While we only hear about the Fortune 500 companies in the news, it is the small and medium businesses that form the backbone of the US economy.
In fact, small businesses make up to 95 percent of almost all businesses. According to SBA Office of Advocacy, there are more than 29 million small businesses in the US, and they employed nearly 56 million people, or 48 percent of the workforce in 2013. That’s a total of 85 million people dependent on small businesses.
Small businesses are set up as sole proprietorships, partnerships or as S-Corp and their tax liability varies with the change in their legal entity. They are also entitled to certain deductions.
In this article, we are going to tell you 5 things every new small business-owner should know about Federal Income Taxes.
1. What is my tax liability?
There are four types of small businesses – sole proprietorships, LLCs, partnerships, and S-Corporations.
Pass-through entities (partnerships, LLCs and sole proprietorships) pass all their profits to the business owners in the form of their individual income.
The new tax reform allows the pass throughs to deduct up to 20 percent of income, subject to what type of business you run and the corresponding formula.
Personal service businesses comprising of realtors, attorneys, architects, engineers and brokers take some amount as salary and pass the rest income as pass-throughs.
The new tax reform allows them 20 percent deduction if the income is below $315,000 for married couples filing jointly and $157,500 for single taxpayers.
For employee-driven businesses, like restaurants and manufacturers, the deduction for S corporations is dependent on your payroll. The 20 percent deduction will be limited to 50 percent of your payroll.
2. Which ones of my startup expenses are eligible for a deduction?
The Federal Income Taxes supports new business owners by giving them tax deductions on the expenses incurred towards getting their business up and running. As a founder who is starting out, you need to keep in mind the following deductions:
- Up to $5000 worth fees paid to attorneys and accountants
- Money spent on improving business or technical skills related to the subject or your education
- Expenses on building a website, business cards
- The cost of running the startup from home – a portion of your interest or mortgage will get deducted from the tax liability and so will the utilities bills in keeping your start-up afloat.
- The products that you can’t sell will be not taxed by the IRS. Donate them to a charity and get a tax credit!
3. Do I need to file a return even if I’m pre-revenue?
LLCs and sole proprietors don’t, but S-Corporations will have to file a tax-return in the pre-revenue stage if there is some activity in their business. When you are filing pre-revenue return, you can record your expenses to set-off against your other income.
For example, if you spend $20,000 in starting your startup, there is a write-off limit up to $5,000, and any amount over the $5,000 must be amortized over 15 years. This means that the remaining $15,000 will be written off as $1,000 annually for 15 years.
4. Why is there so much more to deductions than I understand?
Figuring out which expenses are eligible for deduction and up to what limit is tough. But we, an advanced tax filing services are here to help make the process painless for you!
- Most startup founders work from home. IRS allows them deductions but they should have a dedicated workspace and you should document it by taking a picture 2x per year to claim a deduction.
- Your business travel is eligible for deduction. Record the reading on the odometer at the start and the end of the trip.
- The large purchases made by new business owners like new PCs, monitors, and other home office equipment is eligible for tax deductions upfront.
- There is a potential for tax savings through 401 (k) or a SEP plan within the business towards your retirement accounts and claim a direct tax-write-off on it.
- If you use your cell phone for answering client calls or writing them an email you can claim a deduction on your total cell phone bill.
- If you have bought a car for the company and use it strictly for business, you will not get a tax reduction on the whole amount but will get a deduction only for the depreciation.
- You can also deduct various federal, state and local taxes directly attributable to the business.
5. How much should I set aside for estimated taxes?
In your first year of operation, IRS exempts the founders from making estimated tax payments, but from the next year onward, they must submit accurate quarterly payments if they anticipate owing $1,000 or more for the tax year. You need the help of business & individual tax filing services if you are filing estimated tax payments for the first time.
You should try to use your last year’s income, income tax credits, and deductions to calculate your tax burden. Also, your estimated taxes depend mostly on the state you’re living in. California, for example, has higher taxes than Texas. In California, if you’re making $150,000, you should keep around 25-30 percent of your net income as taxes, whereas in a low-tax state the percentage could be 20-25 percent.
The IRS is watching you closely. Keep as many documents or receipts as possible, and start filing your return as early as possible.
Tax filing is a time we all dread, but a robust tax filing service will make it simpler for you. Reach out to us, the best Indian CPA in Irving or Plano Email us at firstname.lastname@example.org for a free 30-minute consultation and find out for yourself.