Tips & Tax Strategies for New Business Owners Starting a Business
Starting a business you are passionate about can be very rewarding. It can also be a little overwhelming for new business owners. From creating business plans and devising unique marketing strategies, there are many things business owners must consider if they want to be successful.
How to Choose the Right Business Structure
The type of business structure you choose will determine the type of income tax return you need to file.
Common business structures include:
- Partnership: The business is unincorporated and ownership is shared between two or more parties.
- Corporation: The business is a separate entity that is under the ownership of shareholders. This is sometimes called a C-corporation
- Sole Proprietorship: Under this structure, the business is owned by one person. There is also no distinction between the taxpayer and their business.
- S-Corporation: This business structure passes corporate income, losses, deductions, and credits to shareholders for federal tax purposes.
- Limited Liability Company: This business structure depends on specific state statutes. You should consult with a business lawyer to see if you can structure your business as a limited liability company.
Important to Note: C-Corps and S-Corps Require Additional Income Tax Returns
It is important to note that both partnerships and corporations (C-Corps and S-Corps) require the filing of additional income tax returns to report the business income.
This means that if you have employees, you will be required to file even more tax returns, even if your business is organized as a single member S-Corp and you are the only employee.
Unfortunately, we have encountered many cases where CPAs advised a person to organize their business as an S-Corp, for purposes of tax savings, but any savings they might have achieved ended up being outweighed by penalties they incurred for failing to file the required returns.
Such penalties can include:
- Failure to file 940/941 returns
- Failure to file W-2s/W-3s
Additionally, if you operate in a state that has a state income tax, then you will also have additional filing requirements on the stateside that need to be reported for employment tax purposes.
Assume John Doe is a plumber who works for himself and has no employees. One option he would have is to operate as a sole proprietor. In that case, the income from the business would be reported on a Schedule C to his 1040 return.
Alternatively, he could organize as an S-Corp, and pay himself a W-2 salary, holding out state and federal income tax. The income from the business would be reported on an 1120-S which gets filed once per year.
John Doe would then have to issue a K-1 to himself showing net profit, which would flow through and be reported (and taxed) on his individual 1040 return.
His 1040 return would reflect his W-2 wages, plus his net profit from the K-1. He’d also have to file a 941 return four times per year to report the wages he is paying himself, and a 940 FUTA return once per year. John Doe would also have to file a W-2 and a W-3 once per year.
As a sole proprietor, he’d file a single return: a 1040 return with a Schedule C. As an S-Corp, he’d file the following:
- A 1040 return
- An 1120-S return
- A K-1 to report the distribution of net profit
- Four 941 returns
- A 940 return
- A W-2 and a W-3
Of course, there are deadlines associated with all of the returns listed above, and late filing penalties are significant. In short, make sure you understand and are willing and able to comply with the many additional filing requirements imposed on business structures other than sole proprietorships.
Pick a Tax Year
When you start a business, you must decide on the type of tax year you will use for annual accounting and record keeping.
You can choose one of the following:
- Calendar Year: This tax year consists of 12 consecutive months that start on January 1st and end on December 31st.
- Fiscal Year: This tax year consists of 12 consecutive months ending on the last day of any month, except the month of December.
You will need to apply for an employer identification number (EIN) that is used to identify the business.
Additionally, all of the employees you hire must complete the following forms:
- Form I-9: Employment Eligibility Verification
- Form W-4: Employee’s Withholding Allowance Certificate
Do you have more questions about starting your own business? Then check back here next month to read our blog discussing IRS and tax compliance guidelines for new business owners. You can also call our seasoned legal team at (405) 256-2619 to schedule a case consultation today.