When starting a business, it is crucial to take time to get the choice of entity correct. The differences between a sole proprietorship, partnership, corporation and LLC will not only affect your legal liability, it will affect taxes.
From estimated taxes to writing off losses, there are many tax issues to consider. In this post, we will cover three potential issues
Business taxes: What are they?
If you are the business, you will need to pay income tax, employment tax and self-employment tax. Unlike working as an employee where your employer splits some tax obligations, you pay the 15.3 percent (12.4 percent Social Security and 2.9 percent Medicare). However, you can deduct the employer potion.
Once you start the new business, keep track of expenses. You may be able to write off the miles you drive to build up a client base or the space you devote to a home office. The expenses must be ordinary and necessary and this is one area that is frequently audited, so you will want to do your homework.
Employer Identification Number (EIN)
Your new business may need to apply for an EIN with the IRS. It is generally easy with an online application process. Other business will ask for this number when you sign a consulting agreement or negotiate a contract above a certain dollar threshold.
Which accounting method?
Unless you have taken an accounting class, you may know what the two options are. You can select either:
- Cash method is when you report your income and deduct all of your expenses in the year received or paid
- Accrual method allows you to report income or expenses even if the actual transaction clears an account in a subsequent year
The cash method is often more easy to track, but as business transactions become more complex the accrual method may be a better fit.
As your business grows and becomes profitable, you will need to consider paying estimated taxes. In another post, we will provide an update on a reported surge in underpayments of estimated taxes.