The pursuit of the American Dream often spurs individuals to break from convention and take a chance on starting their own businesses. Factors such as losing a job or finding yourself living in a region experiencing growth, such as the Marcellus Shale region, can contribute to making the move to opening a new business. Entrepreneurship offers many advantages to those who want the freedom to chart their own course, but starting a business also means learning about the many tax issues before you take the plunge and head out on your own.
Moving forward with an exciting new business opportunity needs to be carefully balanced with tax considerations, say tax experts at Pennsylvania Institute of CPAs. In fact, estimates indicate that, as a sole proprietor or a single-member limited liability company, you may need to generate up to 20 percent more in revenue over your current salary to ensure you can cover the appropriate taxes.
For those with the entrepreneurial spirit, consider the following tax implications as you step closer to making your dreams a reality.
Three importanttax liabilities
Employment taxes. Self-employed individuals are responsible for paying both the employee and the employer portions of Social Security tax and the Medicare tax on their business profits.
The good news is that you can deduct half of your self-employment tax when calculating your adjusted gross income on your 1040 tax form.
If you have employees, you will be responsible for paying 6.2 percent of their covered wages in 2011 for their share of Social Security taxes, plus a Medicare tax of 1.45 percent on every dollar of every employee’s salary or wages. The employee has 1.45 percent Medicare tax withheld from their pay, and for 2011, the Medicare tax will be 4.2 percent.
Withholding tax. If you are a self-employed contractor, you will receive a 1099 form from the companies for which you worked and earned more than $600 in the calendar year.
If you have employees or use contract labor, your tax liability and reporting will be different. During the year, you’ll file payroll reports, generally quarterly. At year-end, you’ll report payroll information for employees using Forms W-2 and W-3. You’ll use Form 1099-MISC to report payments to anyone who is a contractor that you paid more than $600 in the calendar year. You don’t pay or withhold employment tax for independent contractors as you would your employees.
Quarterly business taxes. As a small business owner, you’ll need to make estimated tax payments during the year to cover your federal income tax liability, unless you expect to owe less than $1,000. Generally, estimated taxes are due in quarterly installments. You may also have to pay local taxes based on your earnings, even if you’re an independent contractor.
Maximize tax deductions
The good news is that your taxes are calculated after you deduct your expenses, and your “employer” half is deductible from your federal taxes. But if your expenses aren’t especially high, your total tax costs will go up.
To ensure you get all the tax deductions you’re entitled to, you need to maintain good records of your company’s expenses. Be sure to keep any personal expenses separate. Consider opening a bank account and a credit card solely for business purposes. If you incur an expense that combines personal and business use, divide up the total cost, and take the deduction for the business uses only.
Deductions include business mileage in your car, office supplies, entertainment expenses, and, if you work from a dedicated office space at home, you may qualify for a home-office deduction.
Expert advice from a CPA
Starting your own business is exciting, and it offers many opportunities. Be sure to educate yourself about the various tax issues you’ll face to ensure you’re in compliance, that you fully understand the implications of your decisions, and that you maximize the benefit to your new business.
If you have questions about tax planning strategies for your fledgling business, a CPA can help. To find free entrepreneurial resources or locate a CPA near you, visit www.IneedaCPA.org.
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