Going into business for yourself by forming a corporation or sole proprietorship is an exciting endeavor. Of course, from a taxation standpoint, it can also be a little overwhelming. These seven tips will help you navigate your tax requirements.
1. Learn How Expansion Affects Your Tax Liabilities
"Location, location, location" may be every real estate agent's mantra, but it's also a reminder that the property you purchase for your business is an important factor in your taxes.
As a new or growing business, suppose you've purchased a building. Under Section 179, you can deduct the full purchase price (up to $1 million) during the first year that building is in use. Section 179 does not apply to:
- Investment properties
- Land purchases
- Buildings intended for lodging purposes
However, it does apply to properties purchased for manufacturing or production purposes, facilities where research will take place and any properties used in the management of horticultural products and livestock.
2. Make Sure Your Business Is Categorized Correctly
There are several different business "structures" in the eyes of the law. Not all of them may apply to you, but some may offer a more attractive tax situation. Here's a look at some of your options:
- Sole proprietorship: This is one of the most straightforward ways to keep track of your business expenses, but it also means you assume all of your company's risks, expenses, profits and debts.
- S Corporations: Structuring your business as a "Subchapter S Corporation" is a way to separate your personal assets from your business assets. It also helps you avoid double taxation, since losses and profits "pass through" to you and your shareholders and are not subject to corporate taxation.
- Limited liability company (LLC): With an LLC structure, you can be the sole owner or one of several partners. You will have to pay self-employment taxes, but business earnings pass through to you personally instead of being subjected to corporate taxes first. An LLC structure also protects you from being personally liable for business-related legal actions and debts.
There are other options, too — including partnerships, cooperatives, corporations and, in some situations, nonprofits. You should ask your CPA for advice about which structure would be most beneficial in your unique circumstances.
3. Claim Every Deduction You Qualify For
You owe it to yourself, and your business, to find every possible legitimate way to reduce your tax bill. Unfortunately, even some seasoned business owners aren't as well-schooled in deductions as they should be. Here's an incomplete list of some fully tax-deductible business expenses:
- Education (if it furthers your business in some way)
- Legal and professional fees
- Expenses related to medical care and insurance premiums
- Mortgage loans for home improvement
- Moving expenses related to work
- Real estate taxes
- Advertising and promotion costs
- Business insurance
And here are some expenses that are partially deductible:
- Property improvements for energy efficiency
- Home office depreciation
- Interest paid on money borrowed for investment purposes
- Business meals
- Automobile expenses related to business
Again, these aren't complete lists. If you need more help keeping track of your expenses and possible tax deductions, you're encouraged to proceed to point number four below.
4. Go Paperless With Tax Prep Software
According to the IRS, 21% of physical tax returns have errors of some kind. Meanwhile, just 1% of electronic returns contain errors. You can, and should, go paperless long before tax season. If you're not keeping track of earnings and expenses digitally, throughout the year, you're making your life much harder than it needs to be.
These days, small businesses and contractors can do most or all of their expense and deduction accounting right on their smartphones or tablets. All of the most popular tax software out there provides tools for manually or automatically tagging recurring expenses as business-related. And for entrepreneurs and the self-employed, some of these apps make clever use of smartphone features — such as using GPS to automatically log miles traveled for business purposes.
The ability to integrate your business-related accounts and credit cards with your tax software might help you discover tax-deductible expenses too. You might miss them otherwise, especially if you rely on paper bookkeeping. As your business grows, you may find it useful to outsource some of your accounting tasks to a professional. Remember that their time doesn't always come cheap though, and asking them to pore over piles of paper records can quickly add up thanks to hourly rates. Save them some effort and save yourself some money by going paperless.
5. Seek Legal Advice for 'Fringe' Tax Issues
All of us live, play and work in an increasingly digital economy, and this can sometimes make questions about tax liability difficult to answer. Here's just one example:
The New York State Tax Department rendered an opinion recently on a California-based video service business with an office in the Empire State. The business owner wanted to know whether earnings from these services — where customers generate unique video content through a web app — were subject to taxation. "Software as a service" is not exactly a new concept, but there are some fringe taxation issues related to this concept. In this case, the question arose because customers didn't directly download the software used to create this video content.
Nevertheless, the Tax Department concluded that the business must declare and pay taxes on its earnings because customers had "constructive possession" of the pre-written software. Cloud computing and other software products and services are some of the more controversial taxation situations out there right now, which means companies in this space should seek professional advice any time they have questions about tax liabilities.
6. Take Advantage of Tax-Deferred Retirement Accounts
Retirement plans are a business expense that you can't ignore, but they also provide the potential for tax savings. In fact, no other business expense lets entrepreneurs claim deductions before they've actually provided the funds in question.
In other words, you can deduct the cost of placing funds into employee retirement accounts and defer tax payments until that money is actually withdrawn. You and your employees will get to watch these contributions grow in value without having that value reduced by ongoing tax payments.
7. Hire More Contractors and Fewer Employees
The IRS provides guidance for companies who wish to go this route, including consequences for misrepresenting the nature of your employees' roles. If you feel confident in your legal footing, favoring contract-based employment versus onboarding fully-fledged employees is an attractive way to reduce your expenses and tax liabilities. Contractors aren't eligible for disability insurance, paid vacations or medical coverage. They also mean your company is exempt from paying taxes to fund Social Security and Medicare.
As you can see, you can begin to implement some of these tax tips for businesses practically overnight. Others are slightly more involved and might require input from your lawyer or accountant. All of them, however, have the potential to help your business.