When you decide to start a business, taxes may be the last thing you think about.
However, not realizing that you owe the self-employment tax as well as income taxes can lead to a nasty surprise when you file your taxes. This post is aimed at avoiding that costly surprise.
But, before we discuss the self-employment tax, there are other important steps to take when you become self-employed. Here are the 7 things to do after you start your own business to avoid nasty surprises:
1. Set up bookkeeping right away
Even before you think about income taxes, be sure to set up bookkeeping using software like QuickBooks (either online or on your laptop). You don’t want to be scrambling to find receipts at tax time or not be able to tell somebody if you are making money or not.
You can save time by downloading from your bank and credit card companies. If you become wildly successful, you can hire a bookkeeper to take over managing the input, downloading and reconciling.
If you set up things well, all income and every expense will be properly categorized for your profit and loss statement, or P&L, and for your balance sheet. The P&L is essential for preparing your tax returns. The P&L and balance sheet help you monitor your business to see how well you are doing. The balance sheet will also come in handy if you need to apply for financing.
To ensure that your bookkeeping is set up well, you may want to consult with an accountant.
2. Form an entity
For many small businesses, being a sole proprietor is appropriate. You avoid paying corporate excise taxes and filing annual reports. For income taxes, you just file on Schedule C of the federal form 1040.
However, if you have partners, you may want to form a partnership, corporation or LLC. Details on choosing are beyond the scope of this post.
If your business involves risks that could lead to law suits, form a corporation or LLC to shelter your personal assets from liabilities of the business that insurance may not cover. Make sure that any actions you take for the business are in your capacity as an officer or manager – i.e., never sign personally.
To ensure that you make the proper choice of entity, you may want to consult with an attorney.
3. Get licenses, file annual reports and pay local taxes
Certain businesses require a license to operate. If you hire an attorney to form your LLC or corporation, she can check this out for you.
Most entities are required to file annual reports. If you are not a single member LLC, you also have to file income tax returns for the entity. The entity in turn provides you with the information for your personal tax return, which would be in the form of a K-1 for an LLC, partnership or S corporation.
Your city may impose taxes on the personal property in your business. Be sure to find out so you don’t owe penalties for failing to file and pay.
4. Buy health and other insurance
In addition to liability insurance, you will want to obtain health insurance if you are no longer working for another employer. You may get favorable treatment for this expense on your income taxes – the IRS allows the self-employed to deduct health insurance on the front of your form 1040 – an “above the line” deduction. In this case, the “self-employed” includes over 2% shareholders of private corporations and members of LLCs.
You can also purchase insurance to cover damage to equipment, loss of data, identity theft and so on.
You may want to ask your accountant or attorney if she can recommend anyone for your insurance needs.
5. File payroll taxes
If you hire people to work for you and pay them over $600 per quarter in any year, you need to report the compensation. If they are independent contractors, you file a form 1099 with the IRS. If they are employees, you file a W-2 with the Social Security Administration. You also provide these forms to your people for the income tax filings.
If you have employees, you need to withhold and remit FICA and Medicare taxes. You have to remit what you withheld and make equal contributions to FICA and Medicare taxes for each employee. You will file and pay at least as often as every quarter.
Your employees may also request that you withhold and remit federal and state income taxes (unless you live in a state that does not impose income taxes). Failure to withhold and pay to the IRS and state can lead to serious penalties.
Check with your accountant or attorney to see which filings apply to your business and when they are due.
6. Pay your income tax
One big shock for many who start a business is how much they owe in taxes.
When you received a paycheck, you probably did not focus much on the fact that your employer withholds federal and state income taxes and FICA and Medicare taxes.
More importantly, you never had a chance to spend what was withheld. However, when you run your own business, you have full access to the pre-tax income, so you have to diligently allocate funds ahead of time so that you don’t come up short at text time.
To avoid owing interest on the taxes due, you make estimated tax payments each quarter to the IRS and state. Check with your accountant or attorney for payment vouchers and due dates.
7. Pay the self-employment tax
When you become self-employed, you are responsible for both the employee and employer amounts. This tax is based on your net self-employment income from Schedule C or the K-1 from your S corporation or LLC, and is calculated and reported on your federal form 1040.
A lot to remember, right? Maybe, but knowing and planning ahead is far better than trying to scrape together money in April to cover taxes you did not expect. Good luck with your new business!
What the Fed Said to Spook the Markets
11 Most Read IRIS Articles of the Week!
The Cornerstone of Effective Marketing Is Understanding Your Niche
Find Your Why, Before You Give
How Will Asset Managers Find Ways to Distribute Going Forward?
Get Real: Stepping off the Hamster Wheel of Life
The Culture Perception Gaps Between Executives and Employees
Get Naked With Your Money: Wrinkles, Bulges And All!
Do This To Complete Your Vital Activities Each Day
Traditional Retailers Are Failing And It’s Not Amazon’s Fault
Research12 hours ago
What the Fed Said to Spook the Markets
Advisor2 days ago
Cybersecurity and Privacy: Tips for People with Substantial Wealth
Brand Strategy2 days ago
A Different Way To Think About Leverage
Equities2 days ago
What You Need to Know about Investing in Healthcare AI
Markets2 days ago
The Fed’s Next Move May Be No Move at All
Markets3 days ago
Why The Next Recession Will Be Different
Equities3 days ago
What You’re Not Hearing About the China Trade War
Development3 days ago
The Best Practice Management Idea of the Year