7 things to do when starting a business to avoid nasty surprises

The only thing that hurts more than paying an income tax is
not having to pay an income tax. 

-Thomas Dewar

When you decide to start a business, taxes may be the
last thing you think about.  However, not
realizing that you owe the self-employment tax as well as income taxes can lead
to a nasty surprise when you file your taxes. 
This post is aimed at avoiding that costly surprise. 

But, before we discuss the self-employment tax, there are
other important steps to take when you become self-employed.  Here are the 7 things to do after you start your own business to avoid nasty
surprises:

Avoid nasty surprises –
set up bookkeeping, form your entity, get licensed, buy insurance, and pay
taxes

Bookkeeping – set up bookkeeping using software like
QuickBooks (either online or on your laptop). 
You don’t want to be scrambling to find receipts at tax time or not be able
to tell somebody if you are making money or not. 

You can save time by downloading from your bank and credit card companies.  If you set up things well, all income and every expense will be properly categorized for your profit and loss statement, or P&L.  The P&L and balance sheet help you monitor your business to see how well you are doing and are essential for preparing your tax returns.  The balance sheet will also come in handy if you need to apply for financing. 

 

For all these steps, you may want to hire an accountant
or speak to an attorney.

Okay, keep going ….

Entity – for many small businesses, being a sole
proprietor is appropriate.  You avoid paying
corporate excise taxes and filing annual reports.  However, if you have partners, you may want
to form a partnership, corporation or LLC (details on choosing are beyond the
scope of this post). 

 If your business involves risks that could lead to law
suits, form a corporation or LLC to shelter your personal assets from
liabilities of the business that insurance may not cover.  Make sure that any actions you take for the
business are in your capacity as an officer or manager – i.e., never sign
personally.

Remember, you may want to consult with an attorney.

Get licenses, file annual
reports and pay local taxes –
certain businesses require a license to operate.  Most entities are required to file annual
reports.  And, your city may impose taxes
on the personal property in your business.  Be sure to find out so you don’t owe penalties
for failing to file and pay.

Buy health and other
insurance –
in
addition to liability insurance, you will want to obtain health insurance if
you are no longer working for another employer. 
You may get favorable treatment for this expense on your income taxes.  You can also purchase insurance to cover
damage to equipment, loss of data, identity theft and so on.  

File payroll taxes – if you hire people to work for you
and pay them over $600 per quarter in any year, you need to report the
compensation.  If they are independent
contractors, you file a form 1099 with the IRS. 
If they are employees, you file a W-2 with the Social Security
Administration.  You also provide these
forms to your people for the income tax filings. 

You may need to withhold and remit FICA and Medicare
taxes.  Also, your employees may request
that you withhold and remit federal and state income taxes (unless you live in
a state that does not impose income taxes). 
Failure to withhold and pay to the IRS and state can lead to serious
penalties.

Pay your income tax – one big shock for many who start a
business is how much they owe in taxes.  When
you received a paycheck, you probably did not focus much on the fact that your
employer withholds federal and state income taxes and FICA and Medicare
taxes.  And, you never had a chance to
spend what was withheld. 

However, when you run your own business, you have full
access to the pre-tax income, so you must diligently allocate funds ahead of
time so that you don’t come up short at text time.  To avoid owing interest on the taxes due, you
make estimated tax payments each quarter to the IRS and state.  

Pay the
self-employment tax –
when you were an employee, your employer withheld FICA and Medicare
taxes from your paychecks.  The employer
also contributed FICA and Medicare taxes on your behalf

When you become self-employed, you are responsible for both
the employee and employer amounts.  This
tax is based on your net self-employment income

A lot to remember,
right?  

Maybe, but knowing and
planning is far better than trying to scrape together money in April to cover
taxes you did not expect. 

Good luck with your
new business!
 

In future posts, we will
examine partnering with others, assessing your profitability, rules on deducting
expenses, and entry into the real estate market. 

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