You’ve had enough of being a wage slave. It’s time to start your own business. That means it’s also time to consider the tax implications of becoming your own boss.
Here are four tax matters to think about as you plan your move from the corporate cubicle to your own self-employed suite.
1. Select a business structure.
How you’ll run your business will affect your taxes. You have several choices. The most common forms (and the federal tax forms required) are:
- Sole Proprietorship (Schedule C or C-EZ as an attachment to your personal Form 1040, along with Schedule SE to pay self-employment taxes),
- Partnership (Form 1065 and Form 941 for any applicable employment taxes),
- Corporation (Form 1120 and Form 941 for any applicable employment taxes), and
- S Corporation (Form 2553 to become an S Corp, then Form 1120S, 1120S Schedule K-1 and Form 941 for any applicable employment taxes).
Many business owners also elect to form a Limited Liability Company, or LLC. This is a business structure allowed by state, not federal, law. Check with your state if you are interested in starting a LLC.
Most states do not restrict LLC ownership, and so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit single-member LLCs, which are, as the name indicates, LLCs that have only one owner.
The Internal Revenue Service treats one-member LLCs as sole proprietorships for federal tax purposes. This means that the LLC itself does not pay taxes and does not have to file a return with the IRS. As the sole owner of your LLC, you must report all profits (or losses) of the LLC on Schedule C and submit it with your 1040 tax return
2. Pay your business taxes.
There are four general types of business taxes. They are:
- Income tax is due on the money your business earns. All businesses except partnerships must file an annual income tax return. Partnerships file an information return. See the business structures segment above for the tax form you’ll use.
- Self-employment (SE) tax goes toward Social Security and Medicare. Just like when these payments are withheld from salaried workers’ paychecks, your SE taxes contribute to your coverage under federal retirement benefits, disability benefits, survivor benefits and Medicare’s hospital insurance benefits. Generally, you must pay SE tax and file Schedule SE (along with your Form 1040) when your net self-employment earnings are $400 or more.
- Employment tax payments are required when you have employees. These include collection and filing of your workers’ (and your portion of) Social Security and Medicare taxes, federal income tax withholding and federal unemployment (FUTA). Employment taxes can be complicated, so it’s a good idea to hire a tax professional who specializes in this area. You can get an overview of employment taxes at the IRS’ special employment taxes Web page.
- Excise taxes may be required if you manufacture or sell certain products, operate certain kinds of businesses, receive payment for certain services or use various kinds of equipment, facilities or products. The IRS website has a summary of the various types of excise taxes and forms required to file and pay them.
In most cases, the types of tax a business pays depends on the type of business structure selected.
You also may need to pay estimated taxes (Form 1040ES) on your business’ earnings. These taxes, paid four times a year, cover income and self-employment tax.
3. Obtain an Employer Identification Number (EIN).
Generally, businesses may need to get an EIN for federal tax purposes. Search “EIN” on IRS.gov to find out if the number is necessary. If needed, it’s easy to apply for it online
4. Choose an accounting method.
An accounting method is a set of rules used to determine when to report income and expenses.
The two most common are the cash and accrual methods.
- Under the cash method, you normally report income and deduct expenses in the year that you receive or pay them.
- Under the accrual method, you generally report income and deduct expenses in the year that you earn or incur them. This is true even if you get the income or pay the expense in a later year.
Whichever you choose, the IRS demands that you be consistent in its use. You can read more about accounting methods in IRS Publication 538, Accounting Periods and Methods.
If you find that’s a bit much, a good tax accountant can help you determine which method works better for your business.
You also should check out the IRS’ basics on starting a business, as well as a general overview of business owner, either as a one-person shop or a bigger business with employees at the tax agency’s Small Business and Self-Employed Tax Center.
You also might find these items of interest:
- Deducting a cell phone as a business expense
- The importance of good, and separate, business records
- Make sure you start your business intending to turn a profit