Like it or not, every small business owner needs to deal with tax rules at some point, and the more successful you become, the more important it becomes to have good tax management strategies in place. In this article by guest writer Valerie Jocums we look at some of the basic tax concepts you need to understand when you do business in the United States.
There is nothing more exciting than when you decide to make the big leap and start your own business. You have been thinking about it for a long time, and now that you have decided, you want to jump right in. However, this is the time when you really need to stop and do more planning.
There are lists and lists about all the steps needed to start a business: from writing a business plan to organizing your marketing and social media to securing financing, and more. This article is going to discuss one of the less interesting, but nevertheless important, aspects of planning: taxes. Tax planning is something you need to consider before you even decide on a structure for your business. To make tax time easier in your new business, consider these three points:
The legal structure of your business will affect liability for the business debt, taxes, and organizational structure of the business. There are five main types of business structures: sole proprietor, partnership, limited liability company (LLC), S Corporation, or C Corporation.
Both sole proprietorship and partnerships have no business tax or liability. Both are passed through to the owner/partners, and they declare the taxes on their personal taxes. If there is any debt incurred, they are solely responsible for it.
An LLC is a hybrid structure that provides the owners the same type of liability afforded corporations, with the income taxation of a partnership. For federal taxes, the company is treated like a partnership (unless they elect to be treated like a corporation). The owners pay federal taxes for the company on their personal taxes. State tax laws may vary.
An S corporation is created by a state filing. It is a corporation filed with a special election with the IRS to be treated like a partnership or LLC for tax purposes. So, owners are not subject to corporate income tax. All income or loss is reported on their personal income taxes. However, their debt liability is assumed by the corporate entity.
A C Corporation is also created by a state filing. Because of its limited liability aspects, a C corporation might seem like the best option, however, you do have to consider the additional legal steps to incorporate and the double taxation of income. The corporation is subject to corporate income tax. The company income is taxed. Then any salaries and dividends paid to the owners are taxed on their personal taxes. So, in effect, there is double taxation if you are the only shareholder of the business. However, any liability incurred by the business is limited to business assets. Creditors cannot pursue the stockholders (owners) of the business for payment.
Payroll is an important part of any business, even if you are the only employee. If you are the only employee in a sole proprietorship, you have to pay self-employment tax, which covers the FICA contributions for business and employee. It’s not too hard to figure out, but you still have to file all the corrects forms. These taxes usually must be filed quarterly.
Once you start adding employees, payroll and taxes become more complex. Not only do you have to withhold federal income tax and the employee FICA contributions, you also have withhold any applicable state, city, or county income tax. You also have to remember to pay the employer contribution for FICA. This money has to be set aside for payment to the IRS, and then paid on a schedule you determine at the beginning of each calendar year. Then at the end of the year, there is a fair amount of paperwork to prepare employee W-2 forms. Increasingly, employees also want to have paperless paychecks, which is not necessarily harder to do, but there are specific laws pertaining to it that you might need to consider.
Records and Procedures
Tax law changes yearly. Your business changes almost daily. If you want to take advantage of all possible deductions, you need to plan ahead. If you stay organized on a daily basis, you will be in a position to make changes and adjustments if needed.
Document everything. Not only will you need records for any deductions you claim, but if for any reason a deduction is questioned, clear, complete records will establish your credibility. From the very beginning, establish a procedure for tracking all income and expenses. Use whatever tools work best for you, whether it’s an app on your phone, entry into accounting software, or a manual file system.
Plan ahead and set a schedule for paying all taxes when necessary, e.g. quarterly self-employment taxes.
Read up on the current tax laws and changes to allowable deductions. Staying informed is your best defense against errors.
Finally, seek the advice of a professional. Unless your business is tax accounting, it will be hard to know everything. A professional can help you get setup, explain any new rules, and help with filing questions.
Taxes are the non-glamorous part of owning your own business, but necessary. By planning for them, from the very beginning, you can make them taking care of them (if not paying them), as painless as possible. It might also help you save as much money as possible.