
Are you starting up a business? Then it’s crucial that you prepare a tax strategy to handle all of your new company’s tax obligations. Taxes can make or break a small business, so it’s important that you include tax preparation in your business plan from the start. If you’re a budding entrepreneur, here’s a quick rundown of everything you need to know about small business taxes.
Form a Business Entity
When you open a new business, you’re going to have to form a business entity. The type of business entity you form will determine how you pay your taxes. Most entrepreneurs form a sole proprietorship or LLC (if you’re the only member of an LLC, then you’ll file taxes in the exact same way as a sole proprietor). These two business entities allow you to file your business taxes as part of your personal taxes, which makes tax filing simple and inexpensive.
Whether you choose a sole proprietorship or LLC depends on your liability needs. If you’re a high-risk business, you might prefer to form an LLC (although sole proprietorships can buy liability insurance to protect themselves from lawsuits).
Pick Your Accounting Method
When you report your revenue to the IRS, you’ll have to pick an accounting method. The accounting method you choose affects how to report your revenues and expenses. The two main accounting methods are cash and accrual.
Cash accounting is the most commonly used method because it’s very simple, but if your business relies heavily on long-term investments and future growth, you might benefit more from the accrual method. Make sure you use good revenue management software that’ll help you with bookkeeping and accounting.
Self-Employment Taxes
If you’re running your own business as a sole proprietor, you’ll have to pay self-employment taxes (basically, the Social Security and Medicare tax that employers pay for their employees). You’ll be able to deduct about one half of your total self-employment obligation, and you can also deduct your health insurance.
Payroll Taxes
You’ll have to pay payroll taxes if your business has employees. There are two kinds of payroll taxes. First, you’ll have to withhold a portion of your employee’s tax obligation from their paycheck (withholding tax). You’ll also pay half of each employee’s contributions to Social Security and Medicare. Depending on the state you live in, you may also have to pay an additional tax that’s based on your employee’s compensation.
In the long-run, your employees will basically shoulder most of these costs. But startup businesses may have a difficult time covering these tax obligations, especially if cash flow doesn’t develop immediately. Keep that in mind before you post job listings online.
Sales and Use Tax
Whether you’re selling products in retail or providing a service for customers, you’re most likely going to have to pay sales and use tax when you make sales.
Sales tax is a tax that’s placed on the purchase of a good or service. Generally, it’s up to you to pay the sales tax on each and every taxable transaction—most companies add a sales tax surcharge to taxable transactions to compensate for it. Each state may have a different sales tax rate, and you may also have to pay sales tax that’s levied by the local government you’re operating in.
Use tax is when you make sales to customers who live in another state. Typically, it’s up to the buyer to report use tax on their annual tax return, and most buyers don’t. However, the rise of online commerce has tightened use tax laws tremendously. Nowadays, businesses are generally required to pay sales tax for each interstate transaction they make (the business must pay the sales tax for the state in which the buyer lives). Obviously, that’s bound to cause major headaches for business owners. It might be beneficial for you to look for sales tax consulting services so you can learn exactly what your sales and use tax obligations are in your area.
Maximizing Your Tax Savings
Every smart business owner works year-round to try and maximize their company’s tax savings. If you’re a startup business, you can typically deduct your startup costs, which may include:
- Cost of new equipment and facilities
- Cost of advertising and promotion
- Cost of initial business fees and licenses
- Costs of exploring the viability of a new business
You can also earn tax deductions by making business donations to charity. The more you donate to charitable causes, the more of your business revenue you’ll be able to deduct when it comes tax time.
Those are the tax basics that every entrepreneur needs to know! Start getting familiarized with your state’s tax laws and make a plan that details how you’re going to pay your tax obligations and maximize your tax savings.