Know the Tax Implications of Starting Your Own Business

Whether it’s the result of mass layoffs during the economic crisis or just the ongoing pursuit of a dream, individuals continue to break from convention and take a chance on starting their own businesses. 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 changes on the tax front before taking the plunge.

Tax experts with the Oklahoma Society of Certified Public Accountants say moving forward with an exciting new business opportunity needs to be carefully balanced with tax considerations. 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.

Those with the entrepreneurial spirit should consider the following tax implications before heading out on their own.

Know three important tax liabilities.

Employment taxes: Self-employed individuals are responsible for paying both the employee and the employer portions of the 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.

If you have employees, you will be responsible for paying 6.2 percent of their covered wages paid in 2011 for their share of social security taxes, plus a Social Security 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 self-employed, sometimes you might work as a contractor for another organization. If you have worked as a contractor, you will receive a 1099 from the companies for which you worked and earned more than $600 in the calendar year.

If you have employees or utilize contract labor, your tax liability and reporting will be different. During the year, you’ll file payroll reports, generally quarterly, and 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 to which you’re entitled, 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 used solely for business purchases. If you incur an expense that combines personal and business use, divide up the total cost and take the deduction only for the business use.

Other deductions include business mileage in your car, office supplies, entertainment expenses, and, if you work from a dedicated office space at home, you qualify for a home-office deduction.

“Starting your own business is an exciting concept and offers many opportunities,” said Daryl Hill, executive director of the OSCPA. “But 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 tax benefits of your new business.”

If you have questions about tax planning strategies for your fledgling business, a CPA can help. If you do not have a CPA, for a FREE CPA referral, which also includes a free 30-minute consultation.

Updated 03-02-2011

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