Tuesday, August 12, 2014

Understanding Tax Deductions for Your Business & Tax Considerations When Setting Up Your Business

Tina Orem writes: Understanding Tax Deductions for Your Business.  There are numerous reasons why it’s important to have good bookkeeping practices when conducting business, not the least of which is to make tax preparation easier and more accurate. Businesses pay a variety of taxes, one of which is a tax on their profits, more commonly known as the income tax. 
Your profit is the revenue remaining after deducting expenses. Accordingly, the higher a business’s expenses are, the less tax it pays on its profits. This is a big reason why keeping track of business expenses is so important. 
If the expense appears on your company’s income statement, it’s a general indication that the expense might be tax-deductible. There are lots of rules and exceptions, however, so be sure to get professional advice before you attempt the deduction. One of the best guides to deductible expenses is IRS Publication 535 (“Business Expenses”). In general, however, the IRS says a business expense must be “ordinary and necessary” to be deductible. 
Below are some of the most important tax deductions for your business. 

1. Cost of Goods Sold 

This is the largest expense for many businesses. It might include the cost of your raw materials, the cost of storing those materials, the freight costs for those items and even the direct labor costs associated with making the materials. For more information, see IRS Publication 538.

2. Payroll 

This is another major expense for most businesses. This deduction generally includes wages, but it can also include what you pay for employees’ healthinsurance or retirement plans

3. Rent 

Businesses that operate in brick-and-mortar locations know that rent can be costly. Thankfully, it’s usually tax-deductible. Just be sure to remember that rent is the amount you pay to use property that isn’t yours, which meansequipment rental can be tax-deductible as well. 

4. Professional Fees 

This includes what you pay a third party to do your payroll, your taxes, yourlegal work or any other professional service. Consultants are also included in this category. In general, you deduct the work in the year in which it occurs; however, if the work is for future years, you may have to deduct that work over the useful life of the work. 

5. Interest

If you’re making payments on a bank loan that’s related to starting or running your business, that interest is probably tax-deductible. This can be tricky, though, especially if interest is accruing on the loan but you’re not making payments yet (this may be due to the terms of the loan or something you’ve negotiated with the lender). Be sure to consult an accountant to understand exactly what you can and cannot deduct. 

6. Insurance 

It’s very important to have insurance, and it’s even better when that insurance is tax-deductible. This includes liability insurance, director and officer insurance, commercial property insurance, product liability insurance and others. Be aware, though, that some life insurance and annuities are not deductible; neither is insurance that you buy in order to secure a loan. The IRS offers more insight here

7. Your Home and Your Car

You can indeed deduct some of your mortgage, rent, utilities, homeowners insurance, house repairs and car expenses if you use these things for business. For example, if you’re a freelance writer who works from home and uses the car occasionally to meet sources for interviews, you may be able to deduct a portion of your home and car expenses (the deduction is related to the proportion of your home and car that you use for business). 
Use the actual-expense method to deduct car expenses if you’ve kept track of every business-related auto expense; otherwise, use the standard-mileage-rate method and deduct a flat amount per business-related mile driven. You also have the option of taking a flat home-office deduction (rather than itemizing those expenses), but again, this is only if you use your home for business. Expenses associated with personal use aren’t deductible. For more, see IRS Publication 587 and IRS Publication 463

8. Bad Debts 

Most businesses have the unfortunate experience of selling to customers who end up being unable to pay. Some customers are slow payers or work out repayment terms that are longer than normal, but sometimes the check just never comes, and the business takes the loss. Consult IRS Tax Topic 453 for more information about deducting bad debt. 

9. Travel and Entertainment 

Businesses frequently incur these costs by sending employees to conferences or conventions, or when meeting with and entertaining clients. The catch here is that meals and entertainment expenses are generally only 50% deductible. Consult IRS Publication 463 for more information. 

10. Taxes 

For example, let’s say that you pay $1,000 in personal property tax to your state on assets you use in your business. This may be tax-deductible, as would be employment taxes and many others. The catch is that you generally can only deduct taxes in the year that you pay them. 

11. Advertising 

Billboards, commercials, online ads, print ads, business cards and sponsorships are all usually deductible as long as there’s a clear connection between the purchase and your business. For example, if you sponsor a local school event or festival, the acknowledgments should reference the business rather than an individual. 
As you can see, lots of things are tax-deductible in business. Some people have even used businesses to lower their taxable income, although unless you have substantial wealth, this “strategy” will probably not apply to you. The bottom line is, as a business owner, you must educate yourself on the items and expenses you can and should deduct. Not doing so could have two negative consequences. First, you could be paying higher taxes than necessary, and two, you could be exposing yourself to a tax audit, which is an even bigger problem.
Bridgette Austin writes: Tax Considerations When Setting Up Your Business
After much debate and consideration, you’ve decided to take the leap and start your own business. While you may have a lot of startup costs to consider, there are numerous tax advantages that help offset the expenses of setting up and operating a business.
Like many new entrepreneurs, deciding on the right business structure for your product or service may seem confusing and daunting. Further complicating matters are the federal tax implications and IRS requirements you must consider when forming your company.
Before diving into the legalities of creating and running an organization, hire a qualified accountant or attorney to help steer you through the complex legal requirements of establishing a business. The following is a brief overview on the most common types of business structures, as well as some of the tax considerations unique to each entity.

Sole Proprietorship

sole proprietorship is by far the simplest and most common type of business structure. Sole proprietorships are popular primarily because they’re the easiest and least expensive to establish.
However, as a business owner, sole proprietorships leave you the most legally vulnerable. Any business debts and liabilities will be the owner or sole proprietor’s responsibility. In addition, all company profits must be accounted for on your personal tax return. The same applies to any eligible write-offs andhome office deductions. Although your business and personal assets are more vulnerable with a sole proprietorship, keeping all necessary paperwork to file and back up deduction claims can help you minimize potential risks.
Tax Implications
  • Sole proprietors are taxed at their own personal tax rate, which might be lower or higher than the corporate tax rate.
  • Sole proprietors can protect personal assets and income from a tax audit by deducting only legitimate company expenses.
For additional information on tax implications for sole proprietorships, refer to the Sole Proprietorships page on the IRS website.

Corporation 

Corporations are the second most common business structure after sole proprietorships. In addition to being versatile, corporate structures are also popular because they’re considered separate legal entities from the owner. In other words, if you’re sued for unpaid debts, only your business assets are legally vulnerable (your personal assets remain separate). In rare cases of fraud or co-mingling of personal and business assets, this separation of liability can be legally breached; this is called “piercing the corporate veil.”
Although corporations can raise capital through the sale of stock or equity financing, the financial reporting requirements are more complex than a sole proprietorship. Accounting processes can also be expensive to establish.
Tax Implications
  • Corporations can be subject to a double tax, since dividends are paid to shareholders after taxes (i.e. any profit earned by the corporation is taxed). Shareholder dividend payments are then taxed a second time, since they’re recognized as income distributed to individual shareholders.
  • In addition to taking the same deductions as sole owners and proprietors, corporations are eligible for special deductions since the IRS views corporate structures as separate taxpaying entities. 
Corporations may be liable for taxes such as Social Security and Medicare. For a complete list, see the IRS tax guidelines for corporations.

S Corporation

S corporations, or “S corps,” are similar to regular corporations, but can only have a maximum of 100 shareholders. Furthermore, shareholders can only be individuals, estates and certain trusts. 
An S corporation must be based in the United States and contain only one class of stock. Some business sectors, such as certain insurance firms, financial services companies and domestic international sales corporations, are ineligible to claim subchapter S status. 
These restrictions are not meant to make it more difficult for startups to set up S corporations, but to prevent large, publicly held corporations from taking advantage of this alternative business structure. Likewise, S corporations must operate for a set time period before converting to a C corporation. The same is true for C corporations looking to convert to an S corporation.
Tax Implications
  • S corporations “pass through” taxation of profit, losses, gains and deductions to their shareholders. This means that shareholders are taxed only once, which allow S corporations to avoid the traditional “double taxation” on corporate profit.
  • At the entity level, S corporations are responsible for paying taxes on certain built-in gains and passive income.
Refer to the S Corporations page on the IRS website for further guidance on tax forms and filing requirements.

Partnership

partnership involves two or more individuals who form a legal business entity. The individuals become co-owners of the company. When setting up a partnership, it’s best to consult a qualified attorney to draft a legal agreementdetailing the business arrangement, partner responsibilities and ownership interests.
Tax Implications
  • Since each partner contributes financial capital and business resources to the partnership, each partner also shares responsibility for any profits or losses.
  • Because partnerships are not taxable entities, profits and losses are “passed through” to the company’s owners and reported on each partner’s individual tax return.
  • Partnerships must file an annual information return reporting the company’s income, gains, losses and deductions.
Refer to the IRS website’s Partnerships page for further guidance on the tax forms partners are required to file with the IRS.

Limited Liability Company

Often posed as an alternative to regular corporations, a limited liability company (LLC) operates like a partnership but limits owners’ liability risk for company debts (and shields their personal assets). Any profits and losses are passed to company investors depending on their level of ownership. 
While both provide liability protection, an LLC offers more flexibility than a corporation. There’s no requirement regarding the type or number of owners within an LLC, and it offers simpler taxation that a corporate structure. Certain companies, such as banks and insurance companies, are ineligible to form an LLC. Generally, eligible owners can form one of two types of LLCs:
  • A single-member LLC, which is owned by one individual or corporation and treated as a sole proprietorship for taxation purposes.
  • A multiple-member LLC, which is owned by two or more members. Thus, the LLC is treated as a partnership, unless it elects to be taxed under a different status.
Tax Implications
  • LLCs are allowed by state statute and must be filed with the Secretary of State.
  • By forming an LLC, you’re allowed pass-through taxation. Profits are taxed at the member (i.e. investor) level rather than at the LLC level, thus avoiding double taxation.
  • As an LLC, you have wide flexibility when it comes to tax status elections. For example, LLCs can be classified as a sole proprietorship, partnership, corporation or S-corporation.
  • Owners assume no personal liability for company debts.
Your filing requirements will depend on what entity classification you choose for your LLC. Refer to LLC Filing as a Corporation or Partnership on the IRS website for further information.

Conclusion 

The considerations listed here are by no means an exhaustive list of the legal and tax ramifications of setting up a business. If you’re ready to establish your business entity, work closely with a qualified attorney and tax professional who can advise you on the best practices for building a solid foundation for your company. Finally, refer to tax resources, such as the article “Choosing a Business Structure” on the IRS website, for additional information on tax requirements for business owners.

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