Basic Steps to Take
When first opening up your business, there are a few important steps to take with regards to taxes. Getting everything right from the very beginning is necessary to keep the inevitable tax frustration down to a minimum.
- Select Your Business Structure: Which type of entity you choose for your business will directly impact your tax requirements and strategies. This makes selecting the right one for both now and in the future important, and can save you a lot of money and avoid problems down the line. The main types of business entities are sole proprietorship, partnership, LLC, and corporation.
- Acquire an EIN: Aside from a sole proprietorship, all types of businesses require an EIN, or Employer Identification Number. Getting your EIN is a simple and free process, and can be completed entirely online here at the IRS website. The interactive tool provided by the IRS is extremely helpful in determining if an EIN is something you need.
- Set Up Estimated Payments: If you are likely to incur a tax debt over $1,000 per year, estimated payments must be made on a quarterly basis. It helps tremendously to set aside money as you go for this purpose, rather than having to come up with a large lump sum when the estimated payment is due. Opening up a business savings account, and making regular deposits into it, will give you an orderly and reliable system for making estimated payments on time and for the correct amount.
Taxes by Business Structure
Not all business structures are responsible for the same taxes. Some structures require more taxes than others, making them more costly and complex to select when it comes time to choose which type of entity you want your business to be. Knowing which taxes each entity requires helps you make a more informed decision on which is right for you.
- Sole Proprietorship: The most basic type of entity, a sole proprietorship requires only personal income taxes and self-employment taxes. Self-employment taxes are divided between Social Security and Medicare, which currently stands at 15.3 percent.
- LLC: Operating as an LLC means you can be taxed in a few different ways. For smaller LLCs, you may elect to have things taxed as a sole proprietorship, which is the simplest. If your LLC has more than one founder, you will file as a partnership. If you are, or expect to be, a large online business, you can elect to be taxed as a corporation.
- Partnership: Partnerships do not pay taxes, rather any profit or loss is passed through to each individual partner. This would then be taxed the same as a sole proprietorship, on personal income taxes and self employment tax.
- Corporation: Due to the fact that a corporation is considered a separate legal entity from its owner/s, it is the only one of these structures where tax is based directly on any profits or losses the company would make. The two types of profit would be retained earnings, or those kept to pay for expenses or growth, and any dividends paid to shareholders.
There are a number of important tax forms that may apply to your business depending on which structure you have selected. The most common forms used by small business owners that operate online include:
- Form 1040: This form deals with personal income taxes, and applies to sole proprietors, partners, and most LLCs.
- Schedule C: Here you would report any profits or losses from your business, if you file form 1040.
- Schedule SE: Also related to Form 1040, this is used for your self-employment tax.
- Form 1040-ES: Used for reporting any estimated tax payments.
- Form 1065: An informational form used for partnerships.
- Form 1120: Used by corporations if assets are in excess of $10 million.
Even if you are only selling your products or services online, there is still a chance you will need to charge sales tax for some transactions. In the past, sales tax for online purchases was a murky area in the overall tax scheme; however, the law has become much more concrete in recent years.
There are a few factors when it comes to deciding if you should collect sales tax, and, if so, on which transactions. These include:
- State Law: While most states do require some form of sales tax, there are a few that do not. It is important first to figure out if your states is one that does mandate it, and how much the tax is. You should also find out if your local city or municipality charges an additional sales tax on top of that which the state collects.
- Physical Business Location: The general rule is if you have a physical location in the same state where the customer resides, you must charge them sales tax. This is a little more difficult with an online business, considering a physical location usually means a separate office or warehouse. Many online businesses are home based, which may or may not qualify as a physical location. Check your state and local authorities just to be sure if your setup qualifies as a physical location.
- Where Products Are Shipped From: If orders are sent by a central clearinghouse, such as Fulfillment by Amazon, you may need to collect sales tax from any customers located in the same state as the Amazon facilities.
- Customer Location: If a customer does not reside in the same state as your location, you do not need to charge sales tax.
Claiming deductions when tax time comes around is one of the best ways to save money that can be used to grow your business. A wide variety of activities and payments are eligible as deductions, and knowing all of the ones your business qualifies for maximizes how much of your hard-earned cash you can keep hold of.
The size and diversity of the list of deductions available to small business owners that operate online is vast, no matter which type of business entity you register as. Listing and detailing them all would turn this guide into a small novel, so let’s take a look at some of the most popular and common deductions virtually every proprietor can claim.
- Vehicle Use: Just because your business takes place online does not mean you have no activities in the real world you need to take care of. If any of your activities and responsibilities require the use of a vehicle to get to or accomplish, you can deduct associated expenses, such as gas, maintenance, and repairs. This can be figured based on what you actually paid for, as a percentage you used the vehicle for business. If that seems like too much work, you can also opt to go at the rate the federal government sets. The amount of the federal rate for 2018 is 54.5 cents for each mile traveled for business purposes.
- Employee Payments: While many online business owners may get by operating the business by themselves, success and growth is likely to mean taking on extra help. Any payments made to employees, such as salary, commissions, or bonuses, can be fully deducted on your taxes. This, however, does not include payments to yourself as the business owner, since you are technically not an employee.
- Business Supplies: Any supplies you use with your business can be deducted. This can include things like basic office supplies, or items used with your business in specific. Any postage for business correspondence or items may also be deducted.
- Property and Equipment Depreciation: Any costs incurred as the result of purchasing business-related equipment or property is classified under depreciation, and is considered a capital asset. You can do this one of two ways, either all at once when you buy it, or smaller deductions over the life of the item. If you choose the latter method, the IRS determines how long different types of equipment generally last. This is used to divide up the total cost, and figure out how much you can claim each year.
- Rent and Utilities: If you operate your online business outside of your home, any rent or utility costs can be deducted. Rent deductions can also include leases payments on business-related equipment, or monies paid to terminate a lease early. Common utility costs include electricity, heat, and cellphone charges.
- Advertisement: Any expenses for communication with people outside your business to promote the company as a whole or individual products or sales is considered advertisement, and is fully deductible for an online business. This does not only include the ads and promotional material themselves, but also costs incurred designing and creating your virtual storefront. Extras like giveaway items and email marketing lists, to name just a few, also qualify.
- Home Office: Operating your business out of your home has a different set of rules for some things than having an outside office. Because only a portion of your home is used for your business, you may only claim a portion of things like rent and utilities rather than the total cost. This amount is established by taking the percentage of your whole home that you use for business, and adjusting the total amount accordingly.
Best Small Business Tax Software
One of the most helpful products to come out of the rise of the digital age is tax software. Doing personal taxes can be daunting, not to mention the additional complexities found when doing taxes even for a small business. Going to an outside accountant or firm is expensive, which left business owners of the past limited in what their options were. Now, with the amazingly-capable programs and services available to even the smallest proprietor, tax season has become much less scary.
Not all tax software is perfect for each type of size of business, so it is important to choose the best suite or service for your situation specifically. Things to consider include:
- Business Structure: Some tax software is pretty basic, and usually only adequate if you run a sole proprietorship without any employees. It is vital to check the prospective resource to make sure it covers the type of entity structure you chose.
- Required Forms: Make a list of all the forms you will need to file, and compare it to those supported by the tax software or service. If there are any missing, move on to the next candidate.
- Online or Download: This is mainly a personal preference, whether you want to download a piece of software or do the whole process online. Many of the top brands offer both, so finding one that offers your preferred type is pretty easy.
Most basic accounting software and services include resources to keep track of the tax aspects of your normal accounting duties. If you want to find out which are the most beneficial in this area, be sure to take a look at our guide, Accounting and Bookkeeping for Your Online Business.
Tax preparation software and services, however, are a completely different animal. These handy resources not only figure out all of your tax specifics, they can help you file electronically when tax time rears its ugly head. Some of the best software suites and services include:
Preparing, maintaining, and submitting your taxes correctly and completely is one of the most necessary, albeit onerous, set of tasks an online business has. Tax problems can be both costly and nightmarish, so getting everything right the first time is a must.