- When starting your business, determine the correct business entity structure to ensure taxes are handled properly.
- If you have others work for you, classify them correctly as either employees or independent contractors. Then withhold payroll taxes accordingly.
- Keep your business and personal finances separate.
Tax time never just rolls around. It appears suddenly in your doorway demanding your time and attention. Small businesses feel stalked by the IRS, waiting for a mistake to bring down the company.
You don’t have a dedicated department of experienced accountants to help you maintain your tax records and withholdings. You’re not a tax expert. Yet you must pay your taxes. Every. Quarter.
Many small businesses have three tax issues in common. If you can master them, you are less likely to hear the IRS using dreadful words like “audit” in relation to your company.
1. Selecting the Right Business Entity
Before you form your business, you need to determine the correct tax entity for your company among one of the following:
- Sole Proprietorship – a single owner is responsible for paying personal taxes on income—as well as Medicare and Social Security withholding—as a self-employed individual.
- LLC or limited liability company – members of the company pay taxes on business profits through their personal tax returns, although a business return is still filed.
- C-Corporation – the corporation is treated as a separate entity and pays income tax at the corporate tax rate. Shareholders who receive dividends from the company must pay dividend tax. If the shareholder is also an executive employee, he or she is subject to payroll tax withholdings just like all other employees.
- S-Corporation – a type of “pass-through” entity, S-Corporations pay taxes at the personal tax level of the owner(s). In other words, the taxes pass through to the owners rather than being paid as a separate entity like a C-Corporation.
Your business entity forms the basis of your company’s taxation, filing, and payment.
2. Correctly Classifying Workers
Your workers can be classified as employees or independent contractors. If you treat your workers as independent contractors for tax purposes and the IRS says they should be classified as employees, you will be on the hook for their payroll tax withholdings.
Determining the difference between an independent contractor and an employee comes down to the extent of control you exercise over how, when, and where the worker performs the job. The more control you exert, the more likely the individual should be classified as an employee.
For example, if you require the work to be performed on-site at your business between the hours of 9am and 5pm, Monday through Friday, you should classify the worker as an employee. That means you should withhold all required payroll taxes and issue a Form W-2 by January 31 for the previous year’s wages.
3. Separating Business and Personal Income and Expenditures
Many small business owners—especially if one person is the sole employee—may be tempted to put all income in a single bucket, whether it came from the business or not. That way lays the madness of an audit.
Keep all business financial matters separate from your personal finances. The best way is to keep scrupulous records of all income and expenses, including their origination, date of payment or receipt, and the amount of taxes already paid.
Also, be certain whether an expense is deductible according to the IRS and any state taxing authorities before you take a deduction. If you underpay your taxes, you must pay the amount of the underpayment along with interest and penalties.
When you start or run a business, make it your mission to understand the various ways tax law impacts your company and your personal finances. Hire an experienced tax consultant to help you set up your records and prepare your taxes to ensure you are paying what you owe to Uncle Sam. Running a business is stressful enough. Tax time is an opportunity to share the load with an expert.