What to know about federal income taxes
“If you are planning to start your own small business, it’s important to pay attention to your tax responsibilities in the early stages of formation to maximize deductions and prevent liability issues as you move forward. Here are a few things every new small-business owner should know about federal income taxes.
YOUR LEGAL ENTITY AND YOUR TAX BURDEN
From sole proprietorships and limited liability companies to S corporations and partnerships, there are various business types, each with its own benefits and limitation. 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.
HOW MUCH YOU CAN DEDUCT
The various operational costs of a start-up – e.g., raw materials, employee salaries, business rent, utilities – can be overwhelming. Fortunately, as a new small-business owner, you may be able to deduct many expenses to minimize your tax burden.
According to the IRS, businesses can deduct both ordinary and necessary expenses. 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. Necessary expenses are helpful (but not always obligatory) in your field.
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 health care benefits for their employees.
The IRS also allows small-business owners to deduct a wide array of startup expenses before they open their doors to customers. Although startup expenses can differ by industry, most business types can deduct investigational costs related to researching markets and analyzing products. Additional, startups can deduct costs accumulated before they open for business, such as training employees, attending trade shoes 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.
MAKING ESTIMATED PAYMENTS
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 $1,000 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 our expected tax burden. Business owners who fail to submit at least 90 percent of the taxes they owe may be subject to penalties, so perform your due diligence to ensure you’re in the clear.
PAYING SELF-EMPLOYMENT TAX
Comprising 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.
As a final point, 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 your personal wealth, but it also allows you to focus on what matters: building your company into a successful operation.” – April Maguire