Starting Your Own Small Business
Starting your own small business can be as exciting as it is terrifying. Most times entrepreneurs are taking a big leap of faith by going out on their own, putting their dreams, and finances, on the line. One of the most intimidating parts of starting a business is knowing what to do legally and financially. Being sure you have the proper claims, registrations and forms is essential to save yourself from accruing penalties and fees, which can add up to a significant amount in the long run. There are tons of important details to know and remember, but the more educated you are, the better off you will be come tax time. Below is our list of the top 10 key considerations to make when starting your business, as well as some tips for saving you time and money come tax time.
1. Create a Business Plan
Not only is your business plan your roadmap to success, it should also be your financial plan. Be sure to include in it your financial goals and projections. This will be an important starting point for you to refer back to in filling out documents and benchmarking your success.
2. Find the Business Structure that Works Best for You
The most common US business types are: sole proprietorship, partnership, corporation, S corporation, Limited Liability Company (LLC) or non-profit. Each offer unique benefits so it is important to do you research to determine which kind will be the best for you, and which you are eligible for. Your choice of business determines your taxation- schedule time with an accountant for more information.
3. Figure out your Tax Requirements
There are four types of business taxes: income, self-employment, employment and excise. On a federal scale, you need to be concerned with income tax, self-employment tax, taxes for employers and the excise tax. At the state level, you will have to pay business or corporate taxes unique to the state in which you are registered. As a ballpark figure, small businesses collectively face an average effective tax rate of 19.8%, according to the US Small Business Administration’s Office of Advocacy.
4. Open a Business Account
Not only is this important to keep your finances separate for accounting purposes, it also is a good way to build up a strong credit record should you need to apply for a loan in the future. Most importantly, if you are a corporation or an LLC you are required by law to maintain separate financial records and accounts. Avoid confusion and legal issues by establishing a separate company financial account from the start. It’s also a good idea to apply for a business credit card for purchases, and establish a separate savings account for your taxes.
5. Enlist a Team of Experts
All entrepreneurs should seek legal and financial advice before starting their business. These experts will be there to educate and guide you, but even more importantly to prevent any potential problems before they occur. When starting a business your accountant and your lawyer are your allies.
6. Choose your Method of Accounting
An accounting method is a set of rules you use to determine when you report your income and expenses. The most common accounting methods are cash and accrual. Using the cash method, you report income and deduct expenses in the year in which you receive or pay them. This method is mostly used by sole proprietors and self-employed/freelance workers that do not need to hold on to an inventory. Conversely, in the accrual method, you report income and deduct expenses in the year in which you earn or incur them. What method you choose will have big implications on your taxes; ask your accountant which will be best for your business.
7. Register Your Business
One of your first steps as a new business owner should be to register your business with the federal and state government and apply for your EIN number. Your EIN (Employer Identification Number) will be needed to file your return, and for other important business documents. EIN numbers are not needed if you have created a sole proprietorship or if you are a single-owner LLC. In these cases you can simply use your social security number.
8. Pay your Taxes Quarterly
You need to make estimated tax payments quarterly to the government in order to cover your federal income tax liability, except in the case where you expect to owe less than $1,000. Payments should be submitted via Form 1040-ES. Generally, these taxes are due the 15th of April, June, September and January. It is a best practice to automatically set aside a percentage of your monthly revenue in your savings account. Your accountant can help you estimate your payments each quarter.
9. Determine your Employee Taxes
If your business will have employees, you will be required to pay a share of their Social Security and Medicare taxes and also to withhold their half from their wages. If the employee makes over $127,200, you and the employee keep paying only the Medicare portion of the tax. You are then able to deduct half of your self-employment tax, as well as half of Social Security and health insurance premiums for yourself and your employees. If you have less than 25 full time employees you also qualify for the Small Business Health Care Tax, a credit of up to 50% of premiums paid for small business employers.
It is essential to understand that there is a fine line between “employee” and “contractor.” Your tax liability and reporting will be vastly different, so it is important to classify workers correctly. So how do you determine the difference? The IRS looks to see how much control you have over the workers performance and environment. If you dictate where a worker does their work, and provide them with equipment, they are most likely an employee and should be treated as such. For employees, employment tax must be withheld, and you will report payroll information using W-2 or W-3 forms. For contractors, you do not pay or withhold employment tax. At year-end, you will give contractors a 1099 (if you have paid them over $600 during the course of a year) to fill out that will be used to report payments. Failure to send these forms to the individual AND the IRS can result in fees of $250 per form.
10. Keep Good Records of your Expenses
Expenses allow you to deduct from your taxable income, so the greater your expenses, the less you are taxed. Keep detailed records of any and all business related expenses. This is essential for your reporting come year end. It is recommended you keep monthly expense reports that you update daily. Not only will this help you get organized at tax time, it will also provide you with a good benchmark of the monthly expenses you incur.
When in doubt as to the deductions you can claim, ask yourself “Did this purchase help my business?” If the answer is yes, it is a business expense. Be sure to keep track of all of your receipts as you will have to itemize these expenses at the end of the year. Some of the common business expenses you can claim are:
Costs for conferences or educational webinars in your field
Business books, industry magazine subscriptions
Associations and networking groups
Phone expenses for talking to clients (if you do not have a separate phone line for business only, you will only be able to deduct a part of your phone bill)
Internet (same rule applies as above, if it is used for personal use as well you may only deduct a portion)
Supplies such as paper, toner and ink
Business trip expenses such as airfare, hotel, rental cars, even laundry
Business meals and entertainment expenses are tax deductible at 50%. Be sure your receipts label who you met with as well as the purpose of the meeting.
It is highly recommended that you invest in apps such as Expensify for tracking expenses and QuickBooks for recording and managing your expenses. This will keep you organized and save you time and frustration when it comes time to file your taxes.
Special Small Business Deductions:
If you use your personal car in the course of business (travelling to meet with a client, for example) you can claim a deduction. You have the option of taking the standard mileage rate or deducting your actual expenses. If you choose to deduct actual expenses, you can deduct for gas, repairs, insurance, registration, even depreciation. In either case, parking and tolls should be added up and included in your overall deduction.
Home Offices Deduction
The home office deduction is a bit tricky. It works like this: If you operate your business out of your home, you qualify for it, but you have to prove you have a special area in your home that is used exclusively for your business (a living room or kitchen table will not count). You can still perform work elsewhere, but your home office must be your principal place of business. Your claim is then dependent on the square footage of your home that is used for business. You will need to determine what % of your home the office/business space takes up, and from there you can include deductions for rent/mortgage utilities, maintenance, interest and even property taxes.
Generally speaking “Equipment” is considered a high value item that is meant to last well over the course of a year. Computers, printers, office furniture, hardware and software are all considered equipment and are tax-deductible up to a certain amount. Depending on the item, you can deduct the full cost on the year of purchase, or split it between several years. It is important to note if you only have one computer, you can’t justify that as purely a business machine, you inevitably use that for personal use as well and so it is only deductible up to the % you use it for business. If you’re going to purchase a computer, make sure it is only used for work. When it comes to claiming equipment expenses you can write off a portion for each year the appliances are in use, or the full amount for the year in which it was purchased.
Startup costs are the price of researching the creation or acquisition of a business, or the cost of getting your business prepared to operate. This includes everything from visiting potential business locations to legal consulting fees, advertising costs, and travel costs associated with finding employees or customers. These expenses can only be claimed if the costs end with the formation of a business and should be kept under $50,000.
As a new business owner, it’s easy to get overwhelmed in your first year of operation. The best advice we can give is to consult with a professional, and to set yourself up for success by keeping the most detailed records you can. This year in particular, will be one facing a lot of changes with the new tax bill. For more information on small business accounting, or if you have an interest in divorce accounting or general tax services, contact us today. We offer complimentary 30 minute consultations to help give you the financial piece of mind you need.