Here are 8 tax tips that will help you when you start a new business. As you create this new business and run it in the future, keep in mind the first rule of tax law. It is the first thing my tax professor in law school told us on the first day of class. Here’s what he said. “Ladies and gentlemen. Let me tell you the one rule, which if followed, will keep you out of tax trouble. It is this: Pigs may get fat but hogs are slaughtered.” In other words, when it comes to taxes you may be able to get away with being (a little) greedy. Be too greedy, however, and you will not enjoy the results.
The IRS provides quite a few resources to help you start a new business. The IRS website has an A-Z index of business topics that is a good place to start.
1. Choose a business structure
A business can be your alter ego (a sole proprietorship) or it can be a separate legal entity. Many businesses are set up a limited liability companies. But you could also create a regular corporation, an S corporation, a partnership, etc.
The structure you choose controls the income tax return you must file. That structure also can control whether you are personally liable for debts and the activities of the business. Although it may seem to be a simple decision, it can have far-reaching results. The Small Business Administration website has information that may help you understand the pros and cons of the different entities. Your legal and tax advisers will be able to help with the final decision.
2. Get an Employer Identification Number (EIN)
Most businesses need an EIN. That’s the business equivalent of your personal Social Security number. Your Social Security number identifies you to the IRS as a taxpayer. A business’ EIN identifies it to the IRS as a taxpayer. You can apply for an EIN online and get it in minutes. An IRS publication will give you more information.
Good records will help you check the progress of your business, prepare your financial statements, identify source of receipts, keep track of deductible expenses, prepare your tax returns, and support items reported on tax returns. There’s no substitute for good records. If you do nothing more than put pieces of paper in a box, that’s better than nothing. Tax law makes you responsible for proving what income you receive and what deductions you may take. If you don’t have records it’s not necessarily the end of the world. But you’ll find a tax audit much easier if you have them. With only a few exceptions, the law doesn’t tell you what records you need to keep. However, the kind of business and its structure will make certain records necessary. Whoever you have helping you with your taxes will be able to help you. They will also tell you how long you need to keep them. You may want to read the IRS publication on record keeping.
You may not deduct personal expenses. However, if you have an expense that is part business and part personal, divide the total cost between the business and personal parts. You may deduct the business part. Check out chapter 4 of IRS Publication 535.
4. Decide What Your Tax Year Will Be
Most businesses use the calendar year as their tax year – it ends on December 31st. Sometimes, however, you can choose to end your tax year anytime in the year. You make the choice when you file your first tax return. After that you need IRS approval to change it, so decide carefully.
5. Choose an Accounting Method
You also need to decide which accounting method you’ll use. The cash method and the accrual method are the two main choices. Under the cash method, you report income in the tax year you receive it and deduct expenses in the tax year you pay them. Under the accrual method, you report income in the tax year you earn it, regardless of when you receive the payment, and deduct expenses in the tax year you incur them, regardless of when you make the payment. The IRS has a publication that provides a fair amount of detail.
Once you start hiring people (including yourself) to help make your business a success, there are special duties you’ll have. You need to have them sign the proper tax forms. You will need to withhold taxes and pay that money to the government on time. One of the worst things you can ever do as a business owner is not pay these payroll taxes on time. The IRS is fairly unforgiving when it comes to not paying money you’ve collected from employees for taxes. If you’re doing your own payroll, get a copy of the IRS Employer’s Tax Guide and follow it religiously.
Be sure you know the difference between an employee and an independent contractor. Some businesses try to classify people as independent contractors to save on taxes – there are rules that tell you if a person is, in fact, an independent contractor.
7. Special Rules for Home Businesses
If you’ll be running your business out of your home, read the IRS publication on business use of your home. There are special rules you’ll want to be aware of.
8. Take Advantage of Benefits You Can Offer
Once you start making money, there are many fringe benefits and retirement plans you can take advantage of. There are distinct tax advantages of owning your own business – don’t pass them up. There is an IRS publication about fringe benefits as well as a publication about choosing a retirement plan for small businesses.
Final Thoughts
It’s a pretty good bet that many of those who lost their jobs because of the current financial crisis will end up creating their own businesses. What are your thoughts? Leave a comment to share what you’re thinking.
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Great article with lots of useful links and references – thanks for sharing! [Posted in the General Electric Alumni group on LinkedIn.com]
Right on with your 8 steps. I just started a sole proprietorship where I will be an affiliate for a debt settlement company. I know this is a crowded field but I like the challenge and the opportunity. I am changing careers from Engineering to Income Tax and Accounting. In fact I just got my Enrolled Agent certificate yesterday. I plan to have at least 3 businesses going. The debt settlement, at-home accounting, and Tax Returns.
GREAT post, thanks so much. I will make sure to read up on the links you posted.
Another tax tip that I like is that if it is a tax scheme in which you are not taxed at some point on some level. It is a tax sham!