If you’ve decided to dive into the world of entrepreneurship, congratulations! To be your own boss and earn a living by doing what you love can be extremely rewarding — if you do it right. As a new business owner, there are a lot of important financial decisions to make, including those determining how taxes will impact your business. So, let’s start you off on the right foot with some tax tips.
Choose Your Business Structure Carefully
Choosing the right business structure can impact how you file and how much you’ll pay when tax season comes. For legal and tax purposes, you can structure your business in different ways.
Sole proprietorship is the most common business structure. You own an unincorporated business solely and there’s no distinction between you and the business. You get all the profits, but also all expenses, debts, and risks. Moreover, you’re responsible for your own record-keeping and tax-paying as self-employment taxes.
Usually, businesses with this structure are home-based businesses, shop or retail businesses, or one-person consulting firms. Take note, though, that small online businesses without a physical location are now required to pay taxes for online sales.
The limited liability company (LLC) is one of the newest business structures, and the IRS does not have a specific tax category for it, so they use the tax categories of other business structures. One benefit of forming your own LLC is that you can avoid double taxation. LLCs enjoy a “pass-through” taxation, where no income tax is paid at the business level, and owners can choose how exactly they want to be taxed.
If your LLC is set up as a sole proprietorship, you’ll have to report your profits and losses on your personal tax return. If you choose to be taxed as a C corporation, the owners or members will report only the income that’s passed on to them on their individual tax returns as dividends or interest. Meanwhile, in LLCs set up as S corporations, the members report their share of income on their personal tax returns, avoiding double taxation. And lastly, as a partnership, each owner of the LLC will pay taxes according to his or her share of the profits and losses.
A C corporation is another business structure that is a separate legal entity subject to corporate tax rates. Here, only the business has legal liability and debt. While corporations may offer the greatest protection from personal liability, they’re also generally more expensive to establish.
An S corporation is a special type of corporation that allows for profits and losses to pass through to the shareholders rather than the business itself, avoiding double taxation. They’re also not subject to corporate tax rates.
Lastly, in a partnership, you share ownership of the business with one or more people. Each partner has equal share in the net profits and losses. Like a sole proprietor, each partner reports their income on their personal tax return and pays self-employment taxes.
Be Aware of Self-employment Taxes
Depending on your business structure, you could be required to pay self-employment taxes on your business income. This consists of Social Security and Medicare taxes, similar to the taxes employers withhold from their employees’ paychecks.
You may also want to make estimated tax payments to avoid huge tax bills and penalties at the end of the year.
Stick to Your Chosen Accounting Method
There are different types of accounting methods, but cash and accrual are the main two. To avoid confusion, it’s best to stick to just one method.
The cash method is the most common method, generally because it’s more straightforward for accounting and tax purposes. Basically, you account for income for the tax year in which you received it, and for expenses for the tax year in which you paid them.
With the accrual method, you account for income for the tax year in which you earned the right to receive it, and you can determine the amount owed with reasonable accuracy. Basically, you account for income and expenses on the year the service was fulfilled, even if billing or payment was done the following year.
Take Advantage of Tax Credits
You are entitled to claim tax credits to reduce the taxes you pay, as long as you qualify. The government “rewards” businesses with tax credits for worthy acts, like strengthening the economy, fighting climate change, or improving other people’s lives. Businesses usually file these as part of their annual tax filing process.
To make the most of available tax credits and deductions, consider working with an accountant who can lead you in the right direction.
Prepare for Tax Season Early
Start with a separate checking account and credit card for your business so you can have a financial statement for everything. Keep meticulous records of your receipts and the miles you travel for business to avoid losing deductions.
Payments are generally made quarterly and can be paid online, by phone, or by mail. Underpaying your taxes throughout the year could result in penalties when you file.
Starting a business can make filing taxes more complicated, so the sooner you start organizing your finances, the better.