One of the least understood and most unglamorous parts of running a business is taxes. Not only is it one of the least fun things to deal with – unless you’re really passionate about accounting and numbers – but it’s also scary and intimidating because tax laws change all the time. It’s hard to know for sure what you can and can’t deduct, and if you haven’t been on top of your bookkeeping, it can be even more stressful as you need to dig through your mountain of digital and paper receipts (hopefully you can still find them!).
In light of the recent events surrounding COVID-19 and its impact around the globe, I have taken this time to really dig in and evaluate the numbers in my business.
Just in case you are not aware of this news yet — the due date for filing tax returns has been extended to July 15, 2020 instead of April 15, 2020. Planning is crucial when it comes to dealing with accounting especially during these difficult and uncertain times. While tax season is something we can’t avoid, there are ways to make the process more feasible.
Here are a few tips that can help with all the tax season stress.
Step 1: Set up a formal business structure
It can be easy to start an online business these days. However, one of the biggest mistakes I’ve seen is when people eagerly start with the fun things, like building a website and designing business cards, but don’t pay nearly enough attention to understanding how taxes work and what IRS requirements are so they can actually make money with the business.
It doesn’t do any good to put in all the work to set up all the pretty things, bring in money, only to owe a bunch at tax time because of the way the business is set up with the government. I can’t emphasize enough how important it is to protect ourselves not only as business owners, but as individuals as well.
Trust me, it’s worth the time and energy to figure this all out from the beginning so you’re not surprised or emotionally damaged when you receive a letter from the government come April. Let’s go through a few common ways to form a business.
Most people start their business as a sole proprietor, which makes sense because it’s probably one of the easiest ways to get the ball rolling without fully committing to registering an LLC or forming a corporation. But just because it’s easy doesn’t mean it’s the most beneficial for your business.
Here’s why: when your business is a sole proprietorship, that’s how the law will treat you personally as well. Even if you have separate accounts, legally there is no difference. So if something goes wrong with your business, your personal life can potentially be affected as well.
Now, operating a sole proprietorship is not wrong, but it’s risky because you won’t receive any liability protection.
So how is being a sole proprietor different from being a Limited Liability Company (LLC)?
Limited Liability Company (LLC)
Business structures such an LLC are popular for many reasons, mainly because they create a fence between your personal assets and your business assets, so if you’re sued for anything involving your business, a court can’t allocate your personal assets to pay damages.
However, even if you have an LLC, you’re still considered self-employed and must pay self-employment taxes.
Another option to set up a formal business structure would be forming a corporation. A corporation is structured to avoid double taxation. Corporations allow profits, and some losses, to pass directly through to the owner’s personal income without being subject to corporate tax rates. However, there are some limits to corporations: You can’t have more than 100 shareholders, and all shareholders must be U.S. citizens. Plus, corporations still have to follow strict filing and operational processes.
Step 2: Establish a separate checking and savings account and credit cards
Now that you have your business structure set up, the next step is to separate your business and personal spending into separate accounts. If you’re not doing this already, do this TODAY! This will save SO MANY HOURS in the long run and will also help you streamline your bookkeeping and organize your expenses, profits, and savings (#allthethings), which will help when it comes time to categorize your expenses (see step 4).
Step 3: Implement a tax plan strategy
As a small business owner you’ll need to keep up with estimated tax payments throughout the year so you don’t get hit with a big tax bill once tax season rolls around. By paying taxes throughout the year, it’s less of a financial burden and you stay in compliance with IRS regulations.
This is where I’d recommend hiring a professional accountant who can guide you on the payments you should be making. No matter where you are at in your business, hiring a professional is crucial for setting up a tax strategy for future years and filing your taxes the right way. When I say professional, I mean a legit CPA you can meet in person or at least have direct contact with via other forms of communication such as email or phone. It’s best to have someone who knows you AND your business AND the tax laws.
Since my expenses and incomes are not overly complex, I personally do my own bookkeeping and have an accountant file my taxes each year. As part of her service, she also produces my contractors 1099s in January and answers any major tax questions I have via email.
SO WHAT TAXES DO I NEED TO PAY AND WHEN?
- Quarterly Income Taxes: Freelancers, independent contractors and small business owners who expect to owe at least $1,000 in taxes need to estimate and pay quarterly taxes. If you don’t pay them, or don’t pay enough, you can be hit with penalties and interest, and open yourself up to all kinds of unpleasantness. As part of my workflow, I set reminders on my calendar to pay quarterly estimates.
- Self-Employment Taxes: People who are self-employed have to pay self-employment taxes, which are Social Security and Medicare taxes. You will pay self-employment taxes if your net earnings are $400 or more and are paid when you file your taxes each year.
- Payroll Taxes: If you have employees, you have to pay employment/payroll taxes, in addition to your income taxes. Payroll taxes are taxes paid on wages or salaries your employees earn. Payroll taxes are paid monthly on the 15th for the previous month’s payroll.
BONUS TIP – Any time I use a new contractor, I have them send a completed W-9 along with their contract. This is something we’ve added to our workflows so that we aren’t scrambling to collect W-9s come tax time.
Step 4: Maximize your small business deductions
Did you know that there are over 300 different tax deductions you could be eligible for as a business owner?
As Benjamin Franklin said, “If you fail to plan, you are planning to fail!”
Don’t be like that with your taxes! You’ve worked so hard on your business to get the income to support your family and dream, so plan for success to maximize your deductions so that tax time doesn’t hurt as much.
I remember when I needed a new car because my lease was up. After a little research, I found a tax deduction (Section 179) which allowed us to purchase a new car (that met certain weight criteria) for the business as a piece of “equipment” that would take depreciation over time.
We would do this each year for five years rather than use the standard mileage rate most business owners take. Depreciation and mileage for me was very comparable so there was no harm in trying this new approach since we were getting a new car.
The amazing plus side of this deduction from depreciation in the first year?
A $15,000 tax return!
Step 5: Implement a bookkeeping system for your small business
Last, but certainly not least, whether you are doing your books yourself by using a system such as Quickbooks, or have hired a bookkeeper, it is essential to implement a monthly money routine to stay on top of your expenses throughout the year.
Even if you hire a bookkeeper, you will need a system to track and send receipts to them. This is where our Monthly Money Day comes in. This is one day a month where you set aside to manage business finances. I’ve found staying on top of my expenses each month allows me to make better financial business decisions since I know where my books are at any given time. Your Monthly Money Day doesn’t have to be complicated. Here’s an inside look at my bookkeeping system:
- Review financial statements on a monthly basis – money coming in, money going out and upcoming bills.
- Understand the categories of your Schedule-C for expenses – make sure you’re properly categorizing each expense. Certain categories are weighted more than others, so it is important to categorize correctly to show correct numbers when it comes time to file your taxes. To stay on top of this, I categorize my expenses monthly.
- Create a Profit and Loss Statement – Since we are categorizing our expenses on a monthly basis, we create a Profit and Loss Statement each quarter to review at our team meetings and determine if any changes need to be made.
I hope you found these tips helpful and are ready to get some systems in place to make tax time easier! While they may take some time to set up on the front-end, they will save you TONS of time on the back-end when it is time to file those taxes. Here’s to making life a little easier! Cheers, friend!
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