Whether you are thinking about going freelance, launching a small business, or considering expanding an existing operation, one of the most complex issues you will likely face relates to your new tax obligations.
The reality is, you could spend years as a tax lawyer and still not understand the intricacies of the tax code. We couldn’t possibly cover the ins and outs of all state and federal business tax law, however a basic understanding of tax liabilities will help you protect your rights. Failure to understand your tax responsibilities as a business owner could result in significant fines and penalties, so it’s best to learn as much as you can before you start making any significant money.
Brass “taxes”—here’s what you need to know:
If you have a payroll, you are going to need to pay taxes. Business with employees are required to withhold taxes to cover Medicare and Social Security taxes as well as state and federal income taxes. Depending on your business and the state of incorporation, employers may also need to withhold unemployment and disability insurance. Remember that failing to pay your employee taxes or missing payments could result in serious fines and penalties.
Your liabilities will be based on how many taxable workers you have. While you are responsible for employees, independent contractors are responsible for their own taxes. Taxable wages include salary, bonuses, and gifts. Business expenses and reimbursements for travel or meal expenses are not considered taxable.
For business owners who aren’t exactly math enthusiasts, this may be the time to enlist an accountant or outside counsel. Proper bookkeeping and calculation of payroll taxes will help you protect your profits as well as prevent losses and liabilities. Sole proprietors, freelancers, and small-business owners will still need to pay on self-employment income each quarter based on estimated earnings.
You are going to be liable for business property taxes on real estate the same way as individuals who purchase residential or commercial property. The calculation is based on the value of the real estate including the land and the building value. If you sell business property during the year, taxes will be assessed on new and old owners and distributed between how much time each owner held the property. Remember that taxes are calculated based on “ad valorem” or value tax determined by a property assessor, not based on fair market value.
Sale or Use Tax
Did you know that your state and local government will tax you on personal property including machinery, computers, and other equipment at the point of sale? The majority of states charge a sale tax on “personal property” even for business use. Even if your business is not charged a tax by the seller because of their location, you may still be liable. While state and local municipalities may require you to pay taxes on business personal property, the IRS will allow you to deduct these purchases as business expenses. To qualify for an exemption, any property you purchase for your business should be considered “ordinary and necessary” for your business. In addition to personal property deductions, you can also deduct the majority of other business operating expenses including utility expenses, transportation and vehicle costs, licenses or dues and professional fees.
Sales and use tax may be straightforward but things can get complicated when it comes to depreciating business property and deductions. You may want to enlist a local tax attorney who can help you navigate the filing process, maximize your deductions, and prevent fines or unnecessary tax obligations.
Federal Income Taxes
Business owners will have varying tax liabilities depending on their state and local, but every U.S. business operator must be mindful of the IRS. Tax obligations to the federal government will depend on your formation (sole proprietor, partnership, limited liability company, “S” corps, or “C” corps). Even if you run a one-man operation, you will be liable for self-employment taxes in addition to your basic income taxes.
In general, business owners will need to pay the IRS income taxes based on profits, organization and deductions. Taxes must be paid as income is earned or received during the year, not as a lump sum at the end. These payments can also be made as estimated taxes by regular payments throughout the year.
State Income Taxes
Like your federal tax liabilities, how your state income taxes are calculated depends on your formation. Your liabilities will also vary significantly depending on where you incorporate. Many businesses specifically incorporate in states where laws are more friendly to business owners. Every state offers a variety of incentives or penalties for conducting business, including tax breaks or liabilities. In addition to income tax, many states will charge tax filing fees, sales taxes, franchise taxes, and other regulatory hurdles.
If you are considering incorporation outside of your home state, keep in mind the number of states with favorable tax laws. South Dakota enforces no income taxes or capital gains taxes making it an ideal state for incorporation. Wyoming also has no corporate income taxes and offers tax exemptions for raw material purchases. Nevada is the third state that does not enforce a corporate income tax or taxes on corporate shares. Florida is also business-friendly exempting “S” corporations from state taxation.
Some businesses will be required to pay excise taxes for the manufacture or sale of certain products, operating a specific kind of business, using specific equipment, facilities or products, or upon receiving payment for specific services. An excise tax may be collected by the federal government or local and state governments. The most common types of excise taxes are for luxury goods or those products or services linked to health issues like alcohol, cigarettes, or tanning salons. Other examples of excise taxes include environmental taxes, communications or air transportation taxes, fuel taxes, the sale of trucks and trailers.
Does it seem complicated? It is.
Business tax law may seem complicated because it is. Depending on the size of your business, your industry, and your product or service your tax obligations could be an even greater puzzle. As a new business owner, you don’t need to understand everything or sort it out all at once. You can always enlist a tax attorney, accountant, or other consultant at any stage of growing your business. However, if you do need help, it is best to get advice as soon as possible to avoid potential liabilities and pitfalls down the line