5 Tax Tips for Starting a New Business
So you’ve decided to start your own business. Well done! Going solo can be incredibly rewarding and while there are many boxes to check before you can start billing and scaling your enterprise, with foresight and thoughtful planning, your new business can be a success.
However, on the road to growing your business, you first need to ensure you’re starting on the right foot. So in this guide, we’ll look at 5 tax tips for starting a new business that will put you in the right direction.
Treat Your Business Like A Business
When you’re first considering starting your own operation, it often begins as a side hustle. But once you’ve decided to make your business official, you need to treat it as such — not just as a hobby.
Why? Because hobbies, unlike businesses, are not tax-deductible. To show the Internal Revenue Service that you expect to earn a profit (something they expect you to make for at least three of the past five years), it’s worth writing a business plan and documenting things like marketing initiatives, management choices, etc. Make sure you spend dedicated time every day on your new business and earn provable income.
Like brushing your teeth every day, make documenting your business choices a daily habit. This includes, most importantly, earnings, income, and expenses. Why keep a running tally of these figures? Because you’ll use this information to report your income on your IRS annual tax return.
Expenses are of particular importance if you want to be able to take tax deductions. That means you need to keep track of everything from computer purchases to business memberships, car mileage to business trip expenses. With a well-organized record of all of these expenses, you’ll be better able to substantiate these expenses and claim tax deductions for your small business.
Report Your Income As You Receive It
In a perfect world, every small business owner would be paid upon completion of work. But as many small business owners know, that’s just not the case. A web designer, for instance, may complete a new website for a client, bill them, and do not receive payment for a few weeks.
This is a good illustration of why you should report your income as you receive it, rather than as you bill it. Called a cash method, this policy lets you better represent the actual amount you earned while providing flexibility from year to year to save taxes by shifting income and expenses.
Take the In-Home Office Deduction
The IRS allows individuals who regularly use a space in their home for business purposes to claim it as a tax deduction. Even better, that means you can claim a portion of things like your utilities and even mortgage interest for using this space. To qualify, space must be:
- Regularly and exclusively used.
- Principal place of your business.
And the IRS has also made it easier than ever to claim a home office thanks to its standard deduction made available beginning in 2013. You can determine if your space qualifies by reviewing the IRS’s detailed guideline to in-home office deductions.
Choose the Correct Business Entity
Incorporating one's business is a natural first step when setting out on your own. But which business entity should you choose?
Your business entity is essentially the legal structure by which you’ll operate. And there is more than one to choose from.
- Sole Proprietorship
As the name suggests, a sole proprietorship means one person in charge and one person responsible for all a company's profits and debts. If you plan to operate solo without the help of staff, then this might be the right choice for you.
Potential Tax Benefit: As a single entity, you might qualify for certain business tax deductions, for instance, health insurance deductions.
If a business entity is owned by two or more individuals, then it's called a partnership. But within this title, there are two types of partnerships: a general partnership and a limited partnership. In the former, all parties share equally. In the latter, one person maintains control while the other individuals contribute and receive a portion of the profits.
Potential Tax Benefit: Generally, businesses as partnerships are not subject to paying income tax. Instead, each partner files the profits or losses of the business on his or her own personal income tax return.
- Limited Liability Company (LLC)
An LLC is a business structure that ensures an owner has limited personal liability for their company, but while still enjoying the tax benefits of a partnership.
Potential Tax Benefit: With an LLC, an individual can get the same liability protection a corporation enjoys while allowing earnings and losses to pass through to an owner as income on their personal tax returns.
A corporation is a business entity separate from its owners. And within that definition, there are many corporations, each with its own tax benefit possibilities.
A cooperative is a business entity that is owned by the same people it serves. User-owners, as owners are called, vote on the organization's mission and share profits.
Potential Tax Benefits: A cooperative does not tax its members on their income.
Ready to launch your new business but still need some help in determining the kind of entity you want to float? Talk to a tax expert to choose the best business entity for you.