seem like a way to save, but it may be better to fight that urge. These common MSP tax mistakes can lead to missed savings, tax penalties, and costly audits. A proactive approach — with expert guidance — can save MSPs both time and money.
Images: iStock, LinkedIn, Asset Strategy Advisors LLC, Wade Yeaman
