It can be easy to wrongly assume that the tax authorities will not be paying attention to your tax affairs because you are a small business. Some may assume that the tax authorities have bigger and more important tax issues to look into. However, recent reports suggest that there has been a significant increase in the number of small businesses being targeted for tax audits by the IRS. Therefore, it has never been so important to ensure your small business is reporting and paying taxes correctly.
Every small business owner should understand the tax laws related to their business or hire a specialist who understands them fully. Here are some essential aspects to keep in mind which will impact your business taxes:
Company Legal Structure
When forming your business, you must be aware of the various legal structures that exist, as each legal structure can differ in terms of its tax implications. Here are the different legal structures and their tax requirements:
Sole Proprietorship
An unincorporated business where you are the sole owner. This structure is the most common business entity and makes up over 23 million companies in the US alone. It is the simplest to set up and manage and the riskiest due to the lack of liability limitation.
Sole proprietors can take advantage of a new 20% tax deduction, which allows them to deduct 20% of the business’s net income from their taxable income, reducing their personal tax liability.
S Corporation (S Corp)
An S Corp can pass their income directly to shareholders in order to avoid double taxation.
To set up an S Corp, the company must have no more than 100 shareholders, and all of them must be US residents. In addition, there must be only one class of stock owned by each shareholder as well.
S Corps are eligible for a 20% tax deduction, but shareholders must pay taxes upon the business profits at their income tax rate. This setup means that an S Corp has many advantages of a traditional corporation, but with some added tax flexibility.
C Corporation (C Corp)
C Corporations must pay taxes on the company level. The current corporate tax rate is a flat 21%. Unlike an S Corp, a C Corp can only share profits to shareholders in the form of a dividend, and then shareholders must pay personal taxes upon those dividends.
This taxation structure on both the company and shareholders is known as ‘double taxation. This setup can be a core factor that turns people off from starting a C Corporation, and therefore many business owners will look towards an LLC instead.
Limited Liability Company (LLC)
An LLC is a common business structure for small businesses, as LLC members will have two crucial tax law advantages: no double taxation and deductible business losses.
LLCs are only taxed at the individual level. This means that members of the LLC will pay taxes on any business income on their personal tax returns (similar to a sole-proprietorship or an S Corp). This is known within the industry as ‘pass-through’ tax.
There is no limitation to the number of members within an LLC, unlike the cap of 100 shareholders within an S Corp. This has obvious benefits in terms of business and capital expansion.
If the business is a multi-member LLC, you can choose to either be taxed as a partnership or a C Corp. The differences being that as a partnership, you’ll report your share of business income in your income tax returns, while a C Corp is subject to double taxation. While a sole-member LLC is automatically taxed in the same way as a sole-proprietorship.
Cost Write-Offs
Many new small business owners do not take advantage of one tax law is the initial business expense deductions. Some make the mistake that an expense isn’t deductible until the business is fully operational. However, the IRS does allow a small business owner to deduct startup expenses before beginning business operations.
You can deduct up to $5,000 in business startup costs, $5,000 in organizational costs, as long as the total startup costs amount to less than $50,000.
Additional costs could include items such as locating suppliers, advertising, or employee training. Certain expenses cannot be deducted, such as licensing and incorporation fees. However, a tax accountant can provide insight on the specifics.
As a new small business, you must take advantage of deducting these expenses.
Tax Deductions
Small businesses will have a wide array of business expenses, such as wages, contract labor, vehicle expenses, supplies, equipment, etc. The list could go on! However, these expenses can be utilized to reduce your business taxes come tax season, as they can be written off as operational expenses.
Tracking your business expenses accurately is important for this reason, as including expenses that cannot be deducted could land you in hot water. This is why utilizing a top accountant, or accounting software is beneficial when remaining within the tax laws.
Lesser-Known Taxes
Some lesser-known taxes have to be paid, and the laws around these should be fully understood. However, some taxes may come as a great surprise if you are a new small business owner. Some of the most common taxes are:
Self-Employment Tax
Businesses pay a 15.3% FICA tax, which is used to fund social security and medicare. Employees pay 7.65%, while employers pay the other 7.65%. If you are self-employed, you are responsible for the full amount of 15.3%. However, there is the possibility of deducting half of the self-employment tax on your personal tax return form.
Payroll Tax
If you have taken on employees within your business, you will have to follow the laws surrounding payroll taxes on wages. These include federal income tax withholding, Social Security, Medicare, and deferral unemployment taxes. As a result, many businesses see it fit to hire a payroll service company to fully understand how these taxes should be paid.
Conclusion
Ensuring you have a reputable accountant working with you to go over your startup, how you classify your small business, and what tax laws you need to follow are crucial to ensuring you follow the laws and regulations. Working with that accountant from step 1 will make sure you don’t have to worry about going back to the beginning or owe something you may have missed, later on, causing frustration and possible hardship, especially in your first year or two of business.