The Tax Implications of Starting Your Own Business

Starting a small business is rife with regulations, tasks, and endless streams of expenses. One thing many entrepreneurs don’t consider at the onset of a new business is the major tax implications this venture can have. Check out what you can expect from the IRS after deciding to start your own business.

Consider Your Business Structure

As you begin your venture, consider how you’re going to structure your business. Will you classify your business as an LLC, partnership, S-corp, or C-corp? Many small business owners elect to declare their business as an LLC because this structure typically provides a larger amount of protection and a fair number of tax benefits. It’s always a good idea to consult with a business attorney before choosing a specific structure to ensure you have all the details you need to make an informed decision.

Applying for an EIN

As you get your business off the ground, you’ll need to apply for an Employer Identification Number (EIN) from the IRS. This number will be used anytime you interact with the government agency, and listed on your return and any other type of document that must be filed. If you are the sole proprietor of your business and you have no employees, you can use your social security number instead. You may also use your SSN if you have a government certified single-owner Limited Liability Company. Procuring an EIN is simple, as you can apply online or over the phone.

Prepare for Self-Employment Taxes

As you own your business, you will be subject to the self-employment tax. These taxes pay for contributions towards Medicare and social security options. In any other position of employment, your employer would withhold this money for you, so it will be up to you to keep track of and save the amount you’ll need to hand over to the IRS come tax season. You’ll pay 15.3 percent for the first $118,500 of your net earnings from self-employment income, and for anything over that amount you’ll owe Medicare taxes at a rate of 2.9 percent.

Employment Taxes

If you have employees, you’ll be required to pay the employer’s share of Medicare and Social Security taxes, and withhold their share of these costs from the paychecks. If your employees make less than $118,500, you and your employee will each be responsible for 7.65 percent on those wages. If your employees make upwards of this amount, you’ll only pay Medicare taxes, which is 1.45 percent for each party. You’ll need to have a clear understanding of the difference between employees and contracted individuals, as your tax liabilities can vary greatly depending on this distinction. If you employ independent contractors, you won’t be liable for employment taxes, and you’ll utilize different forms come the end of the year.

Prepare for Quarterly Estimated Payments

Small business owners and self-employed individuals are required to make estimated quarterly tax payments throughout the year to handle federal income tax liability. These payments generally fall in April, June, September, and January, and it’s important to remain on top of your finances year-round with the help of a financial advice service like that offered by Vanguard.

Accounting Methods

There are two general accounting methods for small businesses, known as Cash and Accrual. Using the Cash method means you’re counting income or expenses at the time you receive a payment or pay off a bill. These types of accounting repots only show the income you’ve received, and only the expenses you’ve paid off. In contrast, an Accrual method records income when it’s earned and expenses when you’re billed, not necessarily when you actually receive a check or make a payment.

Audits Become More Likely

It’s an unfortunate facet of being your own boss, but the IRS tends to audit self-employed individuals on a more regular basis. Being audited doesn’t necessarily mean you’re in trouble, but it’s safe to say that if you’ve done something illegal with your taxes, the IRS will figure it out. This is why it’s essential to remain organized and keep detailed records of all of your financial movements, income, and expenses. If you find yourself in debt with the government, your business could easily go under and you could face serious legal ramifications. If you currently owe money to the government, be sure to work out an IRS tax payment plan before beginning your business.

Starting your own business isn’t always a straightforward task, but remaining on the right side of the IRS regarding taxes is vital to success. Keep these tips in mind and work with professionals to ensure your business remains protected and you stay out of hot water.

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