There are many reasons why people decide to take the leap and jump into business on their own. For some, it’s the freedom to be their own boss. Others may want to pursue their passion. Most, however, are drawn by the unlimited earning potential. If you are contemplating starting your own small business, one thing is for certain – you will need to pay taxes. Whether you are an independent contractor, an online retailer, or open a brick-and-mortar store, there are many things to consider when it comes to your tax liability. Planning ahead is a must, if you don’t want to be blindsided at tax time. To ensure you start off on the right foot, follow these five tax tips for new small business owners.
1. Choose the Right Business Entity
Choosing the right business entity not only impacts how you file your taxes, but also how much you will owe. That’s why it’s important to speak with a tax professional before making a decision on which will be best for you. In general, most small business owners will file under one of the following:
Sole proprietorship is one of the most common business structures used to start a business. It is an unincorporated business owned and operated by a single individual. As a sole proprietor, you are entitled to all the profits, but you are also responsible for all debts, losses, and liabilities. Since you and the business are one and the same, you’ll use Form 1040 and report your income, losses, and expenses using Schedule C.
If you plan to go into business with one or more people, a partnership is the simplest structure available. There are two types of partnerships to choose from: limited partnerships (LP) and limited liability partnerships (LLP). Partnerships are required to file Form 1065, U.S. Return of Partnership Income, to report their income, losses, and other details. Profits, however, are passed through personal tax returns (Form 1040). In an LP, the general partner with unlimited liability must also pay self-employment taxes.
Limited Liability Company (LLC)
An LLC may be formed by one or more people. The main benefit is that your personal assets (home, car, bank accounts, etc.) will be protected if your company goes bankrupt or faces a lawsuit. Single member LLCs are treated like a sole proprietorship for tax filing purposes. Those with two or more members may file taxes as a partnership or a corporation. Members of an LLC must also file self-employment taxes (social security & Medicare).
C corporations provide the most protection from personal liability and are taxed as a separate entity. Each year, the corporation must file Form 1120, U.S. Corporation Income Tax Return. In some cases, a C corporation’s profits may be taxed twice; first, when it makes a profit (corporate return), and again when it pays dividends to its shareholders (personal tax returns). Although a corporation provides more personal protection, it can be expensive to establish.
Unlike a C Corporation, an S Corporation is not subjected to double taxation. That’s because its profits, as well as some losses, are passed directly to the shareholders and not the business itself. S corporations do not pay corporate income taxes and are generally treated like a partnership for tax purposes. An S Corporation must file with the IRS to gain its status, which is completely separate from filing with your state. Keep in mind that there are some states that do not recognize S corporation status, and it’s not treated equally across the states that do allow it.
2. Keep Good Financial Records
The most time-consuming part of being a small business owner is often managing your financials. That’s why it’s so important to implement a system for maintaining your invoices, receipts, and other important paperwork. There are numerous software programs and online accounting services that can help you keep everything organized. MoneySolver, for example, offers an affordable monthly bookkeeping service that allows you to upload items by simply using your mobile device. We handle line item expense entry and classification, monthly reporting, and provide a year-end tax prep summary. If you go the do-it-yourself route, just be sure to keep similar items together so it’s easier to manage at tax time.
3. Take Advantage of Tax Breaks
There are numerous tax credits and deductions available to small business owners. Although you may not qualify for every tax break, here are some of the most commonly used:
- Advertising and promotional. This may include business cards, digital and/or print ads, sponsorships, the cost of building and launching your website, as well as other promotional expenses.
- Depreciation. The IRS allows you to write off the cost of certain purchases, such as equipment and other business assets. Most businesses use the Section 179 deduction, but there are others available, as well.
- Business insurance. Property coverage, workers compensation, professional liability insurance, auto insurance for business vehicles, health insurance for workers, and more.
- Legal and professional fees. Expenses related to running your business, such as those incurred for legal advice and services, accounting or bookkeeping, and other professional fees.
- Home office. If you work from home, you may use either the standard or simplified method to deduct your home office expenses.
- Business travel expenses. When traveling for business, you may be able to deduct lodging expenses, parking and tolls, WiFi, and other fees.
- Education. Subscriptions for professional publications, seminars/webinars, certification courses, workshops, and other things to increase your knowledge within your business field.
- Work Opportunity Credit (Form 5884). If you hire an employee who is from a certain targeted group, such as qualified veterans or ex-felons, you may be eligible for a tax credit up to $9,600 for each new hire.
- Disabled Access Credit (Form 8826). Did you make any modifications to your business to improve access for those with disabilities? If so, this tax credit is worth up to $5,000.
- Credit for Employer-Provided Child Care Facilities and Services (Form 8882). The maximum credit is $150,000 annually, if you offer on-site childcare services or participate in a referral program.
These are just a few of the available tax credits. To see the full list, visit the IRS website.
4. Don’t Commingle Personal and Business Expenses
As a small business owner, it may be easier to keep all your funds in one account, or use a single credit card to make purchases, but this can complicate matters at tax time. In addition, it can open you up to potential legal problems. If someone sues your company, they could potentially come after you personally, if the line between personal assets/income and business assets/income gets too blurry. To avoid potential problems, follow these tips to avoid commingling your personal and business funds.
- Set up a separate business bank account
- Get a business credit card
- Document everything
- Record business transactions as soon as possible
If you work from home, it’s equally important to create a separate space just for your business activities, as this will make it easier to determine your home office deductions when you file your tax return.
5. Make Quarterly Tax Payments
Do you plan on setting up your business as a sole proprietor or a partnership? Don’t make the mistake of waiting to pay your taxes when you file your personal tax return. If you do, you may find that you owe more in taxes than you can afford. The IRS may also assess penalties and interest, if you did not pay enough throughout the year (underpayment). Typically, quarterly tax payments are made on April 15, June 15, September 15, and January 15. This year, however, the April and June payments were pushed to July 15 due to the coronavirus pandemic. There are various ways to make your quarterly estimated payments, including:
To view all of the ways to make your IRS payments, please visit IRS.gov/payments.
MoneySolver offers several services to help new small business owners. Be sure to check our business startup packages, bookkeeping and payroll services, as well as our tax preparation and planning tools. You can also find more tax tips for new small business owners by visiting our blog. If you’d like to see how working with our company can help your business succeed, schedule a free consultation today!