So you want to get your business off to a strong start?
You do everything the right way: Purchase bookkeeping software, open a separate bank account for your business, and have a dedicated bank card (not cash) to make all business purchases. What is a big, expensive mistake that business owners make after all of this effort? Failing to consult with a tax professional to get their financial affairs in order well before the tax deadlines. Here’s what we wished you knew before you start ringing up that cash register. So save yourself some heartache (and IRS penalties) and follow solid advice. You’ll be glad you did.
1. You will be taxed differently if you register as a sole proprietor versus a partnership.
As soon as possible in the business formation process, register your business. Here is a link with information on how to register a business with the IRS and state agencies, where to get an EIN, etc.
Sole Proprietors are single individuals who own a business. Their business profits and losses are reported on a schedule C and filed at the same time as their individual income taxes. During typical tax years, the schedule C is due April 15. It’s important to use proper bookkeeping during the year so that every expense and asset is accounted for at tax time. Proper bookkeeping helps lower your overall tax liability and protects you during an audit.
If you and one or more people have contributed money to form a business, you are in a partnership. Partnerships are registered with the IRS and these business entities report profits or losses by filing a form 1065 to the IRS by March 15. Once the 1065 is filed with the IRS, your tax preparer will generate a K-1 for every partner to use to report his partnership income on his personal tax return, which is due April 15.
2. Plan for tax season in the summer – talk to a professional early on in the process.
While some small sole proprietors do successfully complete their schedule C and personal taxes in late March, partnerships and corporations should never do this! Waiting until March or April to decide who to hire to complete your business taxes is a huge mistake – first, you will pay penalties for failure to file a timely 1065, and second, most tax preparers are extremely busy in March and April, and may not be able to assist your partnership. To complicate and make the situation even more expensive, if the partnership owes taxes, the IRS (and states) will also charge penalties for late payment. Your taxes are not “due” in April – the IRS wants you to pay as you go during the tax year (more about that later).
3. Certain eligible startup costs are tax deductible
Startup costs are amounts you’ve paid while creating your business or during the research and marketing process. The limit on deductible startup costs is $5000. Purchase bookkeeping software and establish a bank account that is separate from your personal funds. Use a dedicated credit card for all business purchases. Linking the credit card to the bookkeeping software makes keeping track of these expenditures very simple. Remember, good bookkeeping can mean lower tax liability.
4. All business profits are taxable, even if you don’t take a paycheck
What are the filing requirements of a small business? In 2019, individuals who are single and earn under $12,200 are not required to file tax returns with the IRS. However, all small business owners who earned more than $400 in revenue are required to file. Sometimes business owners believe that if you reinvest business profits back into the business, the IRS will not tax that income. This is not true. Also, business owners do not get “tax refunds” of business expenses. Your tax liability or refund is dependent on your business profits or loss, how much self-employment tax you paid during the year plus any other estimated tax payments during the year. You may receive a refund of overpaid estimated taxes. Occasionally an individual who is self-employed may make so little income that he or she qualifies for the Earned Income Tax Credit; however, these credits come under strict scrutiny of the IRS so take extra precautions to retain records and pristine bookkeeping.
5. Self-employment tax and payroll taxes can be very expensive
When you own your own business, you are responsible for paying self-employment taxes. I wrote another post here intended for pastors, but the implications are true for all business owners. Self-employment tax pays for contributions to both social security and Medicare. Currently for 2020, self-employment tax at a 15.3% rate on your net earnings from self-employment of up to $137,700, and Medicare tax only at a 2.9% rate on the excess.
An additional 0.9% Medicare tax will be imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is an additional tax, added to income tax when calculating your total tax liability, but you can deduct half of your self-employment tax as an adjustment to income.
If your business is a corporation, you and all shareholders who are employed by the corporation will then be subject to payroll taxes as shareholders who perform services for their corporations. Your corporation will then issue Form W-2 to employees, which are subject to social security and Medicare withholding (payroll tax).
6. When should business owners pay their taxes? What are quarterly tax payments?
Unlike employees of a business, self-employed business owners are responsible for withholding and paying taxes during the tax year. You cannot postpone paying taxes until April 15. The IRS is a “pay as you go” system, meaning the IRS expects you to make 4 estimated tax payments during the year. These are called “quarterlies” and can be mailed to the IRS or paid by credit card online. Heritage Income Tax will assist business owners by printing estimated tax payment forms and advising on the amount needed to avoid underpayment penalties. However, if you own a business and also work for another employer, you can avoid an underpayment penalty by increasing your tax withholding on your W-4 with your employer. It is very important to ask your tax professional for guidance in predicting the estimated tax liability.
7. Small business owners are more likely to be audited
Being audited should not be cause for alarm, but the IRS is more likely to audit businesses and high-income individuals over other taxpayers. It is important to have accurate and timely bookkeeping. Keep receipts, logs of vehicle mileage and records of any deductions or assets you intend to report with your tax return.
See how Heritage can help with starting a business and tax questions
While these tax implications of starting a business may seem daunting, we’re here to help. Find out how we can help you with your small business taxes today.