Let’s face it: No one in their right mind starts a business to become a tax expert, this is exactly why taxes are one of the last things on the “to do” list of most startups, at least until tax time. By far one of the biggest mistakes most small business owners make is they don’t take the time to put an accounting system in place before they are making money to help them manage their newly found cash flow or to help mitigate the risk of a new startup. So to help you avoid this costly pitfall, here are four things every entrepreneur should know about small business taxes.
These are general tips and should never take the place of personalized advice from a tax accountant or CPA.
1. Pick the right business structure.
Having the right business structure is much like having a solid foundation to build a house on. The stronger the foundation, the stronger the structure will be on top of it.
Your tax requirements largely depend on the legal structure of your business, so whether you operate as a Sole Proprietor, LLC, S Corporation or C Corporation, your filing requirements will vary. Choosing which entity to operate your business involves several fundamental choices, this should give you a better sense of direction:
- Do you want to remain personally liable for business debts?
- How do you and your business want to be taxed?
- How do you plan on paying yourself?
- Do you want to minimize the self-employment tax?
- Are you looking to raise capital or bring in partners?
Once you can answer these questions, you’ll have a better idea of which business entity might be more suitable for you.
2. Know your deductions.
According to the IRS deductions are business expenses that are both ordinary and necessary. An ordinary expense is one that is common in your business industry and a necessary expense is one that is helpful for your business.
The good news is for small business owners there are over 300 potential tax deductions that you could be eligible for. Knowing what you can or can’t do is crucial to keeping as much as legally possible. This is especially true if you operate as a Sole Proprietorship, LLC or S Corporation, which are all pass through entities. The key point is to take the time to educate yourself on all the juicy deductions you may be missing out on.
3. Keep your books in order.
Having a well thought-out bookkeeping system will do two things for your business. (1) Strictly from an operational standpoint, it will help you save money. Understanding your cash-flow is just good business. Each month you should be reviewing your Profit and Loss Statement in addition to your Balance Sheet to keep a finger on the pulse of your business. (2) It will help you stay in compliance. As a business owner, the IRS puts what is called the “Burden of Proof” on you, so basically it is your job to be able to prove your income and expenses. Not to mention good bookkeeping is the best defense against an audit.
4. Know what to file and when.
In addition to your personal and business taxes required by the federal government, you will also have to pay some state and local taxes. Take the time to understand what your business is required to file and when. This will help you avoid any costly penalties and interest not only with the IRS but also with your state. The SBA provides a resource here for each state’s tax filing requirements for small business owners.
Employee vs. Independent Contractor.
There is no question that hiring employees is expensive, especially when you compare it to bringing in independent contractors. So why not make everyone an independent contractor?
If it were only that easy, the problem with that approach isif the IRS determines that you incorrectly designated an employee as independent contractor, you may be subject to penalties for not collecting Social Security taxes in addition to more than 40% of workers compensation for the specified time period. So the penalties can be pretty harsh.
So how do you know whom to hire? The general rule is that an individual can qualify as an independent contractor if the employer only has the right to control or direct the result of the work and not the “what to do and how to do it”.
Check out IRS Publication 1779 to make sure your new hires pass the test.
[box]Zach Olson is the CEO at TaxAlli.com. Tax Alli is the leading provider of online tax and accounting services for small business owners. By capitalizing on the convenience and power of the web Tax Alli is changing the way small business owners manage their tax planning, bookkeeping & tax preparation needs.[/box]
Mario Schulzke is the Founder of ideamensch, which he started a decade ago to learn from entrepreneurs and give them a platform for their ideas.