Small Business Tax

A Guide to Small Business Taxes

November 2, 2013 : Mike Slack - The Tax Institute

Starting a new business on your own can be both intimidating and rewarding at the same time. Hopefully; with a solid business plan and proper guidance those stepping-out on their own will be successful. To make this process a little easier, here are some basic tax considerations a new business owner should take into account.

Choosing Your Type of Business Entity

One of the first decisions that you will have to make is to choose the type of entity that you wish your business to operate as. Your choice plays a factor in your personal liability for the business’ activities and how taxes are imposed on the business and yourself as the owner. The most common forms of business are the

  • Sole Proprietorship – Subject to income tax at the individual level, subject to the self-employment tax
  • Partnership – Subject to income tax at the individual level, subject to the self-employment tax
  • Corporation – Income earned by a corporation that has not elected to be an S corporation is taxed at the corporate level; with shareholders of the corporation being treated as employees subject to payroll taxes on their wages.
  • S corporation- Subject to income tax at the individual level, shareholders treated as employees subject to payroll taxes

Each form of business has its own advantages and drawbacks; so consulting a tax professional as to which is best for you is always advisable.

Many individuals choose to operate their businesses as a limited liability company (LLC). The IRS will by default treat an LLC as either a sole-proprietorship or partnership, depending upon the number owners of the business. Alternatively, an LLC can elect to be taxed as a corporation or S corporation.

3 Steps for Small Business Taxes

1. Obtain an EIN

If you form a partnership or corporation, or plan on having employees, you will be required to obtain an employer identification number (EIN) from the IRS. Applying for an EIN is free and easily done via the IRS website. The IRS also provides an interactive tool that can help you determine whether your business will be required to obtain an EIN. Even if you are not required to have an EIN, getting one may be advantageous for your business if you would prefer to not give out your personal social security number to customers or vendors.

2. Keep Good Records

One of the most important steps in starting a business is to establish a solid recordkeeping policy. Not only is good record keeping required in order to prove items of income and expense reported on your business’ tax return, but they also are crucial for monitoring the progress of your business.

Quality records can show whether your business is improving, which items are selling, or what changes you need to make.  With any business, quality records can increase the likelihood of business success.

3. Deductible Costs of Starting Your Business

With most new businesses the old saying “you gotta spend money, to make money” will apply, and how expenses you incur before bringing in revenue is treated depends upon the type of expense.

  • Currently, the IRS allows businesses to deduct up to $5,000 of certain start-up expenses in the year the business begins (subject to limitations), even if the expenses were incurred in a prior year.
  • Expenses that qualify are those that would be deductible if they were paid after the business actually began.
  • Amounts paid to acquire capital and intangible assets, such as equipment or franchise fees that a business would have to depreciate over a period of years, do not qualify for this deduction.
  • If your eligible start-up costs exceed the amount allowed for deduction, you will have to “capitalize” the excess expenses and will recover those costs via an amortization deduction ratable over a period of 15 years.

In addition to eligible start-up costs, corporations and partnerships are allowed to deduct up to $5,000 of organizational costs in their first year of activity. These include legal fees, filing fees, and other costs directly related to the formation of partnership or corporation business entity.

Keep Up with Estimated Taxes

A major misstep many new business owners make when starting out is failing to plan well for their end-of-year tax bill. This is especially a problem for individuals leaving work as an employee where their income tax was withheld by their employer.

In order to avoid making this mistake a small business should pay estimated taxes to the IRS if it expects to owe taxes of $1,000 or more for the year ($500 if you operate as a corporation). Not only will paying estimated taxes help you avoid IRS penalties, they will prevent (at least some of) the sticker-shock when you file your tax return.

Join in the conversation and let us know your questions about small business taxes in our Community.

Editor’s Note: This post was updated on August 4, 2016. 

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Mike Slack - The Tax Institute

Mike Slack - The Tax Institute

The Tax Institute

Mike Slack, JD, EA, is a senior tax research analyst at The Tax Institute. Mike leads research teams focused on business and investment tax issues.

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