So, you have decided you want to start a small business. Good for you! Before you venture much further, the most important considerations you need to make are: how will you set your business up, how much in taxes you will need to pay, and how often. Many entrepreneurs feel overwhelmed by the thought of taxes and the preparation that goes into them. Rightfully so, however, it may not be as hard as you think. Here are the 10 tax considerations that you must consider when starting a small business.
10 Tax Considerations when starting a Small Business
1. Know your bracket
Each of us is bucketed into a bracket. These brackets define how much tax we will need to pay as small business owners. How are brackets defined? There are seven tax brackets that the federal government have defined ranging from taxes at 10% to 37%, click here to view.
2. Determine how you typically file
Keep in mind that this may not be all you have to pay as there is still, State and Self Employment taxes. Also consider how you file i.e.) Single, Married filing Jointly, Married filing Separately, Head of Household
Based on the type of structure you plan to implement for your business, you may decide that you want to explore your options rather than proceeding with how you typically file based on your overall tax picture.
For example, if you file jointly with your spouse, you will both be responsible for the tax due. If you file separately you will not be eligible for certain credits such as the child tax credit etc.
Be sure to speak with a professional to review the most advantageous options for your overall tax picture.
3. Schedule time with your accountant
Don’t have one? Find one.
The legalities of structuring your new business are complex and can sometimes seem daunting. Having a qualified accountant that can help you sort through your options is a MUST HAVE.
4. Align with your Spouse
One of the biggest mistakes you can make in a marriage or partnership is not ensuring that each party is informed and aligned. When I started my business, this was a huge point of contention and it is not the fighting you will have later to do this on your own.
There is a lot of money that will be due to big brother and you will want to ensure that each of you understands the amount of taxes that you will both be required to pay.
Make no mistake that if you are married, you will be taxed on both of your income and therefore it should be a mutual decision.
5. Self-Employment Tax
Self-Employment tax are the Medicare and social security taxes that you must pay for yourself. When you have an employer, that employer pays a portion of these taxes in each paycheck. As the employee are responsible for a portion of these taxes.
When you are self-employed, you must pay both of these amounts.
As a self-employed individual you must pay taxes on the net income received. “The current self-employment tax rate is 15.3% of net self-employment income,” as per fundera.com.
This comes from the 12.4% social security tax (up to $132,900 in earnings for SS) and the 2.9% Medicare tax.
If it seems like a lot, it is! The silver lining however is that the IRS understands this cost to business owners and lets you deduct half of your self-employment taxes (7.65%)
If your company net profits are more than $400, then you must file
6. Understand your business structure options as defined below:
This is a business that is owned and operated by an individual. This is one of the easiest options for business owners as it provides the following benefits:
The Schedule C form will give you the total taxable self-employment income that you will report on your 1040 form.
Benefits of a Sole Proprietorship
- Simplicity with only one person’s taxes involved
- Report your income profits and losses of the business on your personal return
- Your write-off’s and home deductions also are reported on your personal return
- Business profits will be taxed at your personal income rate
Disadvantages of a Sole Proprietorship
- Unlimited liability (your assets are at risk)
- Can be difficult to raise investment capital
- May be difficult getting a line of business credit
If you decide to structure your business as a corporation you have two options, S- Corp and C-Corp.
There are a couple of advantages to starting your business as a corporation including the potential for benefits in taxes, liability, and opportunity to raise money (fundera.com).
- This is a traditional corporate structure containing shareholders, directors, employees.
Benefits of a C-Corp
- No restriction on ownership (unlimited growth potential)
- They offer LLC for shareholders
- Tax deductions that are not available for other structures
- Greater ability to raise capital and grow
- No limit on the number of shares a C-Corp can issue and they can have multiple classes of stock
- No shareholders limit and both individuals and firms can apply
- Enhanced credibility
- Can deduct 100% of health care premiums and fringe benefits
Disadvantages of a C-Corp:
- Double taxation (taxed at company level 21% and shareholders pay personal taxes on their dividends)
- Expensive to open and start
- No deduction of corporate losses
- Greater regulation and government oversight
Similarities between a C-Corp and an S-Corp
- Both offer LLC for shareholders
- Both require articles of incorporation to be filed.
S Corporations are pass through entities like a sole proprietorship where the shareholders claim their taxes and income on their personal tax returns.
They are taxed only on the individual level versus both the corporate and individual level. S Corp’s file on a Form 1120S.
The business owner then provides a Schedule K-1 to each shareholder as that reflects the profits or losses in the business that belong to the shareholders.
Benefits of an S Corp
- Protects the personal assets of its shareholders
- Unlimited number of management employees
- Flow through taxation
- Good privacy protection
- S Corp owner does not have to pay self-employment tax on the pass-through income / distributions for the business
- Plan ahead with reduced taxable gains (if the owner decides to sell the company the taxable gains will be lower than a c-corp).
- Unlimited life span, the business will continue to exist when the owner leaves the company.
- Ownership transfer is easy (through the sale of stock)
Disadvantages of S Corps
- Limited to 100 shareholders
- Cannot be owned by another C Corp, S Corp, LLC, Trusts or partnerships
- Cannot have more than one class of stock
- All shareholders must be us citizens
Partnerships are companies that contain more than one party and are considered co-owners of a business for profit.
There are two types of partnerships (general and limited partners).
General partnerships are those that own and manage the company and assume liability for the partnership.
Limited partnerships contain both general partners and limited partners who serve as investors only.
When filing, each partner files a Schedule K-1 form, showing his or her share of partnership income, deductions and tax credits.
Benefits of a Partnership Company
- Pass-through taxation (income, deductions and credits flow through the individual owners)
- No taxation at the partnership level
- Easy to establish
- Increased ability to raise funds
- Wider pool of knowledge and resources
- Flexible management
- Flexibility to allocate income
Disadvantages to a Partnership
- Unlimited liability (your assets may be at risk)
- Liability potential for negligent or wrongful acts
Limited Liability Company (LLC)
Limited Liability companies bring together a blend of both partnerships and corporate benefits.
Benefits of an LLC
- Limited personal liability (protests your personal assets)
- Do not have a tax classification but Can be assumed under a S Corp, C Corp, Partnership or Sole proprietorship.
- Can take advantage of pass-through taxation (passes through to the owner’s personal tax return where the owners pay on their profits)
- Flexible management
- Flexible profit distributions (i.e. you can distribute profits how you choose)
Disadvantages of an LLC
- LLC’s can be more expensive than a sole proprietor’s expenses to operate
- Checks made out to an LLC cannot be cashed, they must be put into a corporate bank account
- Business records must be maintained separate from personal records, including meeting minutes.
7. Each State has Different Requirements
Just as the federal government requires you to pay taxes, so does your state. Each state is different so refer to each state's website for more guidance to your particular situation.
Be sure to set aside additional funds to compensate for your state taxes due. Click here for more information on your state's current small business tax rate.
8. Start-up Expenses can be written off
As you start your business you will incur start up costs, even with a business that maintains low overhead. The IRS allows you to write off up to $5,000 in startup costs.
Typical costs can range from office space, technology needs, a website, office supplies, business assets, and professional fees. To see more on deductible start-up expenses click here. For how to for how to create a start-up budget for your business click here .
9. Set Up a Separate Bank Account
Regardless of your business's structure, it is wise to keep your finances separate. Choose a bank that suits the needs of your business.
Prior to opening a bank account you will need to apply for an EIN (Employer Identification Number) on the IRS website.
If you are going to be doing a significant amount of work online, ensure that there are the capabilities to track online transactions and perform online business banking.
Once you understand an estimate of what you will need to pay in for taxes, you should separate this money from any additional company revenue.
For a great guide on how to set your business up for success financially, listen to Amy Porterfield's interview with Amber Dugger titled, "Profit First."
10. Additional Tax Considerations
Dependent on the product or service you sell, your company may be responsible for additional taxes due in April.
Here are some of the other most common types of taxes business owners need to be aware of:
- Self-Employment Tax (as indicated in number 5 above)
- Payroll Taxes (if you have employees you will be responsible for withholding and paying federal, state, medicare and social security taxes)
- Excise tax (indirect taxes included in the price to the consumer, paid by the business such as cigarettes, alcohol or gasoline)
- Sales Tax (indirect taxes included in the price of the product to the consumer, paid and reported to the government by the business).
- Property Tax (if you own commercial real estate)
Next Tax Steps to Starting a Business
Apply for an Employer Identification Number (EIN) to begin the process of opening your own business. Here you will select a business structure and make your company officially recognized. Then you will name your business.
I cannot stress enough, be sure to check your preferred domain name (web address available) and all of your social media handles so that your business can can fully occupy the marketing space and more easily get customers to your business.
For more tips like these head to the 10 Steps to starting a business blog and download my free workbook below to successfully think through all of the important details for your business!