It’s National Small Business Week, and this year’s theme is “Building a Better America Through Entrepreneurship.” Fittingly, the Internal Revenue Service is observing the occasion by providing free, tax-related resources to entrepreneurs entering the big world of small business.
Whether you currently serve business clients or want to start attracting entrepreneurs to your practice, this information can serve as a refresher before you have those conversations. Here are several highlights from the IRS top tips for new business owners.
Choosing a business structure
One of the first steps any new business owner must take is to choose the official reporting structure that best suits their company. This decision will determine which income tax return forms the new firm will have to file.
Here’s a quick overview of the most common business structures from the IRS:
- Sole proprietorship – When someone owns an unincorporated business by themselves.
- Partnerships – The relationship between two or more people to do trade or business.
- Corporations – In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock.
- S Corporations – Are corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes.
- Limited Liability Company (LLC) – Are allowed by state statute and may be subject to different regulations. The IRS will treat an LLC as either a corporation, partnership, or as part of the owner’s tax return (e.g., sole proprietorship) depending on elections made by the LLC and its number of members.
Business taxes decoded
Business structure also dictates which taxes are owed and how they should be paid. To help new entrepreneurs navigate their tax liability, the IRS lists four basic types of business tax and which entities need to pay them:
- Income tax – All businesses except partnerships must file an annual income tax return. Partnerships file an information return.
- Self-employment tax – Is a Social Security and Medicare tax primarily for individuals who work for themselves. Payments contribute to the individual’s coverage under the Social Security System.
- Employment tax – When small businesses have employees, the business has certain employment tax responsibilities that it must pay and forms it must file.
- Excise tax – Excise taxes are imposed on various goods, services and activities. Such taxes may be imposed on the manufacturer, retailer, or consumer, depending on the specific tax.
In most cases, business owners pay their income-based taxes—including self-employment tax—on a quarterly basis, using estimated taxes to avoid the shock of trying to pay an entire year’s worth of taxes (including possible penalties) at once.
What’s your business year?
New small businesses also choose a tax year: the accounting period they are expected to report income and expenses. While the calendar year—12 consecutive months starting January 1 and ending on December 31—may be the obvious choice, some will opt for a fiscal year—also 12 consecutive months, but ending on the last day of any month other than December.
As with all good rules of thumb, there is an exception: “A 52-53-week tax year is a fiscal tax year that varies from 52 to 53 weeks but does not have to end on the last day of a month.”
What’s an Employer Identification Number?
Most new businesses need an Employer Identification Number (EIN). “An Employer Identification Number (EIN) is also known as a Federal Tax Identification Number and is used to identify a business entity,” the IRS explains. “This is a free service offered by the Internal Revenue Service and business owners can get their EIN immediately.”
Taxpayers who want to get an EIN just need to visit “Apply for an Employer Identification Number (EIN) Online” on IRS.gov. The page explains the simple, three-step application process.
Good record keeping will save headaches
Keeping good records is critical to a business owner’s success. As the IRS notes, adequate recordkeeping is crucial for the following tasks and activities:
- Monitoring business progress
- Preparing financial statements
- Identifying sources of income
- Tracking deductible expenses
- Tracking basis in property
- Preparing tax returns
- Supporting items reported on tax returns with proper documentation
Business owners should also know that tax records need to be maintained for at least three years.
Additional resources
The IRS website has a number of tools and webpages devoted to helping small business owners make good decisions:
Interested in learning about business-tax topics and earning continuing professional education credits? DrakeCPE.com has courses ranging from Fundamentals of Preparing Form 1120 to Fringe Benefits: Tax Implications!
Source: IR-2022-98