Starting a business, or becoming an independent contractor, will open opportunities – and potential traps that you won’t know about until they appear. Here are some ideas to help smooth the business, reporting, and IRS side of your business.
- Maintain a Separate Bank Account for business income and expenses versus personal income and expenditures: The IRS hates it when a business owner “co-mingles” business funds with their personal checking account. It is reasonable to make the audit trail as easy as possible for them, in case you are inspected. It is not unusual for the IRS to throw out all business expenses paid from a personal account (as they will deem them “personal”) and include any and all income deposited in your personal account as business income.
- Obtain an Employment Identification Number to transact business under (instead of your social security number): Keeping your personal life from your business life is mandatory to maintaining quality records, and using an EIN to conduct business is a great assist. You would want 1099s cut in the new Employment ID Number, not your social security number
- Setup a Limited Liability Company (LLC) to protect your personal assets from attorneys: You can lose everything you own if sued for an error, or something that happens because of your business, if you do not protect your assets using an LLC. The LLC sets up your business as a separate entity. If there is a lawsuit or claim, the assets of the business might be at risk, and you might lose them (e.g., cash in bank, assets owned by the business, etc.), but you would be protecting your personal assets from loss.
- Determine how you are going to “keep the books” (how you will record income and expenditures from the business): It is vital to keep exact records of income received and funds expended for the purchase of assets (computers, etc.) and for everyday business expenses. Many businesses, especially starting out, use an excel spreadsheet to record checks, debits and credit card transactions. Quicken Home and Business is a nice, relatively easy program that creates the information the tax preparer needs to do your tax return. Remember, any sort of remuneration (e.g. cash) is included in your income.
- Always ask yourself when buying something, “Is it deductible (and why)?” When purchasing something, make sure you buy it correctly. You do not want to buy a business-related item (which would be a tax deduction) with your personal funds.
- Make sure you are tracking mileage (easy using an app): The first thing an IRS auditor usually looks at is business mileage. Because it is quite generous, the deduction for auto use is often abused as a deduction by business owners. The IRS REQUIRES the recording of business mileage, the date, and the purpose of the trip. Absent this kind of log, they will eliminate your mileage deduction, costing you potentially thousands of dollars in back taxes as well as penalties and interest.
- Keep receipts either in a manila envelope (e.g., VISA – 2019; paid by check – 2019) or scan them into a program like Neat: Note, it is vital to keep record via the receipt of business meals. A business meal receipt must include the date, the amount and purpose. If you do not have a receipt for something purchased for the business, the IRS would throw it out at audit.
- Set up an Office-in-Home if you are using a room specifically to run your business: Many business owners work out of their home as their primary place they conduct business. It is ridiculously expensive to rent a separate office space, especially when one is starting out. And, an office-in-home deduction will allow you to deduct a portion of your living expenses that you pay for anyway, such as a percentage of utilities. Publication 587 lays out the rules for taking an office-in-home deduction.
- Do NOT send your tax preparer receipts or bank statements. We only want a summary of expenses and income by category (e.g., “office supplies,” “travel”): Your tax preparer is not auditing you. It is up to you to substantiate expenditures in your business by keeping receipts (as discussed above). However, do NOT send your tax preparer these receipts or bank statements as it is a huge time waster and will run up your tax preparation fee. Your tax preparer wants summary numbers, not the detail behind them.
- Consider setting up an S Corp when the business turns profitable ($50,000 and up) to save on payroll taxes: Taxes can become very pricey for a self-employed individual as well as a new business. The net profit from a business will be taxed on your Form 1040 for individual income taxes AND payroll taxes. For example, you are in the 25% tax bracket and your business earns $60,000 in profit for the year. You would owe about $15,000 in income taxes AND $9,000 in payroll taxes on that amount. The tax code allows the creation of something called an “S Corporation” as a way to shield some of your profits from payroll taxes. This is done by hiring the owner as an employee and paying them a reasonable amount for services rendered. For example, with an S Corp, using the business above, one could conceivably pay the owner $35,000 salary (if reasonable), and the remaining $25,000 in profit would be untaxed for payroll taxes saving the business owner approximately $3,800 in taxes.
- Determine if you have to pay sales tax or not: Take a look at https://floridarevenue.com/taxes/taxesfees/Pages/sales_tax.aspx for an explanation of what might be subject to sales tax in your business.
- Start saving for retirement by setting up a 401K or SEP-IRA when you can afford the cash flow out of the business (as it will not be accessible if you need it to pay bills): You can have the business start providing for your retirement and have these payments act as a business deduction. Discuss this with your financial adviser.
- Set a sales goal for the year for revenues as a simple way to plot out the future of your business and keep it on track: Many businesses reach the end of the year and wonder what happened. Setting a sales goal for the year and placing this number in a place you will see very visibly daily, can create the subconscious ideas and accompanying actions, to help you reach your goal. This is similar to someone wanting to lose weight: without a specific goal in mind, kept front of mind, it is only going to happen by accident. You do not want the results of your business to be by accident!
If you have any questions regarding being self-employed or starting a business, just email us at [email protected] and we will be happy to answer them.