Thinking about starting your own business? Here are the tax obligations you need to know about as an entrepreneur in the US
Work by Salt and Pepper Creative
Which should include information company structures and reliefs available to start ups
To start business in the United States, it is important to determine whether or not the IRS would consider the start-up a “hobby” or a business. The IRS determines if it is a business when there is an expectation to earn a profit. According to the IRS, a business is for profit if they make a profit during at least three of the last five years (including the current year).
When setting up a business, it is necessary to determine which structure it will fall under, as this will determine what types of taxes need to be reported and filed. Businesses can be established as a sole proprietorship, a partnership, a corporation, an s corporation, or a limited liability company (LLC). A sole proprietorship consists of a single owner of an unincorporated business. Sole proprietors only need to pay their own personal income tax. A partnership exists when two people or more start a business in which they both contribute money, property, labour or skills. When the business earns or loses a profit, each partner shares in it. To file taxes, a partnership must file their own report, but is not required to pay any income tax. Each partner also files their own tax return including their own share of partnership income. A corporation exists when shareholders exchange money and/or property for the stock in the company. When paying taxes, a corporation is considered a separate entity, so when a profit is earned the corporation pays a tax, and when dividends are issued the shareholder pays a tax. Thus, shareholders of a corporation are double taxed. An S corporation is a special corporation, which avoids the double taxation of normal corporations. However, an S corp. must be domestic; must have no more than 100 shareholders who can only be individuals, certain trusts, and estates; must have only one class of stock; and not be ineligible corporations as listed by the IRS. A Limited Liability Company (LLC) can be established dependent on certain state regulations. The IRS can classify an LLC as a corporation, partnership, or as an owner dependent upon the number of owners they have and elections made by the LLC.
Dependent on the business structure, businesses will need to pay different taxes. All business structures must file an income tax return, except for partnerships. Each business will have different forms they need to file for their federal income tax, dependent on their business structure. Estimated taxes are taxes paid throughout the year. This is required of sole proprietors, partners, and S corp. shareholders. Corporations will also need to pay estimated tax payments during the course of the year if they expect their will owe an amount greater than or equal to $500 when they file their tax return. When starting a business, if you are self-employed, you will need to pay a self-employment tax, which is comprised of social security and Medicare, as long as your earnings are above $400. Additionally, if you have employees, you need to pay employment taxes, which include social security and Medicare taxes, federal income tax withholding, and federal unemployment tax. The last form of tax a business may have to pay and file is an excise tax, which are taxes paid on specific goods like gasoline. If the business manufactures / sells certain products, operates certain kinds of businesses, uses various kinds of equipment, facilities, or products, or receives payment for certain services as outlined by the IRS, they will need to pay an excise tax and file certain forms.
Additionally, to start a business it is important to keep clear records. These records should include sources of income, deductible expenses, purchases, travel, entertainment, charitable donations, transportation, assets, employment taxes and investment in property. They can be used to prepare your tax return and show evidence of what is being reported on the tax return and financial statements. The IRS may ask to review the items that are reported on your tax return and may ask for an explanation, having the records will show support of what is reported. Keeping records can be done in a journal and a ledger. Journals can be used to record each business transaction for different accounts, which a ledger contains the total of each account from different journals. The length of time you should keep your records depends on when the period of limitation runs out. The period of limitations refers to the period of time when you can make changed to your tax return to receive a credit or refund or when the IRS can request additional taxes. Information about the period of limitations for specific taxes can be found on the IRS website. Employment tax records should be kept for at least four years after the 4thquarter filing.
When deducting business expenses, businesses cannot deduct all their start-up costs. Instead, start-up costs are considered capital expenses and must be capitalized. The start-up cost can be recovered through depreciation or amortization of the expenses. However, if the total start-up costs are $50,000 or less, the IRS allows you to deduct up to $5,000 of business start-up and $5,000 of organizational costs if it was incurred after October 22, 2004. If the total start-up costs are under $55,000, the IRS will only allow you to deduct a portion of $5,000. For example, if the start-up costs are $53,000, you can deduct start-up costs up to $2,000, or if they are $52,000 you can deduct $3,000. The deduction can only be claimed in the month in which the business begins. The start-up costs that aren’t deducted can then be amortized over a 180-month period, which starts the month the business begins operations.
Other tax credits that are available include Research and Development (R&D), bonus depreciation, professional fees, office expenses, employee expenses, software subscriptions, travel, marketing / advertising, and banking / lending fees. A business can apply to use up to $250,000 of their federal R&D tax credit for their Social Security and Medicare employment taxes when their gross receipts are less than $5 million. This can be done for five years. Bonus depreciation allows a business to depreciate fifty to one hundred percent of a qualified property that was placed into service after September 27, 2017 and before January 1, 2023. A professional fee refers to a tax deduction that businesses can claim for consulting with professionals such as lawyers, accountant, etc. Businesses may also claim a deduction for payroll taxes and insurance plans established for their employees. Additionally, software services that the business uses may also be eligible for a tax deduction from the IRS. The IRS also allows a deduction for expenditures related to traveling for the business. When a business acquires fees from marketing or advertising, including creating a website, producing apparel, etc. these items are eligible to be tax deductible. Finally, businesses may be able to write off loan interest, ATM fees, and other banking fees.
Additionally when starting a business, for tax filing purposes a tax year needs to be determined and most businesses will need an Employer Identification Number (EIN). Businesses can operate their tax year on the calendar year schedule from January 1 – December 31 or under their own fiscal year. A fiscal year consists of 12 consecutive months ending on the last day of any month but December. The IRS identifies a business by using the Employer Identification Number (EIN). Applying for an EIN can be done through the IRS website.