One of the most challenging aspects of starting a new business is understanding the tax issues. You need to make some important initial choices, such as type of entity. You also need to be aware of rules regarding tax reporting and payments due to federal, state and local taxing authorities. Here are some of the most important tax-related issues that you should address.
Choice of entity: Will you do business as a sole proprietor, partnership or corporation? How about a limited liability company (LLC) or an “S” corporation? Depending on your type of business, there may be distinct tax advantages to one form or another. There is one golden rule, though: Never put real estate into a corporation. It’s very difficult to get the real estate out of the corporation without negative tax consequences. If you own the building in which the business will live, have the business rent it from you.
Accounting method: Cash or accrual? Some businesses are not allowed to use the cash method. The cash method is simpler, but doesn’t always reflect the business’ true financial condition.
Accounting period: Most entities are required to use the calendar year, which is why CPAs are so busy January through April! There are a few exceptions, and your business may qualify for one of them.
Self-employment taxes: These pay for Social Security and Medicare benefits, and they’re on top of the income tax. An employee only pays half of these taxes, but the self-employed person pays both halves. This comes as a shock to some new business owners, who find that they owe more tax than they expected.
Estimated payments: With self-employment comes the challenge of making quarterly estimated tax payments. You can always use the prior year “safe harbor,” which means paying 100 percent or 110 percent of your prior year tax. But that amount may be more than necessary. You should estimate your current year’s income so you can determine the appropriate amount of estimated payments.
Tip: Avoid getting behind on your estimated payments by setting aside a percentage of net income each month. You’ll avoid the “double whammy” on April 15, when you owe the balance of the prior year’s tax plus the first quarter estimate for the current year.
State and local taxes/payroll taxes: Determine how the Washington state excise taxes (business &occupation, sales, use) apply to you. If you have employees, be sure you understand the federal and state payroll tax filing and deposit requirements. Don’t forget the county’s personal property tax — it’s often overlooked. If you’re doing any out-of-state business, check to make sure you comply with tax requirements there as well.
Business owners must educate themselves regarding taxes when starting a new business. Ongoing businesses also can benefit from reviewing their choice of entity, accounting methods, and compliance with federal, state and local tax filings. Consulting with your CPA can help you optimize your choices and make sure you’ve covered your responsibilities.
Mary Decker is a CPA, Certified Financial Planner and a principal of Hascal Sjoholm &Co., a full-service CPA firm in Everett. She specializes in tax and estate planning. She can be reached online at www.hascal.com or at 425-252-3173
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