While the government may not be interested in your business before it turns a profit, it’s important to pay attention to your tax responsibilities in the early stages of formation in order to maximize deductions and prevent liability issues moving forward. Here are five things every new small business should know about federal income taxes.
- Your Legal Entity Affects Your Tax Burden
Think that all small businesses endure the same tax burden? On the contrary, the legal entity you elect to form can have a tremendous effect on your tax liability throughout the years.
From sole proprietorships and LLCs, to S corporations and partnerships, there are various business types, each with its own benefits and limitations. For example, S corporations offer small business owners the advantage of paying taxes at the shareholder level, rather than being subject to higher corporate rates. However, a company of this kind must be limited to 100 shareholders and feature a single stock class. On the other hand, while C corporations can deduct a wider range of expenses and include hundreds of shareholders, these groups must contend with double taxation.
Do your research to determine what legal entity best suits your needs.
- You Can Deduct More Than You Think
It’s no secret that small business owners have to learn ways of stretching their scant financial resources. From raw materials, to employee salaries, to business rent, to utilities, the various operational costs of a startup can be overwhelming. Fortunately, as a new small business owner, you may be able to deduct a number of expenses in order to minimize your tax burden while maximizing company profits.
According to the IRS, businesses can deduct expenses deemed both ordinary and necessary. Ordinary expenses refer to those that are common to your specific trade, meaning what’s reasonable for one company may not be relevant for another. On the other hand, necessary expenses are helpful (but not always obligatory) in your field.
Some of the most common business deductions include rent on a business or home office, supplies, furniture and equipment, such as computers, copiers and fax machines. Additionally, many small businesses can deduct costs associated with providing healthcare benefits for their employees.
Do your research to identify all possible deductions and give your company a leg-up come tax time.
- Don’t Forget About Startup Expenses
Many brand-new startups make the mistake of thinking business expenses aren’t deductible until their businesses are up and running. However, the truth is that the IRS allows small business owners to deduct a wide array of startup expenses before they open their doors to customers.
Although startup expenses differ by industry, most business types can deduct investigational costs related to researching markets and analyzing products. Additionally, startups can deduct costs accumulated before they open for business, such as training employees, attending trade shows and seminars, locating suppliers and advertising to potential clients. While companies cannot deduct licensing and incorporation fees as startup expenses, these costs may be deductible as incorporation expenses.
It’s important to remember that startup founders can only deduct those expenses leading to the creation of a viable business entity. If you decide against forming your business, the above costs will be labeled as personal expenses, and you may not be able to deduct any of your costs.
- You Must Make Estimated Payments
As a new small business owner, you probably know that it’s important to pay taxes accurately and on time. However, you may not realize that self-employed persons are responsible for making quarterly estimated tax payments throughout the year.
While startup founders are excused from making estimated tax payments in the first year of operation, they are responsible for submitting accurate quarterly payments in the years to come. Business owners filing as sole proprietors, partners and S-corporation shareholders must all make estimated tax payments if they anticipate owing $1000 or more for the tax year.
Filing estimated tax payments for the first time? You may want to use last year’s income, tax credits and deductions to calculate your expected tax burden. Business owners who fail to submit at least 90% of the taxes they owe may be subject to penalties, so perform your due diligence to ensure you’re in the clear.
- You’re Responsible for Paying Self-Employment Tax
If you’ve never owned your own business, then you are likely unaccustomed to paying self-employment taxes. Comprised of Social Security and Medicare taxes, self-employment tax is paid by workers whose income is not subject to employer withholding. As a self-employed person, you are responsible for both your own portion of the self-employment tax and the half typically paid by an employer.
To ease the burden at tax time, small business owners should remember to deduct the employer-equivalent component of their self-employment tax. Business owners can claim half of what they pay in self-employment tax as an income tax deduction, so a $5,000 tax payment decreases income by $2,500. Additionally, it’s important to take advantage of all possible business and startup expenses to limit net income and, by extension, your self-employment tax burden.
Want to ensure your tax return is on the up-and-up? You may want to consider hiring a tax advisor to help you maximize deductions while ensuring your startup is meeting its tax burden. Not only does working with a professional safeguard your business and personal wealth, but it also allows you to focus on what matters: building your company into a successful operation.
- Be Cognizant of Overlooked Deductions
While you cannot write off the loan, you might be able to write off things that the loan funded. Auto, health insurance, interest on small-business loans, payroll taxes, office furniture and marketing are just a few of the available tax deductions for small businesses. Many of these expenses, when personally incurred for employees, are not deductible. In other words, it pays to be a business owner! It’s always a good idea to consult with a professional CPA (accountant) about your small business loan and its write-off ability, but we all know that this is not always possible for struggling small businesses.
Filing your taxes is never fun, but it is a nightmare for small business owners. Many leave out important forms or information from their tax forms and often times, merchants wait until it is too late to file and end up incurring penalties. While a small business loan cannot be a write-off, what it is used for can be. The same goes for merchant cash advances. Best recommendation is to keep notes and all documentation filed away and organized with all documents pertaining to your business loan.