Taxes 101 for new business owners
Few would call them fun or easy, but they’re an especially daunting subject for new entrepreneurs. Most folks get the hang of doing their own individual taxes quickly and easily since they’re relatively simple and it’s easy to get advice from a friend or family member who has gone through the process.
As a new entrepreneur, however, you’re facing many added layers of complexity and it can feel like you’re doing it all alone. You might not know anyone who handles their own business taxes, and you might not be able to find room in your budget to hire a professional.
Take heart, though. We won’t say that it’s easy to do your business taxes, but we can say that you’ve tried — and succeeded — at harder things in your journey as an entrepreneur. You can do it with a little research, the right tools, and potentially a little expert advice. To get started, we’ve created this guide with an overview of the key steps and concepts you’ll need to know.
The importance of record keeping
In order to successfully file your taxes and take advantage of deductions, you’ll need to keep detailed records of your business income and expenses,
You can keep it simple by recording your business transactions on a spreadsheet, or you can use dedicated accounting software. Here are our tips for record-keeping success:
- Open a dedicated bank account for your business income and expenses. This will make it much easier to keep accurate records and track your cash flow.
- Choose a method that fits your personality and your business needs. For example, if you have a new business with relatively simple accounting needs, there’s no need to pay a lot for expensive software. If you hate spreadsheets, find a service that makes the process easy and intuitive for you.
- Don’t let the work pile up — do your accounting tasks regularly and in small chunks.
- Recognize that record-keeping is one of your key business responsibilities and it will take time. Reserve time on your schedule to do it; if you truly can’t find the time, consider hiring someone to help. You might be surprised by how affordable it can be to hire a virtual bookkeeper, since you’re paying by the hour or by the project and it’s likely a professional can handle this task in less time than you can.
Four steps to filing your first federal annual tax return
- Determine the correct form(s). The tax form(s) you’ll use depends on your business tax structure (more on that below). If you’re using tax-preparing software, it should give you guidance on which form you’ll need. You can also find a list of small business tax forms on the IRS website.
- Collect your records. A detailed report of your business earnings and expenses will allow you to file your taxes accurately and make the most of any eligible deductions. A dedicated business bank account makes it easier to create these records, especially if you connect it with accounting software (for example, Wave, Xero, or Quickbooks).
- Fill out the form. Once you have the right form(s) and you’ve gathered your records, it’s time to fill it out.
- Keep the deadlines in mind. Some of the deadlines for business taxes are different than the deadlines for personal taxes, so double-check them and make sure to file in time.
What about state returns?
The process for your state tax return can vary from state to state, but it’s the same general process: figure out what forms to use, gather your records, and pay attention to filing deadlines.
Take advantage of tax deductions for entrepreneurs
As a new business owner, you may be eligible for hundreds of tax deduction. For example, small business owners can get deductions for their home office space, business transportation, health insurance premiums, and even their own education.
Before you file your taxes, go through a detailed and current list of the eligible deductions and determine which ones you are eligible for. It’s always a good idea to consult a tax professional if you’re not sure whether or not you qualify for a specific deduction.
Should I hire someone to do my business taxes?
Hiring a professional to help with your taxes isn’t cheap. That said, it can be a worthwhile investment depending on your business type, income, and expenses.
If your business taxes are relatively simple (for example, if you’re a sole proprietor or single-owner LLC without any employees), you can probably do your taxes yourself.
If any of the following are true, however, it may be worth getting help from a professional.
- Your time is better spent elsewhere. There are a thousand things you could be doing as a small business owner, so you have to prioritize. If there’s something else that you could do with the time you’d spend on your taxes — something that offers a greater benefit to the business and uses your unique skills — then the money you spend on a tax professional could be well worth the time you save.
- You’re concerned about being audited. One of the advantages of hiring a professional tax preparer is that in the unlikely event you’re audited, they can help you through the process. The money you spend on a tax preparer could be worth the peace of mind.
- Your taxes are complex and time-consuming. It takes time to file your taxes. If you’re a business owner with more complex tax needs, it can take an overwhelming amount of time. Tax professionals, on the other hand, are able to work more quickly because they have specialized software and lots of experience.
- A professional can save you more than they cost. As your business grows and your revenue increases, your potential tax liability will also increase. An expert can help you make sure that you’re maximizing every eligible deduction.
- You’ve made mistakes on a previous return. If you believe there are errors on a previous tax return, a professional can help you resolve them and get on the right track to move forward.
Do I need to pay estimated taxes each quarter?
As an employee, your employer is responsible for withholding your taxes from your paycheck and sending them to the government. As a business owner, you don’t have an employer to handle this task for you, so you may have to pay estimated taxes to the IRS each quarter. Not all businesses have to pay estimated taxes, but many do — and if you are required to do so and don’t, you may be subject to an underpayment penalty.
If you can answer “yes” to any of the following questions, then you don’t have to pay estimated taxes. If the answer to all of them is “no,” however, you will likely need to pay them every quarter.
- Do you expect to owe less than $1,000 for the tax year after you subtract your federal tax withholding from the total tax you owe?
- Do you expect your federal income tax withholding to amount to at least 90% of your total tax debt?
- Do you expect that your income tax withholding will be at least 100% of the total tax on your previous year’s return?
Essentially, you need to pay estimated taxes if you’re not withholding enough money to cover nearly all of your federal tax liability. For more information on estimated taxes, check out this detailed guide from TurboTax.
How your business structure impacts your taxes
Your business structure will have a huge impact on your taxes. It’ll determine what’s taxed and when, the filing forms you’ll use, and even the filing and payment timelines.
Sole proprietorship: Many businesses start out as sole proprietorships because this is the simplest business structure. If you’re a sole proprietor, you’ll report all your business income and expenses on your personal income tax return — there’s no need to file a separate business tax return. There are a few differences between filing your taxes as a sole proprietor and as an employed individual, however:
- Be prepared to pay self-employment taxes.
- You may be required to pay quarterly estimated taxes.
- You’re eligible to deduct business expenses from your income.
Partnerships: If your business is a partnership, you’ll need to calculate annual income, expenses, and deductions. Then, each partner will include their share of the partnership’s income or loss on their own tax return. Like sole proprietors, entrepreneurs who have a partnership will need to pay self-employment taxes and likely quarterly estimated taxes as well.
Limited liability companies (LLCs): LLC is a legal structure rather than a tax structure, so an LLC may be taxed as a sole proprietorship, a partnership, or a corporation. The default tax status is determined by the number of members in the LLC: the LLC has one member, it will be taxed like a sole proprietorship; if it has two or more, it will be taxed like a partnership. If you don’t like the default tax status, you can elect to have your LLC taxed like a corporation by filing a form with the IRS.
C-corporation: C-corporations (also known as general corporations) are considered to be an entirely separate tax entity. This business structure is designed for larger businesses with multiple shareholders. They’re subject to “double taxation” because dividends are taxed once on the corporate level and again on the individual level. However, corporations do offer some tax advantages as well as organizational benefits.
S-corporations: S-corporations are “pass-through” entities and do not have to pay corporate-level income taxes like C corporations. They offer numerous tax advantages, but you do have to meet specific requirements in order to become an S-corporation, and they (like C-corporations) are more expensive and complex to form and maintain compared to other business types.
A couple more notes on business structure and taxes
1. Pass-through business structures
A pass-through business is not taxed on a corporate level. Instead, profits and losses are passed through to the individual business owners. Sole proprietorships, partnerships, most LLCs, and S corporations are all “pass-through” businesses; C corporations and LLCs that elect to be taxed as a corporation are not.
Most small businesses are pass-through entities since they’re often simpler to set up and manage.
2. Business structure and self-employment tax
The IRS defines “Self-Employment Tax” as Social Security and Medicare taxes. When you work for someone else, your employer pays part of your Social Security and Medicare taxes, while you pay the remainder. As a business owner, however, you’re responsible for paying all of the taxes on your wages, tips, and net earnings.
The amount you’ll owe for self-employment taxes will depend on your income and your business type. For example, if your business type is a corporations or a LLC that’s taxed as a corporation, some of your earnings may be considered dividends (which aren’t subject to self-employment tax) rather than salary.
It’s a good idea to consult a tax professional if you have further questions about self-employment taxes or you’d like to explore options for reducing them.
Hi there! This post exists to offer you (hopefully) useful information but it cannot take the place of personalized professional advice. Please consult a qualified expert if you have questions about your business. Also, Azlo doesn’t endorse any third-party sites that are linked here.
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