Useful Tips On Planning And Preparing Your Business Taxes

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This a guest post from Sunil. You can read more about him and his work on his blog.

Photo By Images_of_Money

As a CPA in one of my previous lives, in this article I want to discuss a few income tax specific matters as it may pertain to you and your business operation.

Whether you own an offline brick and mortar business, or run an online ecommerce store like Steve’s wife, or are contemplating starting either, it is around this time of the year that you have to start compiling receipts from the previous year’s activity to prepare your income tax returns.

First off, tax planning and effective compliance is a year long process. Many treat income taxes as a chore that must be done from the time tax related statements start hitting your mail (i.e. W2 forms) through the deadline.

This approach, while it works for many, particularly those with simple lives and just a W2 to report, is not necessarily the most effective or efficient for someone with a more complex tax situation.

Year Long Record Keeping Discipline

To ensure a smooth tax compliance process, clean record keeping is essential. So my first tip right off the bat is to get your business its own credit card.

You don’t have to get a “business card” per se. A credit card can be in your name, but ensure you only use it for business. I understand not everyone can do this, but to the extent you can I strongly recommend you do (not to mention the credit card rewards).

This does a couple things. First, credit card providers have sophisticated websites that allow you to download your card usage activity and slice it and dice it any which way you want. In less than 3 minutes, you can download an entire year’s activity and slice it into a pie showing how much you spent on what category. Pretty nifty stuff.

Second, you ensure close to 100% capture of business activity. Gone are the days when cash was needed in wallets. When was the last time you paid for something in cash that cost over $50? Even if you do, chances are there won’t be many instances.

Even if you were to aggregate the instances, at whatever your tax rate is, you won’t be missing out much in terms of deductions if you lost the receipts and weren’t able to take the deduction. Remember, $100 in deductions doesn’t mean $100 in saved taxes. Your savings depend on your tax rate. Bottom line – keep a credit card just for business usage.

Advantages of Business Formation / Incorporation

I can write a book on this sub section alone. But in the interest of quickly conveying my message, I want to keep things simple by focusing on a Limited Liability Company (LLC), which is the most preferred method of business incorporation by working individuals who own side businesses online.

Because most of Steve’s readership fits this profile, discussing the advantages of an LLC would be most appropriate in my opinion. But that said, the underlying concepts work for other types of legal entities as well. The point is to take advantage of what you are allowed as a business to effective conduct tax planning throughout the year and save on taxes as much as possible come compliance time.

As LLC is mostly a pass through entity from a tax perspective, which means that profits and losses from your business (Schedule C) are to be netted with your wage income from employment. Now if you are conducting business, there are obviously going to be a certain number and type of expenses that come with the territory.

Fortunately, many of these expenses are expenses you would’ve incurred anyway if you didn’t own a business. For example, chances are you always had a phone, a house, a car and internet.

There are many other expense types that one typically incurs anyway, but because of a business, one can deduct a certain portion of those expenses that previously were not deductible to them as just individuals filing a 1040 income tax return.

I am not saying these expenses are the main reason one should get into business. But given the fact that you are allowed deductions for many expenses that you used to, are and would incur anyway, why not?

When your business becomes your only source of income, you can start deducting 100% of these expenses (with the exception of housing and housing related as the IRS would argue your house is not a full time office).

An LLC is also a limited liability entity, which separates you legally as a business from you as an individual. In the unfortunate and unforeseen event that you are sued, authorities cannot comingle your assets so as you don’t either.

You must be able to show separation, thus the initial tip about keeping business activities such as expenses completely separate. Whatever you do, do not ever conduct business as a sole proprietor. This leaves you exposed from every angle and you don’t want that!

Editor’s Note: If you want to learn more about how to decide on a corporate structure, please check out my small business startup guide.

Tax Planning is Your Right

Saving on taxes is your right. Don’t believe me? Ask the IRS who states you should pay as little tax as you legally owe. Many business owners take this to hear and aggressively deduct anything they can so as long as they can reasonably justify it.

Personally, if I can legitimately justify the expense as business, I claim it. I understand that the IRS may challenge, and I / you may lose, but we can try. That said, don’t go gangbusters and start deducting everything like your Colgate toothpaste either. Be reasonable, be prudent.

Editor’s Note: If you want to learn more about what you can and can not deduct for your business, please visit my guide to the most common business tax deductions

Many don’t understand what an effective tax rate is. Do you truly understand how much you are paying in taxes? You may think so, but do you realize what the overall rate is? Many don’t.

Business tax deductions can significantly lower your effective tax rate and thus the overall gross dollars that you pay in tax to Sam.

There are some significant advantages of owning your own business. In my opinion, it is the single best tax planning tool and how you can truly get ahead financially relative to your peer group.

I have stuck to the same answer now for years, especially when friends and family ask me how they can save on their taxes at dinner conversations and casual gatherings.

Readers: Are you taking advantage of all the tax deductions you are allowed? If you don’t have a side business yet, do I make a strong enough argument to contemplate starting one? Of course I recommend you do what you enjoy.

Note: If you are interested in creating your own corporation or LLC, head over to CorpNet.php and get a free consult. Use coupon code: MWQHJ for 10% off!

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17 thoughts on “Useful Tips On Planning And Preparing Your Business Taxes”

  1. Jerry Davison says:

    Why start an LLC over an SCorp for a small business? With a SCorp, you can pay yourself a small wage and then take the rest as a dividend at a lower tax rate. With an LLC, you pay ordinary income on all of your profits.

    1. uhhh that’s incorrect. It may vary from state to state, but LLC’s have the same kind of “flow through” taxation that S and C corps have.

      With my LLC, I don’t have to pay any taxes until this time of the year. It takes great bookkeeping to do that, and I’ll have to part with a significant amount of money all at once, but I have that same privilege as S and C corps, and I don’t have to worry about double taxation statutes.

    2. Jerry,

      Your route certainly maximizes take home pay. I tried to go over the tax benefits from a beginner’s perspective. An S corp is more complex to form and administer. The main objective I wanted to convey was liability protection, which you get with both.

      Hope that makes sense

  2. Larry | JDB Systems says:

    Hi Sunil,
    I talked to my tax attorney about the whole credit card issue. It’s generally not a good idea to make business purchases with a personal credit card because that blurs the line between you and your business. Most new businesses can get a credit card with a really low limit that gradually increases over time. My first business card had a $800 limit.

    1. I agree. To the best of your ability, get a business credit card. Many start ups have challenges obtaining one. The next best scenario is to use a credit card dedicated just for business and pay off the statement from your business funds/account.

      But yes, having a business card is even better

  3. David Howard says:

    Never knew that you had a section on business deductions Steve. Very useful. Is it up to date with the latest tax rules?

    1. David,

      I tried to cover fundamentals that are evergreen. That said, changes are inevitable to the tax code/tax planning landscape.

      Do you have specific questions I can help address?

  4. Great article here! A lot of people never pay much attention to the legal side of their home businesses and suffer when they have to answer to “the man”.

    Damn, I’m the first comment? I hope more peeps come and read up on this. Gotta pay your dues, so you might as well do it right.

  5. Georgia says:

    Could you comment on why an S Corp is harder to maintain? I’ve read that you need meeting minutes or whatever that is. Can you describe exactly what you need to do to maintain an S Corp vs an LLC and why it is more work?

    1. you need adequate records (minutes) in either case. the reasons are more structure related. distributions are reported on separate schedules, more complications when drawing out salary + dividend treatment vs. an LLC where you can flow through all profits/losses directly. also more expensive to set up in many jurisdictions. overall, the two are very similar. LLC in my opinion just keeps things simple.

  6. I think staying organized throughout the year has saved us. By keeping a file folder for all receipts/bills and tax relevant information – come tax time I just add things up and 30min later we’ve got all the info we need to hand over to our accountant.

  7. In regards to legal entities, I struggled with the choosing a C Corp vs. an LLC and when it came down to it. My decision was based solely on who had to do the work to maintain the requirements for the C Corp. It would’ve been me at first and then I would have had to make sure that we were compliant and so on.

    It was just too much up front work for what this business was to become. Especially since I wasn’t going to have any other owners.

    I feel like it is just easier all around to choose an LLC, tax plan throughout the year and then pay the bill at the end of the FY.

    My final reason in the end was legality. I wanted to protect my personal assets.

    TTYL. Mark

      1. Actually, at one point I was considering a C Corp too because the tax rates are much less as long as you leave the money within the business. You can then have your “corp” make purchases for stuff that you use.

      2. Well I would consider it because the long term strategy of having a C Corp would be to ultimately take the business public in my opinion. Then you’ve already established a crucial legal foundation that is scalable in terms of bringing in many more investors. I decided that I wouldn’t bring in investors and decided that I really just wanted legal protection more than an ownership structure. There is a lot of appeal with a C Corp if you’re looking at the right reasons.

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