Small Business Income Taxes

No matter the size of your business, properly addressing your company’s numerous tax requirements is key to the lasting success of your organization. Failure to do so can result in substantial penalties, fees, and in some extreme cases, even a forced a dissolution of your company.

Read ahead for expert information on approaching your business’s income tax burden. If you do this, you’ll ensure that you can keep your organization in good standing at all times. That way, you’ll be are able to take home as much of your revenue as possible.

Plan ahead

Before you formally incorporate your new company, it’s important that you take some time to understand the tax situation that your business will likely face. This is important step when determining the potential net profitability of the company, which can make or break a business idea. It’s also important that you have a general idea of the taxes you will need to pay, in order to plan for ways to legally reduce your tax burden as much possible. While avoiding taxes via legal means is encouraged and expected of business owners, evading them through deceptive practices is not, and will typically be harshly punished.

Another step in the pre-incorporation tax planning phase is to determining which formal business structure (C corp, S corp, LLC, etc.) your new company will adopt. Each structure comes with its own set of taxation implications, which carry unique benefits and limitations. Properly identifying which structure will best serve your specific business’s operations and needs can have a very positive impact on your after-tax earnings.

Deductions

One of the most common ways to reduce your overall tax burden is to understand what you can lawfully deduct as a business expense. In order to “write something off” you will need to prove the expense served a clear purpose for your business. The transaction must have the clear motive of helping your business turn a profit. In order to identify a legitimate expense correctly (and run your business effectively in general), it helps to have a clear, and defined purpose for your business.  

Accounting practices

Due to the sheer number of laws and regulations, small business accounting can get a bit complicated. There are a couple of important accounting choices you must make, which will have a noticeable effect on your bottom line. You must select the start of your tax year, and also which accounting method your business will utilize.

Selecting the start of your tax year (or the start of your accounting period) can be very important for businesses that have highly seasonal revenues. If you anticipate having a “busy” season, it may be best to find a date that will allow you to split that busy season in two, in order to spread the high revenue between two different taxable periods. While this can create some logistical difficulties if you manage their own accounting, splitting your period of high earning can help significantly reduce your effective tax burden.

The accounting method that your business adopts will also have an effect on your effective tax burden. Most small businesses will use either the cash method or the accrual method (or a combination of the two). Depending on the nature of your business, and what your average transaction looks like, one of the systems will make more sense for you than the other. This decision can also lead to significant tax savings.

Determining net income

Quite logically, the most important factor in determining your income tax burden is your business’s reported net income. Due to the various revenue and expense calculations that go into accounting, there can be a significant variance in how a skilled accountant or business owner determines a company’s net income, and the figure an inexperienced individual might come up with. As a result, employing a licensed accountant can actually help you save money.

If you elect to do your own accounting, there are four basic rules you should follow:

1. Tie your gross income to your sales total.
   Your business’s revenues will likely be the same as, or only slightly different from, your overall sales numbers.
2. Properly account for miscellaneous revenues.
   While your sales number will likely comprise the majority of your income, it is important that you properly address any miscellaneous revenues as well. Failing to do so raises red flags with IRS, and may open your business up to an audit.
3. Keep a close eye on your variable costs.
   The biggest mistake that small business owners make when calculating their net income is failing to address all of their variable expenses, especially their cost of goods sold. Be sure to pay close attention to this figure, in order to ensure that you aren’t missing any legitimate expenses that can help lead to tax savings.
4. Learn how deductions work.
   Even if you employ an accountant, it is well worth the effort for any business owner to learn the legalities and logistical realities of how deductions can help a business’s bottom line. By taking the time to learn what can and what cannot be legally claimed as a business expense, you will be able to easily identify what purchases can help you reduce your business’s reportable income.

Depreciation

Most businesses require a substantial amount of equipment, property, and other significant assets in order to maintain their operations. These large purchases aren’t typically accounted for and simply written off like smaller expenses, due to the fact that they are often financed, depreciate in value over time, and add book value to your company. As a result, there are some specific laws and regulations that surround these purchases, and how they may affect your reported net income.

The most important aspect of accounting for capital assets is determining and reporting the value of depreciation. Accounting for the annual loss of value that these assets accrue over time can lead to significant tax savings in either the short-term or long-term, depending on how your company’s strategy. There are a number of legal restrictions on accounting for depreciation, which can make the process even more complicated.

The two most common approaches to calculating depreciation are the straight line method and the declining balance method. Straight-line depreciation typically results in an asset retaining a higher book value for longer, which will cause your taxes to stay higher in the short-term. This is opposed to the declining balance method (typically used by young business looking to save cash in the short term), as this method devalues an asset more quickly, thus allowing for faster accrual of depreciation.

Operating losses and self-employment taxes

Once you’ve addressed the issues discussed above and calculated your actual net income, a majority of your tax-related responsibilities will be complete. (You still must actually file the paperwork and submit payment, of course!) However, there are a few other potential aspects that may need to be addressed.  

As a business owner, there is a very good chance that you will owe self-employment taxes. These taxes are imposed on anyone who owns their own business, and are used to fund several social service programs. If you’ve ever received a paycheck from an employer, deductions supporting these funds were withheld from your wages. As an entrepreneur (and business owner), you will need to explicitly pay these yourself. Depending on your business structure, there are specific rules you will need to follow in order to pay these taxes. Be sure to understand what the IRS will require of you in order to fulfill payment of this tax.

In the event that your business posts an operating loss for an accounting period, you will still need to file all of the annually required tax forms for your business. However, this is in your best interest, as doing so can actually lead to savings on your personal tax return.  

Tax credits

While they aren’t available to all companies, there are numerous tax credit programs that can allow for significant savings by businesses in certain industries, or that meet certain special criteria. These credits can be extremely valuable if your company qualifies for them, because they are deducted dollar for dollar directly from your overall tax burden. As a result, it is in good practice to either speak with a professional regarding the potential of claiming any tax credits, or at least do some basic research tax credit research on your own.

As you can see, there are many factors that must be considered when you’re addressing the filing and reporting of your business’s income taxes. As with any tax or financial related issue, it is always in your best interest to pay close attention to any IRS imposed requirements and due dates. Also, whenever in doubt, it is highly advised that you speak with a licensed accounting professional, as this will protect you from costly mistakes that may prevent you from keeping your business complaint, and in good standing with government agencies.