As a small business owner, you may assume the IRS has bigger fish to fry than your small business operations. However, recent reports have cited that the IRS has increasingly targeted small businesses for tax audits.
The National Taxpayer Advocate estimates small businesses spend approximately 2.5 billion hours each year preparing tax returns or responding to IRS inquiries about their returns. This is the equivalent of 1.25 million full-time jobs. The study also cited that 70% of small businesses employ tax professionals for tax preparation and to represent their interests before the IRS.
To avoid wasting time, money, and resources, pay attention to your potential tax burden when forming your business. The formation stage is vital to maximizing deductions and minimizing your tax liabilities for the future.
With the Tax Cuts and Jobs Act in full effect, many small business owners are unsure how the new tax law will impact their tax bill. Many business owners don’t even know corporate income tax rates, business tax deductions, or what tax cuts they’re eligible for.
Every small business owner should understand these five important things that can affect the business’s income taxes and overall tax situation.
1. Choose your legal structure wisely
When forming your business, it’s important to be aware of the different legal structures that exist, since each structure has different tax implications. Sole proprietorships, S corporations, C corporations, and limited liability companies (LLCs) are all different legal structures with different tax requirements.
Here are the differences between each.
Sole Proprietorships
If you’re operating an unincorporated business and are the only owner, then you’re automatically a sole proprietor. This is the most common business entity with over 23 million sole proprietorships in the United States. It’s the easiest to set up and manage, but also one of the riskiest since you personally assume all financial and legal obligations.
Sole proprietorship taxes are straightforward since you can report business income and losses on your personal tax return (Form 1040), using Schedule C. Your company profits are added to other income (interest, dividends, etc.) on your personal tax return.
With the new tax law, sole proprietors are able to take advantage of the 20% tax deduction, which allows them to deduct 20% of the business’s net income from their taxable income, which reduces their tax liability.
S Corporations
S corporations may pass income directly to shareholders to avoid double taxation. Double taxation means that a firm’s profit is taxed on a business tax return, and any after-tax profits distributed to owners is taxed again as personal income. But this won’t happen if your company is set up as an S corporation.
S corporations must have no more than 100 shareholders, all shareholders must be U.S. residents, and each member is only allowed to own one class of stock. Shareholders report business income, expenses, losses, and deductions on their personal tax returns. S corps are also eligible for the 20% tax deduction, but shareholders pay taxes on business profits at their personal income tax rate. It’s one of the most common types of legal structures for small business owners because they have the same advantages as traditional corporations but with more tax flexibilities.
C Corporations
Traditional corporations are C corporations (C corps). The organizational structure of a C corp consists of shareholders, a board of governors, officers, directors, and employees. Although Fortune 500 firms are the most well-known C corps, it’s still a viable option to structure your small business this way. It provides legitimacy to investors and clients, allowing you to raise funds faster and land larger contracts. If you anticipate quickly transitioning from a startup to a more established company, then the C corporation structure may be right for you.
C corps are the only type of business discussed here that must pay taxes on the company level. The current corporate income tax rate for C corps is a flat 21%. Additionally, in contrast to S corps that lets shareholders report profit and losses on their personal tax returns, shareholders receive dividends (i.e. a share of company profits). Shareholders must pay personal taxes on those dividends.
The taxation structure on both the company and shareholder levels is referred to as double taxation. This turns off many small business owners. When starting out, LLCs tend to be a more popular option than C corps for various reasons.
Limited Liability Companies (LLCs)
Many small businesses tend to form as an LLC. LLC members have two important tax advantages: no double taxation and deductible business losses.
Unlike C corporations, where business income is taxed twice — at the corporate level and at the individual level — LLCs are only taxed once at the individual level. This means that members pay taxes on business income on their personal tax returns in the same way a sole-proprietorship or an S corp does. This treatment is referred to as a “pass-through” tax treatment.
Another advantage of owning an LLC is that you can have an unlimited number of members (i.e. potential shareholders) in your LLC, which makes it easier to raise capital and expand your business. If you have multiple members in your LLC, you have to determine the ownership percentages for each member.
With multiple-member LLCs, you can choose to be taxed as a partnership or as a C corporation. If you choose to be taxed as a partnership, then you’ll report your share of the business income on your personal income tax returns. If you choose to be taxed as a C corporation, you will be subject to double taxation.
Single-member LLCs, on the other hand, are automatically taxed as a sole-proprietorship.
You may pay upfront costs to set up and maintain your LLC with your state. To operate an LLC in California, for instance, small business owners pay $800 in state taxes annually — regardless of how much money the LLC is making or losing.
If you’re in a state where you have to pay annual taxes to operate an LLC, then your job is to grow the business enough to offset that cost. Every state has different annual taxes to operate an LLC and some may not have any annual state taxes, so it’s important to check before you establish your business.
But the tax advantages, pass-through profits, and management flexibilities still make LLCs a popular option. Your tax situation depends on doing your research to determine which legal entity best suits your needs.
2. Use tax deductions to lower your tax bill
New small business owners have to stretch their financial resources.
Small businesses have business expenses that include vehicle expenses, wages, business travel, contract labor (i.e. hiring freelancers and independent contractors), supplies, equipment, depreciation of assets, rent on business property, utilities, insurance (i.e. property, business, health insurance, etc.), and repairs.
Fortunately, as a small business owner, you are able to minimize your business taxes by writing off a lot of those operational expenses come tax season.
Tax preparation software such as the QuickBooks Self-Employed Tax Bundle with Intuit Turbotax automatically tracks your business expenses to minimize your federal tax burden, which allows you to easily claim your deductions.
Completing one’s annual tax return can be a fairly straightforward process. You simply get your W-2 or 1099 forms and other necessary documents in the mail or online, then file using one of the many online software tools available.
But for some taxpayers, completing an annual tax return can cause an immense amount of stress. If your employment status and/or financial picture is complex, you might fall into this category. In addition, if you’re unsure about how the recent tax law changes might impact you, it might make sense to consult a professional this year.
Below, you’ll find seven common reasons why you should consider hiring a pro to do your taxes.
Depositphotos
If your financial picture changed significantly in some way in the previous year, you might want to consider hiring a professional to do your taxes.
“If you’re used to doing it yourself, but you have a big tax income year with a lot of complexity, it makes sense,” said Andrew Rosen, a CFP at Diversified, LLC in Wilmington, Del.
Major financial events could include things like taking money out of a retirement account; having a significantly higher earning year; transferring jobs during the year, getting a large bonus, purchasing a home or having children who started college.
Depositphotos
Perhaps you’re a freelance graphic designer. Or maybe you’re a self-employed consultant. Whatever your job may be, if you’re self-employed, you should definitely consider meeting with a pro when it’s time to do your taxes.
“If you are self-employed, I think it’s a really good idea to use [an accountant],” Rosen said. “If you’re self-employed, typically you have a lot of write-offs and there’s a lot of gray area. You want to make sure you’re categorizing things.”
One added benefit of consulting a professional if you’re self-employed is that you’ll have added protection from being audited.
“Generally, if the IRS sees that a return was done by a tax preparer, it’s less likely to be audited,” said Gary Schaider, a certified public accountant and manager at Weiss & Company LLP in Glenview, Ill. “And you have the firm’s signature behind your return, so they have some responsibility and stake in making your return correct and helping you with any IRS inquiries.”
Schaider said this protection is often why people consult a professional to do their taxes in the first place. “I think the audit risk for someone is pretty low, unless you’re amazingly wealthy,” he said. “But if you do have that signature of the CPA, that definitely gives you a better score on your tax return.”
Depositphotos
If you have children or claim other dependents, it might be worthwhile to consider hiring a professional to do your taxes. Rosen said that if you have children and everything else in your financial picture is normal, you might not need a pro. But if there’s any level of complexity to your finances, you should consider it.
If you have college savings planned for your children or monthly payments for school, for example, it could be beneficial to hire an accountant. In addition, if you have stepchildren or children from a previous relationship, you should consider hiring an accountant, as this may add a level of complexity to your tax return.
Plus, Rosen jokes, parents often don’t have the bandwidth and energy to complete their taxes.
“[Parents] typically don’t have a lot of time with their children, and taxes are complex,” he said. “I’m a firm believer in figuring out where you want to spend your time. Do you want to spend it doing your taxes and looking for receipts or do you want to dump it on someone else’s plate?”
Depositphotos
Most people get everything they need to complete their tax return in the mail: 1099s, W-2s, mortgage interest, etc.
“I think that makes it relatively simple,” Schaider said. “But if you have anything else outside of what generally might come in the mail from the IRS, such as your own business [or] charitable expenses … you might want to consider using a professional to help you make sure they’re presented best on the return.”
Things you might be able to itemize include: mortgage interest, charitable donations, business expenses, interest on investments and medical expenses. If you plan on itemizing any of these deductions come tax season, hiring a professional can make it simpler.
In light of the recent tax law changes in 2018, you may also have questions about your itemized deductions that may not be fully deductible this year. An accountant can help you navigate these changes.
Depositphotos
If you had a significant life event in the previous year, consider consulting a tax professional to ensure you complete your tax return efficiently. Some major life events could include a death in the family, marriage, divorce or the birth of a child.
“If there’s anything unusual that sticks out, I think you should consult a professional,” Schaider said.
Depositphotos
If you have investment accounts, such as college savings funds, stocks, bonds, annuities or individual retirement accounts, your financial picture is likely more complex. Consulting a professional to do your taxes can help ensure you abide by all of the tax rules that accompany these types of accounts.
Depositphotos
If none of the above statements applies to you, that doesn’t mean you have to do your own tax return.
“Why would I tell people to have someone do their taxes? First is if you just don’t have the time or the bandwidth,” Rosen said. “I think there’s a power in outsourcing a lot of things in this world and, quite frankly, getting your taxes done has become a bit of a commodity. You can get it done fairly inexpensively.”
If you decide to consult a professional to do your taxes this year, Rosen advises looking for a certified public accountant, or CPA.
“If you’re going to seek tax help, I would look for a CPA,” he said. “You don’t have to be a CPA to do taxes. For instance, H&R Block and most [tax preparers] aren’t CPAs. If you’re going to pay for [your taxes], you’re not paying very much for a premium with most CPAs anyway. Might as well have someone who has a firm understanding of taxes.”
This article originally appeared on MagnifyMoney.com and was syndicated by MediaFeed.org.
Depositphotos
3. Write off your startup costs
Many brand-new startups make the mistake of thinking initial business expenses aren’t deductible until their businesses are fully operational. However, the IRS allows small business owners to deduct a wide array of startup expenses before beginning business operations.
The IRS allows you to deduct up to $5,000 in business startup costs and up to $5,000 in organizational costs, but only if your total startup costs are $50,000 or less. With the help of your tax software or a tax expert, you can write off typical costs associated with setting up a business during tax filing.
Typical costs to set up a business include business insurance, office space, real estate, office supplies, business cards, business assets, professional fees (i.e. hiring accountants), and small business loan fees. If you’re operating your business from a home office, you can qualify for a home office deduction.
Additional costs can also include employee training, locating suppliers, and advertising to potential clients. While companies cannot deduct licensing and incorporation fees as startup expenses, these costs may be deductible as organizational 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.
4. Pay quarterly taxes
According to the IRS, individuals, including sole proprietors, partners, and S corporation shareholders, have to make quarterly estimated tax payments if they expect to owe taxes of $1,000 or more when their federal returns or state tax returns are filed.
You can figure out your estimated tax payments as a business owner using Form 1040-ES. It may be helpful to use last year’s income, deductions, and tax credits as a starting point. You can also use your previous year’s federal tax return as a guide.
Once you’ve figured out the number and e-file, you can pay the IRS in a number of ways. These include IRS Direct Pay, which takes money owed out of your checking or savings account, and IRS Pay By Card, which allows you to pay with a credit or debit card online. Another option is paying by phone.
Quarterly estimated tax payments for each respective quarter are due every April 15, June 15, September 15, and January 15 (of the following tax year).
The self-employed and sole-proprietor business owners almost always have to pay estimated quarterly taxes unless their business loses money. Unlike a salaried employee — where their employer withholds a certain amount with each paycheck — sole proprietors, freelancers, and business owners assume the full tax burden.
Additionally, people who are partners in a business, a corporation, or an S Corporation often pay quarterly taxes if they expect to owe at least $500 in taxes.
Business owners who fail to submit at least 90% of the taxes they owe are subjected to severe penalties, so working with a tax professional can be very helpful to double check if the amount owed is correct.
5. Some business taxes you might need to pay
Keeping track of the amount of taxes you’re responsible for can come as a great surprise when you own your business. Here are the most common types of taxes to account for as a business owner.
Self-Employment Tax
If you’ve never owned a business before, then you are likely unaccustomed to paying self-employment taxes. Businesses pay a 15.3% FICA tax, which is used to fund Social Security and Medicare. Employees pay 7.65%, and employers pay the other 7.65%.
As a self-employed individual, you’re responsible for the full 15.3%, which is sometimes called “self-employment tax.” However, you can deduct half of the self-employment tax on your personal tax return (Form 1040). Additionally, it’s important to take advantage of all possible startup and operating business expenses to maximize tax deductions.
Payroll Tax
If you have employees, you’ll be responsible for paying payroll taxes on their wages. Payroll taxes include federal income tax withholding, Social Security and Medicare taxes, and federal and state unemployment taxes. Many businesses hire a payroll service to file their tax forms and manage their payroll tax liabilities on their behalf.
Excise Tax
Depending on the nature of your business and industry, you might be responsible for paying excise taxes. Excise taxes are indirect taxes, that are not paid directly by the consumer of a product.
Often the tax is included within the price of the product itself, such as with cigarettes, gasoline, and liquor. Businesses that sell products subject to excise taxes are responsible for collecting the taxes and sending them directly to the IRS.
Sales Tax
Although a federal sales tax doesn’t exist in the United States, the majority of states levy sales taxes. Customers pay a sales tax on goods and services at the point of purchase. Business owners are responsible for collecting and reporting sales taxes to local and state governments. As a small business owner, it’s also important to understand state and local tax rules with respect to sales taxes.
Property Tax
If you own commercial property, you’ll have to pay property taxes to the city or county where your business is located.
Maximize your flexibility as a small business owner
Setting up and operating a small business can come with significant initial costs.
Whether you’re flying solo or working with partners, the tax system is set up to help offset those potentially high costs for self-employed professionals at tax season. Maximizing tax deductions by writing off startup and operating costs can limit your tax liability in relation to your business income.
Having quality small business tax software can guide you. As a new business owner, it also helps to work with a tax professional to avoid common pitfalls like underreporting your business expenses or ignoring an important tax form that can save you money.
Related:
- How small business owners can prepare their books for tax season
- 5 signs your books aren’t ready for tax time
This article originally appeared on the QuickBooks Resource Center and was syndicated by MediaFeed.org.
Featured Image Credit: jacoblund / istockphoto.
