Sunday, October 25, 2015

Opening a business? Beware tax burdens

In today's economy, many people are starting new businesses. For some people, they are converting a hobby or passion into a business. For others, it is a trade or professional experience they have that they feel now it is time to become their own boss. Usually, the last group of people who start businesses sees a need or hole in the marketplace that they try to fill.
Whatever your desire to start a new business, from a bookkeeping and tax perspective you need to do it right from the start. First, you need to consult an attorney on the legalities of your business, such as data security risks, liability risks, protecting intangible property and what type of entity you should be. If you need a referral to some good attorney's in the area, feel free to contact me. Next, you should contact a competent person in the tax area. My recommendation is to see a certified public accountant or an enrolled agent..
Now most people start as a sole proprietor. You do this by using your own name as the business name or get a fictitious name from the state. In operating as a sole proprietor, you generally do not create a separate legal entity. Here are some things you need to know or consider if you start your business as a sole proprietor.
Your bottom-line profit (net income, which is income less deductible expenses) is subject to self-employment tax. That tax is the equivalent of the Social Security and Medicare taxes that you have taken from your paycheck as an employee, plus what your employer matches. Except in this case, you are the employee and the employer. This tax rate is about 15.3 percent of net income. Plus the income is also subject to income taxes. So assuming you are in the 15 percent income tax bracket, your rate is about 30 percent of the income.
So, if you have a profit, you need to make estimated tax payments, increase any federal withholding you may have on other income payments (retirement payments or other W-2 income), or at least be prepared to pay the tax due by April 15. My rule of thumb is to set aside 30 percent of your gross income to cover the tax bill.
Make sure that you have a separate business bank account. This is one of the things that can help you avoid the hobby loss rules. This is assuming that you are truly running it as a business and it is not actually a personal hobby you are trying to get away with deducting the expenses.
Make sure you keep good records. This means keeping all of the receipts and invoices of the items you purchase. Use a software like Quickbooks or Xero to keep track of your accounting. I highly recommend you hire a professional to help you with keeping the books up to date and reconciled. This is not a place in which you should looking at saving a buck. Save your time by outsourcing this function.
If you are going to have payroll, then you should get an employer identification number to report the payroll activity (versus using your Social Security number). This is to reduce potential identity theft.
Remember to report all payments you receive for your products and services, including cash. If you don't report everything, there are ways for the IRS to find out what the cash transactions are. Not to mention, this will make your income less (or losses bigger) and make it more difficult to get business loans or buy a house in the future.
One other consideration to help save taxes is to consider creating a separate legal entity in which you can elect to become an S corporation for tax purposes. This will allow you to reduce the effect of the self-employment tax. The drawback to this is you have to pay to have a separate business tax return prepared and you need to involve a payroll company, because you are owner and employee that needs to receive a reasonable salary. This is why I usually say that your bottom-line profit needs to exceed $25,000 regularly to elect S corporation status.
Always seek professional advice before opening a business. I have seen too many people make very costly mistakes trying to save a buck and I don't want you to be one of them.

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