Tax season can be a headache for business owners and CPAs alike. You want to save money, they want to make money, the process is confusing, the IRS is watching closely – you get the point. Without proper knowledge of your federal income tax responsibilities as a new small business owner, you could run into costly liability issues down the road. We’re here to share some tax truths with you to minimize your risk so that the business you love can thrive.
You Have 4 Legal Entity Options – Choose Wisely
Choosing the appropriate legal entity for your businesses is a critical decision that can impact your tax burden for years to come. As with any important tax decision, you should research your unique situation to determine which of the following four legal entity options is ideal for your needs:
- Sole Proprietor – Structure for people who run their business solo (such as providing freelance services) but will cost more when taxes are due. Note: No tax advantages or liability protection
- LLC – A common choice that is widely recommended by CPAs and attorneys, but is a disregarded entity at the federal level which results in a quick and costly filing. To increase flexibility, LLCs can request to be taxes as an S-Corporation. Note: No tax advantages, more likely to get audited and be taxed higher as an LLC than a traditional S-Corp
- S-Corporations – Gives small business owners the opportunity to pay taxes at the shareholder level (although limited to 100 shareholders) instead of a higher corporate rate. Note: Considered a “pass through” entity, resulting in a major tax advantage
- C-Corporations – Commonly used by publicly traded companies and some privately held companies, but mostly avoided by other businesses. C-corps get taxed twice at both the corporate and shareholder levels. Note: Benefits include a wider range of deductions, increased shareholders and less investment restrictions.
You Can Cash in on a Variety of Deductions
It’s no secret that small business owners aren’t generally rolling in cash at their start. The bad news is that startup expenses can get costly and the IRS is increasingly targeting small businesses. The good news is that you can minimize your tax burden by identifying and utilizing the most common deductions available to you as a small business owner. The IRS states that businesses can deduct both “ordinary” and “necessary” expenses. This commonly includes the following business deductions, but you should do research on similar expenses in your unique industry or field:
- Investigational costs related to startup market research and product review
- Rent on a business or home office
- Supplies and technical equipment (paper, computers, copiers, etc)
- Office furniture (desks, chairs, etc)
- Providing employee healthcare benefits.
You’ll Have to Pay Self-Employment Tax
Since you aren’t subject to employer withholding, you’ll have to pay for both your own portion of self-employment tax and the portion that would have been typically been put forth by your employer. As a business owner, you can only claim half of what you pay in self-employment tax as an income tax deduction. This means that a $5,000 tax payment would be considered a $2,500 decrease in income. Although it can be incredibly difficult to manage, it is smart to put aside a portion of your funds throughout the year to minimize the self-employment tax burden when the time comes to pay up.
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