The spirit of entrepreneurship that drives many to open a small business often comes with a fierce independence and self-reliance. While these are admirable traits and some may say essential for success as a small business owner and operator, they can make one less likely to seek outside guidance and assistance where it could prove beneficial.
If you are contemplating starting a small business or have already embarked on that journey, be certain you fully understand your tax obligations and perhaps more importantly, don’t overpay.
Understand Your Status
One of the basic considerations to realize is how the IRS looks differently at everyone who works for someone else as an employee from those who earn income from a business. You are probably very familiar with earning a paycheck, seeing income taxes withheld each pay period and reconciling everything once a year on April 15 when you file your 1040.
As a small business owner, you will still be required to file 1040, but how you determine the income, or loss, to report, will entail additional tax forms.
Schedule C – The Basic Small Business Income Tax Form
Schedule C is primarily used by a business owner to depict the revenue and expenses of the business and calculate a profit or loss accordingly. Most Schedule C filers are sole proprietors of their business, but other individuals may also be required to file C, such as a single member LLC owner.
Additionally, if you earn income that is reported on a 1099 Form and not subject to withholding, it is most often necessary to file Schedule C. Although a 1099 income earner may not consider herself a business owner, this is where it should be reported, and there are very likely deductible expenses that can offset the income.
One of the primary benefits of small business ownership is to strategically claim write-offs to reduce your potential tax exposure. Depending on the nature and complexity of the business, this can require a sophisticated understanding of the tax code and the percentages and type of deductions other businesses of similar stature claim.
Most small business owners know their business quite well and many ultimately learn their economics as well, but preparation of income taxes requires some accounting acumen as well. For instance, Schedule C requires the filer to:
– Elect an accounting method – cash, accrual or other, to be specified.
– For those who sell goods, elect a method to value closing inventory – cost, lower of cost or market or other, to be specified.
– It probably goes without saying these can be critical decisions in the overall economic health of the business.
In conjunction with Schedule C, a small business owner may be required to file other forms with their incomes taxes. Some or all of these may be required:
– Certain assets have a declining value that can be written off over what is considered the assets’ useful life (use Form 4562) or may be taken all in one year (considered a Section 179 expense.)
Business use of home
– Under certain circumstances, a Schedule C filer may qualify to write off a portion of their home for business purposes. If so, Form 8829 may be required. At one time, declaring business use of the home was considered a red flag likely to catch the IRS’ attention and bring attention to the tax return. Although not as apt to trigger an audit any longer, it remains an area to be carefully considered with a thorough understanding of the tax rules and regulations.
– One of the drawbacks of self-employment is the need to pay all of the taxes earmarked for one’s Social Security pension and Medicare coverage, unlike an employee whose employer pays 50 percent of that total. Aggressively declaring all legitimate expenses as deductions is the best manner to minimize self-employment taxes, which are calculated and reported on Schedule SE.
– Those new to self-employment are often chagrined to find the IRS requires quarterly payments in the current year of what is the anticipated tax liability due on April 15 of the following year. This can be difficult to do, but an accurate estimation is essential. For those who fail to pay or under pay, there are penalty assessments and interest that compounds and adds up quickly. File Form 1040-ES four times a year.
Seek the Guidance of an Experienced Tax Professional
A licensed tax preparer, enrolled agent or CPA can not only assist you in saving money and providing compliance and peace of mind, you will also save valuable time, which can be better put to use running your business.