Opening your own business is a heady time, with many decisions, plans, and strategies to make. Running your business means wearing many hats, especially in the early days when your staff is small (if any) and you’re trying to build the company.
One of the most important considerations is your tax strategy. From forming your business structure to being away from tax credits and deductions, understanding how taxes work is essential to ensure you manage your tax obligations.
Here are four tax planning strategies for your small business.
1. Be Strategic With Forming Your Business Structure
Your business structure is the legal form your company takes. There are many types of business structures to consider. Each has its own advantages, especially when it comes to taxation, liability, management structure, and organization.
For most small businesses, there are two choices when it comes to business structure – a sole proprietorship or a limited liability company (LLC).
Sole Proprietorship
A sole proprietorship is the simplest business structure because it requires no formal paperwork to create. In a sole proprietorship, you are the lone owner of the company and make all the strategic and tactical decisions about the business.
From a tax standpoint, a sole proprietorship is considered a “pass through entity.” That’s because the taxes incurred by the business are simply passed through to the owner’s personal federal and state income taxes.
The business profits and losses are entered on federal Schedule C as part of Form 1040. The sole proprietorship business structure also allows you to deduct certain expenses related to running your business.
Sole proprietors are responsible for paying the self-employment taxes for Medicare and Social Security. When you’re employed by another company, that business typically pays the business portion of these taxes.
It’s important to note that a sole proprietorship does not have the liability protections that other business structures provide. If there is a court judgment against the business or a bankruptcy filing, creditors can come after your assets. That means your house, car, and savings can all be seized as part of a legal proceeding.
LLC
An LLC is the most popular business structure for small businesses, in large part due to the tax and liability advantages. An LLC requires the business owner or owners (called “members”) to file the business type in a state, though not necessarily the one where they are based.
With an LLC, the business is a separate legal entity from the owner or owners.
The LLC structure has several flexible options when it comes to taxes. Fundamentally, an LLC acts the same way as a sole proprietorship. Revenue and losses are passed through to the owner or owners’ tax returns.
However, LLC owners can choose how the Internal Revenue Service sees the business from a tax perspective. The default is to consider the LLC as a disregarded entity, in which case the pass-through characteristics hold.
The LLC can also be considered a corporation or a partnership.
A single-member LLC can be considered either a sole proprietorship or a corporation. A multi-member LLC can be considered either a partnership or a corporation.
LLCs that use the partnership designation pass through the revenue, expenses, and debts to the individual owners’ tax returns. If owners choose the corporation tax designation, there can be savings in their self-employment taxes.
From a liability standpoint, the LLC has major benefits for owners. The LLC protects the owners from personal liability due to a court ruling. That means personal property is protected from being seized due to an adverse judgment.
From a management standpoint, an LLC structure provides several layers of flexibility. First, there can be a single-member LLC, in which you are the sole owner. In a multi-member structure, there is more than one owner/member.
You can choose to be a member-managed organization, in which one or more of the members is responsible for the day-to-day operations of the company. Or, you can choose to be a manager-managed LLC, in which the members hire a manager to run the business.
Forming an LLC requires some formal filings. Determining in which state to file is an important consideration.
Forming your LLC in South Carolina is a smart choice. The state’s business tax rate is just 5 percent. Compare that to New Jersey, which has an 11.5 percent corporate tax rate, or Minnesota, which has a 9.8 percent rate.
2. Leverage Tax Credits
Tax credits are powerful ways to reduce your tax burden. Tax credits are offered at both the federal and state levels for various programs or tactics that a business takes.
To find the tax credits for which you qualify, you can check out the Internal Revenue Service website or consult a tax professional.
Here’s a look at some of the federal tax credits available to small businesses:
- Small-Business Health Insurance Tax Credit. A byproduct of the Affordable Care Act, this credit applies to businesses with 25 or fewer full-time employees and an average wage of less than $55,000 who pay at least half of employee health insurance premiums and by their plans from the Small-Business Health Options Program (SHOP). The credit covers 50 percent of employer-paid premiums
- They disabled Access Credit. For businesses with revenue of $1 million or less, this credit offsets some of the costs associated with providing access to people with disabilities. The first $250 of qualifying expenses are not covered. Afterward, the credit provides 50 percent up to $10,000 in expenses. Eligible expenses include making facilities accessible, offering Braille, large print or audio versions of items, or offering sign language services
- Work Opportunity Tax Credit. This credit offers businesses $2,400 for each employee hired from groups that often face barriers to employment, such as those receiving certain federal subsidies, felons or veterans
- Research and Development Tax Credit. This credit provides businesses relief for R&D expenses, including software development, architectural design, or improvements to products
- Empowerment Zone Employment Credit. If your business is located in an empowerment zone – a designated distressed area of cities – you can earn up to $3,000 for each employee hired
- Retirement Plan Startup Credits. Employers can deduct the costs of creating retirement plans, such as IRAs or 403(b)s for their employees
3. Pay Close Attention To Tax Deductions And Tax Law
Tax deductions are an important part of your small-business tax strategy. Understanding the potential Tax deductions your small business is eligible for can save you lots of money.
Tax deductions change frequently, so knowing the tax laws is critical to ensuring you’re leveraging all the possible tax savings is good business.
Here’s a closer look at the most standard business tax deductions for your business.
- Marketing and Promotions. You can deduct all marketing and promotional costs, including advertising campaigns, social media advertising, newspaper, radio, and television ads, and other work done to promote and raise awareness about your business
- Insurance Premiums. Any insurance policy premiums you need to pay to cover your auto usage for business can be deducted. Please note that this deduction requires you to use the Actual Expenses method of calculating your tax deductions instead of the Standard Mileage method. You’ll also need to calculate the percentage you use your car for business vs. personal driving
- Travel Expenses. Whether you’re flying to visit clients, or traveling to events and craft fairs, you can deduct the expenses, including air or train travel, hotel costs, and meals
- Education and Training. Expenses related to professional development, including coursework, materials, content and training are all deductible
- Office Supplies. The pens, pencils, copier ink and materials required to run your business can be deducted
- Utilities. The cost of your utilities, including heat, cable, wireless and water are all deductible
4. Don’T Fall Victim To Poor Tax Planning
Taxes can be a significant burden for any small business. That’s why it’s important to minimize your tax burden every year. Consulting a professional tax expert or attorney can significantly reduce the total taxes you pay.
Also, remember that you’ll need to pay your business taxes every quarter to avoid fines and penalties. These payments require planning and coordination to ensure you have the cash flow to cover your quarterly expenses.
Running a small business is a complex venture. Keep an eye on the business structure you select, the tax credits and deductions that will reduce your tax obligations, and changes to the federal and state tax laws that can affect your bottom line.
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