Starting a business requires a significant amount of planning but the more prepared you are, the greater the odds of success. One of the most important things entrepreneurs need to be concerned with is what new tax responsibilities are involved. If you’ll soon be debuting a new business, here’s a look at what steps you need to take to make sure you’re toeing the line when it comes paying to Uncle Sam.
Select a Business Structure
The first thing you have to decide is what type of business you’re going to run. There are several different structures to choose from and the one you pick determines how you report and file your taxes. If you’re operating as a sole proprietorship, for example, you’d use Form 1040 and file Schedule C while corporations use Form 1120. Each type of business also has different implications when it comes to your personal liability, which makes it vital that you choose the right one.
Know What Taxes You Will Owe
The type of business you set up also determines what taxes you’ll have to pay. With the exception of partnerships, every business entity has to file an annual income tax return. If your business isn’t set up to pay your income tax due through withholding, you may have to plan for estimated taxes, which are due quarterly. Failure to make your estimated payments can result in a penalty at the end of the year so you need to be clear on whether you’re required to pay.
Business owners who have one or more employees are also responsible for paying employment taxes, which include Social Security and Medicare taxes and federal unemployment tax. When you work for yourself, you’re required to pay self-employment tax, which covers your Social Security and Medicare obligations. As of 2014, the self-employment tax rate is 15.3% and there’s an additional 0.9% Medicare surtax that applies to high-income earners.
Make It Official
Unless you’re planning on setting your business up as a sole proprietorship you’ll have to apply for a federal Employer Identification Number or EIN. This is a nine-digit number that the IRS uses to identify your business for tax purposes. Setting one up doesn’t cost anything and you can either do it online or print out the appropriate form and mail or fax it in. Depending on where you’re starting your business, you may also need to obtain a separate state identification number.
Decide on an Accounting Method
The next step is to decide how you’ll keep track of your income and expenses. The IRS requires business owners to use a consistent accounting system, with the cash and accrual methods being the most common. If you’re using the cash method, you’ll report your income in the year it’s received and deduct your expenses in the year they’re paid. With the accrual method, you report income in the year it’s earned and deduct expenses when they’re incurred. The IRS doesn’t have any set rules regarding which method business owners can choose when they’re starting out but you will have to get approval to change accounting systems once you’re established.
Be Diligent About Recordkeeping
There are a number of credits and deductions business owners can claim at the end of the year but you must have accurate records to back up your claim. Some of the things you’ll need to keep up with include any start-up costs you may have incurred, depreciation associated with vehicles or business equipment, home office expenses, travel costs, supplies, and advertising. The IRS has specific guidelines about what kinds of documents you need to hang on to so you’ll want to make sure you’ve covered your bases in case you’re ever targeted for an audit.
Transforming your business idea into a reality is no easy task and it’s easy to feel overwhelmed, especially when you’re trying to navigate the tax laws. Figuring out what’s expected before you launch can help you avoid some potentially costly mistakes later on.