Thinking about starting a small business to help you earn income and use your skills? New business owners have tax-related things to do before launching any company. Here are the 6 things to know about taxes and starting a small business.
1) Choose a business structure
When starting a small business, an owner must decide what type of entity it will be. The entity type determines which tax forms a business needs to file. Owners can learn more about business structures here. The most common forms of businesses are:
- Sole Proprietorships
- S Corporations
- Limited Liability Company
2) Register your business
Your location and business structure determine how you’ll need to register your business. Determine those factors first, and registration becomes very straightforward.
For most small businesses, registering your business is as simple as registering your business name with state and local governments.
In some cases, you don’t need to register at all. If you conduct business as yourself using your legal name, you won’t need to register anywhere. But remember, if you don’t register your business, you could miss out on both personal liability protection and legal and tax benefits.
Registering with a local agency
Often you don’t need to register with county or city governments to actually form your business.
If your business is an LLC, corporation, partnership, or nonprofit corporation, you might need to file for licenses and permits from the county or city.
Some counties and cities also require you to register your DBA, a tradename or a fictitious name, if you use one.
Remember local governments determine registration, licensing, and permitting requirements, so visit local government websites to find out what you need to do when starting your small business.
3) Get Federal and State Tax Numbers
Tax ID numbers are used for filing and paying certain state and Federal taxes. It will also be used for opening a business bank account, hiring employees, and applying for business licenses and permits. That’s why this is an integral step in starting your small business.
Federal Tax Registration
Your employer identification number (EIN) works similar to a social security number, but for your business. It lets your small business pay state and federal taxes and acts as your federal tax ID.
It’s free to apply for an EIN, and you should do it right after you register your business.
Your business needs a federal tax ID number if it does any of the following:
- Pays employees
- Operates as a corporation or partnership
- Files tax returns for employment or excise
- Works with certain types of organizations
- Sells goods or services
State Tax Registration
The need for a state tax ID number ties directly to whether your business must pay state taxes. Tax obligations differ at the state and local levels, so you’ll need to check with your state’s websites.
To know whether you need a state tax ID, research and understand your state’s laws regarding income taxes and employment taxes, the two most common forms of state taxes for small businesses.
The process to get a state tax ID number is similar to getting a federal tax ID number, but it will vary by state. Be in touch with a trusted accounting professional or do some research online for help with this task.
Keep in mind you might need a state sales tax number, if you’re selling goods, in addition to an unemployment tax number. It all depends on your business entity and classification.
4) Determine business tax responsibilities
The type of business someone operates determines what taxes they need to pay and how to pay them. These are the general types of business taxes.
- Income tax – All businesses must file an annual income tax return. They must pay income tax as they earn or receive income during the year. Keep in mind partnerships must file a return to report income, but do not usually owe any income tax.
- Estimated taxes – If the amount of income tax withheld from a taxpayer’s salary or pension is not enough, you may owe quarterly estimated taxes. You also may owe if you receive income such as interest, dividends, alimony, self-employment income, capital gains and prizes and awards (including gambling).
- Self-employment tax – This is a Social Security and Medicare tax. It applies primarily to individuals who work for themselves as a sole proprietor or LLC treated as a sole proprietor.
- Employment taxes – These are taxes an employer pays or sends to the IRS on behalf of its employees. These include unemployment tax, income tax withholding, Social Security, and Medicare taxes.
- Sales Tax – These are taxes on goods sold. You will owe these to any municipality you physically sell goods including out of state or city locations.
5) Choose a tax year accounting period
You must figure your taxable income on the basis of a tax year. A “tax year” is an annual accounting period for keeping records and reporting income and expenses. The tax years you can use are:
- Calendar year: Jan. 1 to Dec. 31.
- Fiscal year: 12 consecutive months ending on the last day of any month except December.
Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. You have not adopted a tax year if you merely did any of the following.
Filed an application for an extension of time to file an income tax return.
Filed an application for an employer identification number.
Paid estimated taxes for that tax year.
Most businesses use the calendar year as a tax year. Exceptions include seasonal businesses.
Generally, anyone can adopt the calendar year. However, if any of the following apply, you must adopt the calendar year.
You keep no books or records
You have no annual accounting period
6) Set up recordkeeping processes and bank accounts
Being organized helps businesses owners be prepared for other tasks. Good recordkeeping helps a business monitor its progress. It also helps to prepare financial statements, reports, and tax returns.
I strongly recommend using software such as Quickbooks, Xero or Freshbooks to keep your books straight from the start. I have known some small business to keep successful records using spreadsheets. However, spreadsheets make it harder to run reports and see the financial health of your business.
Why open a business account?
I highly recommend opening a business bank account to keep your records for the business separate from personal accounts. A business bank account helps you stay legally compliant and protected especially if your business is an LLC or S-corp. It also provides benefits to customers and any employees.
Common business accounts include a checking account, savings account, credit card account, and a merchant services account. Merchant services accounts allow you to accept credit and debit card transactions from your customers.
These are the perks that many business bank accounts offer that don’t usually come with a standard personal bank account.
- Protection. Business banking offers limited personal liability protection by keeping your business funds separate from your personal funds. Merchant services also offer purchase protection for your customers and ensure that their personal information is secure.
- Professionalism. Customers will be able to pay you with credit cards and make checks out to your business instead of directly to you. Plus, you’ll be able to authorize employees to handle day-to-day banking tasks on behalf of the business.
- Preparedness. Business banking usually comes with the option for a line of credit for the company. This can be used in the event of an emergency, or if your business needs a larger purchase.
- Purchasing power. Credit card accounts can help your business make large startup purchases and help establish a credit history for your business.
Remember that your business might have a unique situation. If so, I suggest you find a tax professional for help with your specific business.
Anything else I can help answer. Leave a comment below or be in touch.