Six Tax Tips for New Business Owners
Starting a business is a big step in your career. In addition to developing, marketing and selling your product /service an important step is to understand the tax compliances which are critical for your business’s success. Below are few quick tips that you may find useful as a new business owner
- Selecting the right business entity for your business : With the changes in the 2018 tax law, the business can be structured in many ways. Choosing the right type of business entity can help you file and understand your tax liability. Below is a very basic overview of the various business structures :
- Sole proprietorship : This is a very basic and simplest business structure. Essentially, you are going solo without any legal structure. This also has the highest business risk as your personal assets may be held liable to pay business risks. From a tax perspective, all the profits, expenses debt and all the risk will pass through to the owner. Also, there is no distinction between the business and you as the business owner. For this reason and the many choices that are available today business owners choose to incorporate either an LLC or a Corporation for their business.
- Partnership : Essentially most of features of sole proprietorship apply to partnership. The only big difference is there are at least 2 members in a partnership. It also has a similar risk of personal unlimited liability and the personal assets may be used for paying off business debts. There are two popular partnership structures -general and limited partnerships. Limited partnerships have limited liability for the limited partners but has unlimited liability for the general partners.
- Limited liability company : An LLC provides the limited liability protection that a sole proprietor/single owner business or partnership is unable to provide. The states govern all major compliances relating to LLCs and vary by state. An LLC provides limited liability protection from business debts. All profits and losses pass through the personal income. Of course, you will be required to pay for self-employment taxes.
- S Corporation : S Corporations as they are called are a special type of corporation. This type of business entity allows profits and losses to pass through to the shareholders. Income from the S Corporation is not subject to corporate taxes and all profits/losses pass through to the shareholders. With the 2018 tax law changes, this is a popular form of business structure that allows for 20% additional deduction on business income Sec 199 A.
- C Corporation : C corporation is a separate legal entity separate from the shareholders. They relatively have higher compliances to follow and are expensive to establish than other forms of business entities. With the changes in 2018 tax laws this has become one of the most popular business structures and a low corporate tax rate of 21%.
There is no right business structure and it is not necessary to create a formal business structure like an LLC or an S/C Corporation.
2. Choosing a book-keeping system : Currently for business owners there are many cloud based applications available at reasonable costs. There are two main types of book-keeping systems.
- Cash based book-keeping system : According to this method, you report revenue when you receive the cash. You report expenses when you incur the cost. Due to its simplicity, it is one of the most popular methods of book-keeping systems.
- Accrual based book-keeping system : Under this system you account for income in which you earned it. As an example, as a business owner if you earned revenue in October of 2018 but have not yet been paid until end of January 2019. You are still required to report it in the 2018 tax return.
The same applies for expenses. If a vendor/individual contractor has done the work for you and you are able to estimate the cost, then you need to account for the expenses in the year the work was completed eg 2018. This applies even if you were billed or you pay for it in 2019.
3. Managing the self-employment taxes : Depending on the business structure, you are required to pay for self-employment taxes.
Self-employment taxes consist of medicare and social security taxes. The total tax rate is 15.3% of net earnings -12.4% social security earnings and 2.9% Medicare taxes. A total of $128,400 is subject to social security taxes and there is no limit to medicare taxes.
There is additional medicare tax of 0.9% if it exceeds the following thresholds :
a) Single or head of household : $200,000
b) Married filing jointly : $250,000
c) Married filing separately $125,000
4. Managing the record-keeping : As a business owner, you need to follow the right record keeping system for all the receipts and invoices. This may be very helpful in case of a tax audit or a financial statement audit. Lack of keeping adequate records can be very costly if you are unable to support the documentation.
5. Tax credits : As a business owner, being aware of the tax credits may be very useful.
a) Work opportunity credit : As a business owner, you may receive tax credits between $1,200 to $9,600 for eligible employees.
b) Disabled access credit : You may be eligible for tax credits if your business/store front gives special access to individuals with disabilities.
c)Alternative motor vehicle credit : This is the tax credit that may be available if you are driving green and if your business purchases SUV or car. You will be eligible in the year it was placed in service and if this not intended for any resale.
6. Employees vs Contractors : As a newly established business this may be an important decision you will need to take hiring employees vs Contractors. Any incorrect classifications can trigger Internal Revenue Service audits. Therefore, if you are unsure consult a tax professional.
Starting a business involves many steps, so the sooner you streamline your finances the better it will be. Investing in the right systems and processes in the startup phase may in turn provide long term benefits to running a profitable business.