For many small business owners, it is important to know what type of taxes you are responsible for early in the process of creating your business. At the same time, many small business owners rely on their accountants or tax professionals to handle their taxes, in terms of reporting and determining how much is owed. Still, it is important to understand the tax options that may result in tax advantages and traps that you may be able to avoid.
Planning for Your Taxes
Tax planning is more than just determining how much tax liability is owed to the IRS. In fact, tax planning is about evaluating your options to determine how to conduct your business so that you can minimize your tax liability. Taxable transactions can often be completed in a variety of methods, so it is important to choose the one that brings the least amount of tax liability. However, you do not want to use deceit or concealment to attempt to avoid tax liability, as this is considered illegal.
Forming a business can also bring specific tax liabilities based on the type of business that you choose to set up. For example, you can form a sole proprietorship, a partnership, a limited liability company or a corporation. Each of these has their own income tax consequences and so it is important to determine which one will work best with your particular business type.
Defining your business means working at a trade or business with a profit motive and economic activity conducted. Therefore, you want to make sure that your business is actually aiming to make a real economic profit, not just tax savings. Additionally, you will need to choose the tax year that your business will follow. Essentially, this determines the time period for which your taxable income will be computed. All the income received or accrued within a single year is reported on that year’s return, along with any expenses that may have been paid or accrued during that specific time period. The cut-off point will be the end of tax advantages for that particular tax year.
Accounting Method – Making a Choice
No matter what type of business you choose to go with, you will have to let the IRS know the type of accounting method that you will be using. There are two types of accounting methods. The first one is cash, where you only record income when it is received and expenses when they are paid. Accrual, on the other hand, is a method that records expenses and income in the month they were billed or invoiced, versus when they were actually paid or the income was actually received.
Therefore, your business will need to determine if you are going to use one of those methods or if you are going to use a hybrid method. Depending on your specific business, the IRS may allow you to use different accounting methods, but these are limited to specific business types.
Different Types of Business Income and Deductions
Business income involves taking your gross business receipts or sales and then subtracting your cost of goods sold to arrive at your gross profit. Then you would deduct from that amount any additional expenses that you incurred in the course of running your business. The income generated from the business should be reported on its own tax return, depending on how your business is set up.
Digging up all legitimate deductions for your business is usually the best way to reduce your taxable income and overall tax bill. Capital expenditures, start-up, travel and vehicle expenses, just to name a few, are all considered potential deductions. Additionally, many of these fall under the heading of common business deductions.
Additionally, you may find that your particular business qualifies for some specific deductions based on your industry. These would include those in the entertainment industry, day care providers and others. Working with a tax professional, you can determine if your business has any unique deductions that you may qualify or be eligible for.
Finally, as you work with your accountant, you will learn about the capital assets of your business and how their depreciation can impact your tax liability. The assets typically are major investments into your business and the depreciation is typically taken over the life of the asset, or the number of years that it is in use for your business. The IRS has specific rules regarding this type of depreciation, which need to be followed. However, working with your accountant, you can learn the type of tax liability your business can incur and how to legally reduce it.
M-E Accounting & Tax Services, Inc.