Small Business Taxes For Dummies E-Book

Eric Tyson

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch
• Veröffentlichungsjahr: 2013

Seitenzahl: 441

Beschreibung

Are you a small business owner taxed by taxes? Not being up-to-speed on tax rules and strategies can lead tomistakes that cost business owners thousands of dollars in finesand penalties every year. Small Business Taxes For Dummiesassists both current and aspiring small business owners withimportant tax planning issues. For the estimated 21 million small business owners in the U.S.,the nation's tax codes continue to change and increase incomplexity. Small Business Taxes For Dummies arms youfor important tax planning issues, including: year-round taxplanning tips and expense tracking advice; small business decisionsand expense basics; business use of your home and self-employmenttaxes; creating an ongoing tax routine; dealing with the IRS andwhere to find help; navigating audits and notices; and more. * Guides you through the current tax laws and ensures that youunderstand your rights and obligations * Helps small business owners save time and money * Empowers you to understand and prepare your own taxdocuments The expert tips and advice presented in Small Business TaxesFor Dummies are for the millions of small business owners likeyou searching for a guide to the latest tax codes andregulations.

Leseprobe

Tax-wise Strategies for Your Small Business and Personal Success

Starting and operating a small business involves many moving parts and issues. Taxes permeate just about everything that you do. Taxes are too often maddeningly complicated. Most folks’ single biggest “expense” is their tax bill. And for tens of millions of small business owners, U.S. tax laws are a complex and constantly changing web ready to trip them up and siphon off their most precious and valuable business resource — their money!

Handled in the best possible way, you can save yourself tens of thousands — if not hundreds of thousands — of dollars by making informed tax moves. And you can comply with the tax rules and regulations and stay out of trouble with the Internal Revenue Service and your state and local tax authorities.

Take charge of your income taxes. Find out enough about the tax laws to prepare your own return and handle your own decisions or intelligently hire a quality tax advisor.

Get and stay organized. Keep your tax and financial documents well organized throughout the year. Doing so saves you many hours when preparing your return and also when making important decisions.

Understand and use the tax laws to legally reduce your income taxes. If you educate yourself about the tax laws and incentives, you can significantly and permanently reduce the income taxes that you pay over your lifetime.

Make use of retirement accounts. Be sure that you and your employees take advantage of opportunities to contribute to retirement accounts, which reduces your income tax bill both now and in the years ahead.

Seek tax help when your situation changes or becomes complicated, or you lack the time to do your taxes well and correctly. Tax advisors can be costly year after year, but a good advisor should save you money and help you with the most difficult issues and returns.

Learn from your return. Don’t simply file your return in a folder after you complete it. Use the information on it to plan ahead for the next tax year.

Keep your taxes in perspective. Life has so much more to offer than just working and making money. If you do such a good job with your small business and minimizing your taxes that you gain great wealth, don’t forget to enjoy the fruits of your labors.

Must-Ask Questions for Prospective Tax Advisors

When you believe that your tax situation warrants outside help, educate yourself as much as possible before searching for assistance. The more you know, the better able you’ll be to evaluate the competence of someone you may hire. Ask the right questions to find a competent tax practitioner whose skills match your tax needs. The following questions are a great place to start.

What tax services do you offer? Most tax advisors prepare tax returns. Many advisors can help you plan and file other important tax documents throughout the year. Some firms can also assist your small business with bookkeeping and other financial reporting, such as income statements and balance sheets. These services can be useful when your business is in the market for a loan or if you need to give clients or investors detailed information about your company. As a small business owner, you should seek out tax advisors who work with a large number of small businesses. This should comprise a significant portion of their practice.

What are your particular areas of expertise or focus of your practice? This question is important because you want to find an advisor who is a good match for your situation. For example, if a tax preparer works mainly with people who receive regular paychecks from an employer, the preparer probably has little expertise in helping small business owners best complete the blizzard of paperwork that the IRS requires. Find out what expertise the tax advisor has in handling whatever unusual financial events you’re dealing with this year — or whatever events you expect in future years.

What other services do you offer? Ideally, you want to work with a professional who is 100 percent focused on taxes. A multitude of problems and conflicts of interest crop up when a person tries to prepare tax returns, sell investments, and appraise real estate all at the same time. That advisor may not be fully competent or current in any of those areas. Avoid tax advisors who sell financial products that pay them a commission — this situation inevitably creates conflicts of interest.

Who will prepare my return? If your tax advisor has assistants and other employees, make sure that you know what level of involvement these different people will have in the preparation of your return. It isn’t necessarily problematic if a junior-level person does the preliminary tax return preparation that your tax advisor reviews and finalizes. In fact, this procedure can save you money in tax-preparation fees if the firm bills you at a lower hourly rate for a junior-level person. Be wary of firms that charge you a high hourly rate for a senior tax advisor who then delegates most of the work to a junior-level person.

How aggressive or conservative are you regarding interpreting tax laws? Some tax preparers, unfortunately, view their role as enforcement agents for the IRS. This attitude often is a consequence of one too many seminars put on by local IRS folks, who admonish and sometimes intimidate preparers with threats of audits. On the other hand, some preparers are too aggressive and try tax maneuvers that put their clients on thin ice — subjecting them to additional taxes, penalties, interest, and audits. Assessing how aggressive a tax preparer is can be difficult. Start by asking what percentage of the preparer’s clients gets audited.

What’s your experience with audits? The IRS audits about 1 percent of all taxpayer returns. Small business owners and more affluent clients can expect a higher audit rate — somewhere in the neighborhood of 2 percent to 4 percent. If a tax preparer proudly claims no audited clients, be wary. Among the possible explanations, any of which should cause you to be uncomfortable in hiring such a preparer: She isn’t telling you the truth, she has prepared few returns, or she’s afraid of taking some legal deductions, so you’ll probably overpay your taxes. Ask the preparer to explain her recent audits, what happened, and why. This explanation sheds light not only on her work with clients but also on her ability to communicate in plain English.

What qualifies you to be a tax advisor? The more tax and business experience they have, the better. Although gaining credentials takes time and work, these certifications are no guarantee that you get quality, cost-effective tax assistance or that you won’t be overcharged. Generally speaking, more years of experience are better than fewer, but don’t rule out a newer advisor who lacks gray hair or who hasn’t yet slogged through thousands of returns. Intelligence and training can easily make up for less experience.

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Small Business Taxes For Dummies®

Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com

Copyright © 2014 by Eric Tyson

Published simultaneously in Canada

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Library of Congress Control Number: 2013949555

ISBN 978-1-118-65061-5 (pbk); ISBN 978-1-118-80722-4 (ebk); ISBN 978-1-118-80724-8 (ebk)

Manufactured in the United States of America

10 9 8 7 6 5 4 3 2 1

Small Business Taxes For Dummies®

Visit www.dummies.com/cheatsheet/smallbusinesstaxkit to view this book's cheat sheet.

Table of Contents

Introduction

About This Book

Foolish Assumptions

Icons Used in This Book

Beyond the Book

Where to Go from Here

Part I: Tax Basics

Chapter 1: Small Business Taxes 101

Valuing Year-Round Tax Planning

Factoring taxes into small business decisions

Checking out common tax mistakes

Understanding the Different Types of Taxes You Pay and Your Tax Rates

Defining total taxes and taxable income

Your marginal income tax rate for federal income taxes

State income taxes

Corporate income tax rates

Chapter 2: Making Important Business Decisions

Choosing Your Business Entity

Sole proprietorships

The incorporation decision

One step further: S corporations

Partnerships

Limited liability companies (LLCs)

Valuing Employee Benefits

Retirement plans

Health insurance plans

Other benefits

Benefits that are deductible for corporation owners

Chapter 3: Retirement Accounts and Investments for Small Businesses

Beginning with Retirement Account Basics: Tax Breaks, Penalties, and Saving Guidelines

Instant rewards: Upfront tax breaks

Ongoing tax breaks on your investment earnings

Additional tax credits for lower-income earners

Retirement account penalties for early withdrawals

Guidelines for saving (but not excessively)

Surveying Your Retirement Account Options

Maximizing your retirement plan’s value

Checking out your choices

Selecting Top-Notch Investments for Your Retirement Account

Considering fund advantages

Maximizing your chances for fund investing success

Understanding and using index funds

Considering exchange-traded funds

Using asset allocation in your retirement fund portfolio

Selecting the best stock funds

Investing in the best exchange-traded funds

Balancing your act: Funds that combine stocks and bonds

Finding the best bond funds

Developing Realistic Investment Return Expectations

Estimating your investments’ likely future returns

Compounding your returns

Chapter 4: Real Estate and Your Small Business

Deciding Whether to Work out of Your Home

Researching local ordinances and issues

Considering controlling costs

Separating your work life from your personal life

Doing a cost comparison

Leasing Space for Your Business

Leaning toward leasing

Leasing burdens of retail businesses

Negotiating a lease

Buying Business Property

Taking stock of your financial situation

Doing a rent-versus-buy analysis

Evaluating leases as a real estate investor

Chapter 5: Estate Planning

Determining Your Estate’s Tax Concerns

Understanding the federal estate tax exemption

Figuring out your taxable estate

Examining estate tax rates

Surveying special estate tax treatment afforded small businesses

Reducing Expected Estate Taxes with a Few Strategies

Giving away your assets

Leaving all your assets to your spouse

Buying cash-value life insurance

Setting up trusts

Getting advice and help

Part II: Ongoing Tax Jobs

Chapter 6: Keeping Track of Your Small Business Revenues and Costs

Establishing an Accounting System for Your Business

Separating business from personal finances

Documenting expenses and income in the event of an audit

Keeping current on income and payroll taxes

Reducing your taxes by legally shifting income and expenses

Keeping Good Tax Records for Your Small Business

Ensuring a complete and accurate tax return

Setting up a record-keeping system

Deciding when to stash and when to trash

Watching out for state differences

Replacing lost business records

Chapter 7: Form 1040 Filing Options

What Version of Form 1040 Should You Use?

Form 1040EZ

Form 1040A (the short form)

Form 1040 (the long form)

Income Lines

Line 7: Wages, salaries, tips, etc.

Line 8a: Taxable interest

Line 8b: Tax-exempt interest

Lines 9a and 9b: Ordinary dividends and qualified dividends

Line 12: Business income (or loss)

Line 13: Capital gain (or loss)

Line 14: Other gains (or losses)

Lines 16a and 16b: Total pensions and annuities

Line 17: Rental real estate, royalties, partnerships, S corporations, trusts, etc.

Line 18: Farm income (or loss)

Line 19: Unemployment compensation

Lines 20a and 20b: Social Security benefits

Line 21: Other income

Adjustments to Income

Line 23: Educator expenses

Line 24: Certain business expenses of reservists, performing artists, and fee-basis government officials

Line 25: Health savings account deduction

Line 26: Moving expenses

Line 27: Deductible part of self-employment tax

Line 28: Self-employed SEP, SIMPLE, and qualified plans

Line 29: Self-employed health insurance deduction

Line 32: IRA deduction

Line 33: Student loan interest deduction

Line 34: Tuition and fees

Line 35: Domestic production activities deduction

Line 37: Adjusted gross income

Tax and Credits: Lines 38 to 46

Line 40: Itemized deductions (from Schedule A) or your standard deduction

Line 42: Exemptions

Line 45: Alternative minimum tax

Tax and Credits: Lines 47 to 55

Line 47: Foreign tax credit

Line 48: Credit for child and dependent care expenses

Line 49: Education credits

Line 50: Retirement savings contributions credit

Line 51: Child tax credit

Chapter 8: Schedules C and C-EZ

Schedule C-EZ

Schedule C

Basic information

Part I: Income

Part II: Expenses

Chapter 9: The Business Use of Your Home

The New, Simplified Home Office Deduction

Filling Out Form 8829, “Expenses for Business Use of Your Home”

Recognizing who can use Form 8829

Measuring the part of your home used for business

Figuring your allowable home office deduction

Determining your home office’s depreciation allowance

Carrying over what’s left

Understanding the Downsides to Home Office Deductions

Audit risk and rejection of repeated business losses

Depreciation recapture when selling a home with previous home office deductions

Chapter 10: Estimated Taxes, Self-Employment Taxes, and Other Common Forms

Form 1040-ES: Estimated Tax for Individuals

Comparing the safe harbor method to the 90 percent rule

Completing and filing your Form 1040-ES

Keeping Current on Your Employees’ (and Your Own) Tax Withholding

Form W-4 for employee withholding

Tax withholding and filings for employees

Schedule SE: Self-Employment Tax

Choosing a version of Schedule SE: Short or long?

Completing the Short Schedule SE

Form 8889: Health Savings Accounts (HSAs)

Understanding how HSAs work and who can use them

Completing Form 8889

Part III: Getting Help

Chapter 11: Dealing with Notices and Audits

Understanding the Basics You’ll Find on an IRS Notice

Assessing Assessment Notices

Income verification and proposed changes to your tax return: Forms CP2501 and CP2000

Request for your tax return: Forms CP515 and CP518

Backup withholding notice

Federal tax lien notice: Form 668(F)

Handling Non-Assessment Notices

Paying interest on additional tax

Receiving a delinquent tax return notice

What You Should Know about Audits

Surviving the four types of audits

Prepping for an audit

Winning your audit

Understanding the statute of limitations on audits

Correcting IRS Errors

Keeping your correspondence short and sweet

Sending a simple response to a balance due notice

Getting attention when the IRS ignores you with the help of a taxpayer advocate

Amending a Return

More expenses than income (net operating losses)

The tax benefit rule

Taking Action Even When You Can’t Pay Your Taxes

Reducing Your Chances of Being Audited

Declare all your income

Don’t itemize

Earn less money

Don’t cheat

Be careful with hobby losses

Don’t cut corners if you’re self-employed

Double-check your return for accuracy

Stay away from back-street refund mills

Chapter 12: Keeping Up with and Researching Tax Strategies and Rules

The Benefits of Preparing Your Own Return

Using IRS Publications

Buying Software

Accessing Internet Tax Resources

The Internal Revenue Service

Tax preparation sites

TaxTopics.net

Research sites

Hiring Help

Chapter 13: Paying for Tax Help

Deciding to Hire Tax Help

Unenrolled preparers

Enrolled agents

Certified public accountants

Tax attorneys

Who’s best qualified?

Finding Tax Advisors

Interviewing Prospective Tax Advisors

What tax services do you offer?

What are your particular areas of expertise?

What other services do you offer?

Who will prepare my return?

How aggressive or conservative are you regarding interpreting tax laws?

What’s your experience with audits?

How does your fee structure work?

What qualifies you to be a tax advisor?

Do you carry liability insurance?

Can you provide references of clients similar to me?

Part IV: The Part of Tens

Chapter 14: (Almost) Ten Often Overlooked Tax Reduction Opportunities

Invest in Wealth-Building Assets

Fund Some Retirement Accounts

Contribute to a Health Savings Account

Work Overseas

Calculate Whether a Deduction Is Worth Itemizing

Trade Consumer Debt for Mortgage Debt

Consider Charitable Contributions and Expenses

Maximize Miscellaneous Expenses

Scour for Self-Employment Expenses

Chapter 15: Ten Resources to Turn to After Reading This Book

To Develop a Good Business Plan and Improve Your Small Business

To Whip Your Finances into Shape

To Select the Best Business Entity

To Set Up an Accounting and Financial Management System

To Hone Your Investment Savvy for Your (and Your Employees’) Retirement Funds

For Help with Payroll Regulations and Employee Tax Withholdings

To Dig Deeper into IRS Rules and Regulations

To Deal with IRS Collection Efforts

For More Detailed Advice about All Aspects of Your Income Tax Return

For Assistance in Preparing Your Income Tax Return

About the Author

Cheat Sheet

Connect with Dummies

Introduction

Welcome to Small Business Taxes For Dummies!

Starting and operating a small business involves many moving parts and issues. Money is the lifeblood of any business. You need money to start a business, and you need money to keep a business going.

As you earn and spend money in your business, taxes permeate just about everything that you do. Taxes are too often maddeningly complicated. But they need not be so. Enter this book!

I’ve owned and operated numerous small businesses in my life. I love the freedom and opportunity to pursue what I believe in and what interests me. And I generally detest dealing with tax issues. But I also know how important tax issues are in terms of the financial success or lack thereof for a small business.

Handled in the best possible way, you can save yourself tens of thousands — if not hundreds of thousands — of dollars by making informed tax moves. And you can comply with the tax rules and regulations and stay out of trouble with the Internal Revenue Service and your state and local tax authorities.

But if you stick your head in the sand or give in to the complexities of the tax laws, you may end up in trouble both financially and with the law.

About This Book

For most folks, their single biggest “expense” is their tax bill. And for tens of millions of small business owners, the nation’s tax laws are a complex and constantly changing web ready to trip them up and siphon off their most precious and valuable business resource — their money.

Small Business Taxes For Dummies assists both current and aspiring small business owners with important tax planning issues, filing issues, dealing with IRS audits and notices, getting help, and more.

This book provides you with a crash course on taxes and your small business. Specifically, the goal is to ensure your understanding of the myriad tax rules and incentives so you can legally minimize your tax bill, stay in compliance with the law, and maximize your company’s success. You need not read this book in the order it’s presented. You can use the book as a reference and selectively read material currently relevant and of greatest interest to you.

Note: 2013 tax forms weren't available at press time, so you see 2012 forms throughout this book. To access the most recent forms available, check out www.irs.gov.

I’ve written this book so you can efficiently find information and easily understand what you find. And although I’d like to believe that you want to pore over every last word I’ve written, I actually make it easy for you to identify “skippable” material. This information is the stuff that, although interesting, isn’t essential for you to know:

Text in sidebars: The sidebars are the shaded boxes that appear here and there. They include helpful information and observations but aren’t necessary reading.

Anything with a Technical Stuff icon attached: This information is interesting but not critical to your understanding of the topic at hand.

Foolish Assumptions

In writing this book, I made some assumptions about you, dear reader:

You want expert advice about important small business tax and financial topics — such as the best way to purchase and write off equipment and other business expenses, establish and fund retirement accounts, and correctly complete common business tax forms — and you want answers quickly.

Perhaps you want a crash course in small business tax and financial issues and are looking for a book to help solidify major financial concepts and get you thinking about your small business taxes in a more comprehensive way.

This book is basic enough to help novices get their arms around thorny tax issues. But advanced readers will be challenged, as well, to think about their small business taxes in a new way and identify areas for improvement.

Icons Used in This Book

The icons in this book help you find particular kinds of information that may be of use to you.

This nerdy-looking guy appears beside discussions that aren’t critical if you just want to understand basic concepts and get answers to your small business tax questions. You can safely ignore these paragraphs, but reading them can help deepen and enhance your knowledge. This stuff can also come in handy if you’re ever on a game show or if you find yourself stuck on an elevator with a tax geek.

This target flags strategy recommendations for making the most of your small business tax decisions.

This icon highlights the best products and services I’ve come across in the small business tax arena.

This icon points out information that you’ll definitely want to take away from this book.

This icon marks things to avoid and points out common mistakes people make when making small business and tax decisions.

This icon alerts you to scams and scoundrels who prey on the unsuspecting.

This icon tells you when you should consider doing some additional research. Don’t worry — I explain what to look for and what to look out for.

Beyond the Book

In addition to the material in the print or e-book you're reading right now, this product also comes with some access-anywhere goodies on the web. Check out the free Cheat Sheet at www.dummies.com/cheatsheet/smallbusinesstaxes for strategies you can use for small business success and more, and be sure to visit www.dummies.com/extras/smallbusinesstaxes for free articles about small business start-up cash needs and sources as well as proven ways to fund a small business.

Where to Go from Here

This book is organized so you can go wherever you want to find complete information. You can check out the table of contents to find broad categories of information and a chapter-by-chapter rundown of what this book offers, or you can look up a specific topic in the index.

If you’re not sure where you want to go, you may want to turn a few pages and start at the beginning with Part I. It gives you all the basic information you need to assess your small business tax situation and points to places where you can find more detailed information for improving it.

Part I

Tax Basics

Visit www.dummies.com for great (and free!) Dummies content online.

In this part . . .

Minimize your tax bill through year-round tax planning. Be sure to factor taxes into your small business decisions, check out common tax mistakes, and understand tax terms and rates.

Decide what business entity (corporation, LLC, sole proprietorship, and so on) to use, and consider what benefits to offer to your employees.

Investigate your small business retirement account options — such as SEP-IRAs, Keogh plans, SIMPLE plans, 403(b) plans, and 401(k) plans — and select top-notch investments.

Handle small business real estate decisions, such as deciding whether to work out of your home, lease space, or buy property.

Plan your estate, including your small business. Determine your estate’s tax concerns and reduce your expected estate taxes.

Chapter 1

Small Business Taxes 101

In This Chapter

Appreciating the value of year-round tax planning

Noting the various taxes you and your business pay

Even though I write about personal finances, including tax issues, I don’t particularly enjoy dealing with taxes. I would rather cut my lawn, take care of my neighbor’s dog, or even visit my dentist. At least in all these cases, I know my time commitment is reasonably limited, and when I’m done, I’m satisfied that the job has been done well, and I can move on to something else.

Filling out state and federal tax forms is often complicated and confusing. Because I write about taxes, I feel that it’s essential for me to complete my own forms and returns, which forces me to wallow in the details as much as possible so that I can more fully appreciate the challenges taxpayers face.

Though some of this book deals with the drudgery of completing required tax forms, much of it deals with the more interesting — and dare I say, fun — part of taxes, which is planning ahead so as to reduce and minimize your taxes. You see, if you simply view your role with taxes and your small business as jumping through the many hoops that federal, state, and local authorities require, you’re missing out on something really big.

This chapter introduces the basics of small business taxes. Here, I discuss the value of tax planning all year long, and I define some important tax-related terms regarding the taxes you pay or may come across.

Valuing Year-Round Tax Planning

Taxes are a large, vital piece of your small-business and personal-financial puzzle. You’re required by law to complete your tax forms each year and pay the taxes you owe. You do this because you have deadlines and don’t want contact initiated by local or state authorities or the IRS, or worse, jail time!

Nothing really forces you to plan ahead regarding your tax situation and small business. That’s why the vast majority of small business owners don’t take steps year-round to plan and reduce their taxes, or, if they do think about doing so, they keep procrastinating. However, tax planning all year is valuable because it enables you to stay on top of your tax and business financial situation and minimize the taxes you legally owe. In this section, I explain typical ways in which taxes enter small business decisions and some common tax mistakes folks make in this realm.

Factoring taxes into small business decisions

Taxes infiltrate many areas of your small business and your personal finances. Some people make important financial decisions without considering taxes (and other important variables). Conversely, in an obsession to minimize or avoid taxes, other people make decisions that are counterproductive to achieving their long-term business and personal financial goals. Although taxes are an important component to factor into your major business and financial decisions, taxes shouldn’t drive or dictate the decisions you make.

The following list shows some of the ways that tax issues are involved in making sound financial decisions throughout the year.

Type of business and benefits offered: The type of business entity you select for your business — sole proprietorship, S corporation, limited liability company (LLC), and so on — can have significant tax and other consequences. The benefits you’re able to utilize and offer to your employees, if you have them, also have tax ramifications (see Chapter 2).

Retirement accounts: Taking advantage of retirement accounts can mean tens, perhaps even hundreds of thousands more dollars in your pocket come retirement time. Offering retirement account access to your employees can also be a valuable employee benefit for recruiting and retaining good employees if they understand what they have. Refer to Chapter 3 for more on retirement accounts.

Spending: Throughout this book, I discuss myriad spending decisions you may face in your small business, such as buying equipment (Chapter 8), spending on employee benefits (Chapter 2), and so on. These decisions will often affect your taxes both now and in the future.

Protecting your assets: Some of your insurance decisions also affect the taxes you pay. You’d think that after a lifetime of tax payments, your heirs would be left alone when you pass on to the great beyond — but that’s wishful thinking. Estate planning can significantly reduce the taxes that are siphoned off from your estate. See Chapter 5 to find out more about estate planning.

Tracking your business financials: Throughout the year, you should stay on top of your business’s income and outflows so that you can see your business’s financial health and record the numbers you need come tax time. Chapter 6 covers these important issues.

Checking out common tax mistakes

Even if some parts of the tax system are hopelessly and unreasonably complicated, there’s no reason why you can’t learn from the mistakes of others to save yourself some money, no matter the time of year. With this goal in mind, this section details common tax blunders that people make when it comes to managing their money.

Seeking advice after an important decision

Too many people seek out information and hire help after making a decision, even though seeking preventive help ahead of time generally is wiser and more financially beneficial.

Before making major small business and financial decisions, educate yourself. This book can help answer many of your questions. You may also want to do further research on your own (see Chapter 12) and/or hire a tax advisor (refer to Chapter 13) for some advice before making your decision(s).

Failing to withhold or submit enough taxes

If you’re self-employed (or earn significant taxable income from investments outside retirement accounts), you need to make estimated quarterly tax payments. You also need to withhold taxes for your employees and send those taxes along to the appropriate tax agencies. Some small business owners don’t have a human resources department to withhold taxes and dig themselves into a perpetual tax hole by failing to submit estimated quarterly tax payments.

To make quarterly tax payments, complete IRS Form 1040-ES, “Estimated Tax for Individuals.” This form (discussed in Chapter 10) and its accompanying instructions (and payment coupons) explain how to calculate quarterly tax payments. For more information on the requirement for employee tax withholding, see Chapter 6.

Missing legal deductions

Some taxpayers miss out on legitimate tax write-offs because they just don’t know about them. If you aren’t going to take the time to discover the legal deductions that are available to you and that I discuss throughout this book, then you should pay for the cost of a competent tax advisor at least once. Fearing an audit, some taxpayers (and even some tax preparers) avoid taking deductions that they have every right to take. Unless you have something to hide, such behavior is foolish and costly. Note that a certain number of returns are randomly audited every year, so even when you don’t take every allowable deduction, you may nevertheless get audited! And, if you read Chapter 11, you can find out how to deal with an audit like a pro.

Forsaking retirement accounts

All the tax deductions and tax deferrals that come with accounts such as 401(k)s, Keogh plans, and individual retirement accounts (IRAs) were put in the tax code to encourage you to save for retirement. That’s something that you as a small business owner should be doing for yourself as well as encouraging your employees to do.

Most excuses for missing out on these accounts just don’t make good financial sense. Some folks underfund retirement accounts because they spend too much and because retirement seems so far away. Others mistakenly believe that retirement account money is totally inaccessible until they’re old enough to qualify for senior discounts. (See Chapter 3 to find out all about your small business retirement account options.)

Not owning real estate

In the long run, owning a home should cost you less than renting. And because mortgage interest and property taxes are deductible, the government, in effect, subsidizes the cost of homeownership.

If you have a home office, you may be able to take additional expenses on your tax return. If you need a retail or commercial space for your small business, you should compare leasing to buying and be sure to factor in the tax benefits of owning. See Chapter 4 for more about real estate and taxes.

Neglecting the timing of events you can control

As a small business owner, you should pay attention to how your net income for the year is shaping up for the current year and how things are looking for next year. For example, if you’re in the early stages of your business and you can see that you’ll have more income next year, then it may be in your best interest tax-wise to delay paying some expenses from late in the current year into early next year.

Or suppose that you operate on a cash accounting basis and think that you’ll be in a lower tax bracket next year. Perhaps business has slowed of late or you plan to take time off to be with a newborn or take an extended trip. You can send out some invoices later in the year so that your customers won’t pay you until January, which falls in the next tax year.

Not using tax advisors effectively

If your financial situation is complicated, going it alone and relying only on the IRS booklets to figure your taxes usually is a mistake. Many people find the IRS instructions tedious and not geared toward highlighting opportunities for tax reductions. Instead, you can start by reading the relevant sections of this book. When you’re overwhelmed by the complexity of particular small business and tax decisions, get advice from tax and financial advisors who sell their time and nothing else. (Chapter 13 has tips on hiring help.)

As a small business owner, ask yourself how much you’re worth running your business versus how much you’re worth as a bookkeeper. Then ask yourself which task you enjoy more and consider hiring a bookkeeper.

Note that using a tax advisor is most beneficial when you face new tax questions or problems. If your tax situation remains complicated or if you know that you’d do a worse job on your own, by all means keep using a tax preparer. If your situation is unchanging or isn’t that complicated, consider hiring and paying someone to figure out your taxes one time. After that, go ahead and try completing your own tax returns.

Understanding the Different Types of Taxes You Pay and Your Tax Rates

Most small business owners pay income taxes at the personal income tax rates. That’s because the vast majority of small businesses are run as sole proprietorships. And many of those that aren’t, such as partnerships, LLCs, and S corporations, pass through their income in such a way that the income is generally taxed to its recipients as personal income. Some small business owners pay a corporate rate if their business is incorporated as a regular so-called C corporation. (The type of business entity you elect is discussed in Chapter 2.) See the later section “Corporate income tax rates” for more details.

When it comes to federal income taxes, many people remember only whether they received a refund or owed money. But you should care how much you pay in taxes and the total and marginal taxes that you pay so you can make decisions that lessen your tax load. Although some people feel happy when they get refunds, you shouldn’t. A refund simply signifies that you overpaid your taxes during the previous year. When you file your income tax return, you settle up with tax authorities regarding the amount of taxes you paid during the past year versus the total tax that you’re actually required to pay, based on your income and deductions.

In this section, I define important tax terms such as total taxes, taxable income, marginal tax rates, and corporate tax rates, and I also discuss the federal and state income tax systems.

Defining total taxes and taxable income

The only way to determine the total amount of income taxes you pay is to get out your federal and state tax returns. On each of those returns, about one-third of the way before the end, is a line that shows the total tax. Add the totals from your federal and state tax returns, and you probably have one very large expense!

Your taxable income is different from the total amount of money you earn during the tax year from employment and investments. Taxable income is defined as the amount of income on which you actually pay income taxes. You don’t pay taxes on your total income for the following two reasons:

Not all income is taxable. For example, you pay federal income tax on the interest that you earn on a bank savings account but not on the interest from municipal bonds (loans that you, as a bond buyer, make to state and local governments).

You get to subtract deductions from your income. Some deductions are available just for being a living, breathing human being. For tax year 2013, single people receive an automatic $6,100 standard deduction, heads of household qualify for $8,950, and married couples filing jointly get $12,200. (People older than 65 and those who are blind get slightly higher deductions.) Other expenses, such as mortgage interest and property taxes, are deductible to the extent that your total itemized deductions exceed the standard deductions.

Your marginal income tax rate for federal income taxes

Marginal is a word that people often use when they mean “small” or “barely acceptable.” But with taxes, marginal has a different meaning. The government charges you different income tax rates for different portions of your annual income. So your marginal tax rate is the rate that you pay on the so-called “last dollars” you earn. You generally pay less tax on your first, or lowest, dollars of earnings and more tax on your last, or highest, dollars of earnings. This system is known as a graduated income tax, a system that goes back hundreds of years to other countries.

The fact that not all income is treated equally under the current tax system isn’t evident to most people. When you work for an employer and have a reasonably constant salary during the course of a year, a stable amount of federal and state taxes is deducted from each paycheck. Therefore, you may have the false impression that all your earned income is taxed equally.

Table 1-1 gives the 2013 federal income tax rates for singles and for married people filing jointly.

Table 1-1 2013 Federal Income Tax Brackets and Rates

Singles Taxable Income

Married-Filing-Jointly Taxable Income

Federal Tax Rate (Bracket)

Less than $8,925

Less than $17,850

10%

$8,925 to $36,250

$17,850 to $72,500

15%

$36,250 to $87,850

$72,500 to $146,400

25%

$87,850 to $183,250

$146,400 to $223,050

28%

$183,250 to $398,350

$223,050 to $398,350

33%

$398,350 to $400,000

$398,350 to $450,000

35%

More than $400,000

More than $450,000

39.6%

Your marginal tax rate is the rate of tax that you pay on your last, or so-called highest, dollars of taxable income. For example, according to Table 1-1, if you’re single and your taxable income during 2013 totals $50,000, you pay federal income tax at the rate of 10 percent on the first $8,925 of taxable income. You then pay 15 percent on the amount from $8,925 to $36,250 and 25 percent on income from $36,250 up to $50,000. In other words, you effectively pay a marginal federal tax rate of 25 percent on your last dollars of income — those dollars in excess of $36,250.

After you understand the powerful concept of marginal tax rates, you can see the value of the many financial strategies that affect the amount of taxes you pay. Because you pay taxes on your employment income and your investment earnings (other than retirement accounts), you need to make many of your personal financial decisions with your marginal tax rate in mind.

For example, when you have the opportunity to earn some extra money, how much of that extra compensation you get to keep depends on your marginal tax rate. Your marginal income tax rate enables you to quickly calculate the additional taxes you’d pay on the additional income.

Conversely, you quantify the amount of taxes that you save by reducing your taxable income, either by decreasing your income — for example, with pretax contributions to retirement accounts — or by increasing your deductions.

Actually, you can make even more of your marginal taxes. In the next section, I detail the painful realities of income taxes levied by most states that add to your federal income tax burden. If you’re a middle-to-higher income earner, pay close attention to the sidebar later in this chapter where I discuss the alternative minimum tax.

Your federal income tax rates can effectively be higher than the amounts listed in Table 1-1 because some tax breaks are reduced when your income exceeds a particular level. For example:

Itemized deductions, which are recorded on Schedule A, are reduced for tax year 2013 when your adjusted gross income (AGI — your total income before subtracting deductions) exceeds $250,000 ($300,000 for married persons filing separately).

Personal exemptions are a freebie — they’re a write-off of $3,900 in tax year 2013 just because you’re a living, breathing human being. However, personal exemptions are whittled away for single-income earners with AGIs of more than $250,000, married people filing jointly with AGIs of more than $300,000, and married persons filing separately with AGIs of more than $150,000.

If you own rental real estate, you may normally take up to a $25,000 annual loss when your expenses exceed your rental income. Your ability to deduct this loss begins to be limited when your AGI exceeds $100,000.

Your eligibility to fully contribute to Roth Individual Retirement Accounts (see Chapter 3) depends on your AGI being less than or equal to $112,000 if you’re a single taxpayer or $178,000 if you’re married. Beyond these amounts, allowable contributions are phased out.

State income taxes

Your total marginal rate includes your federal and state income tax rates. As you may already be painfully aware, you don’t pay only federal income taxes. You also get hit with state income taxes — that is, unless you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming. Those states have no state income taxes. As is true with federal income taxes, state income taxes have been around since the early 1900s.

You can look up your state tax rate by getting out your most recent year’s state income tax preparation booklet. Alternatively, Figure 1-1 gives you an idea of your state tax rates; it reflects state individual income taxes. Some states impose other taxes — such as local, county, or city taxes; special taxes for nonresidents; or capital gains taxes — which aren’t included in this table.

Source: Federation of Tax Administrators, January 2013. http://www.taxadmin.org/fta/rate/ind_inc.pdf

Figure 1-1: State marginal tax rates.

The alternative minimum tax

In 1969, Congress created a second tax system called the alternative minimum tax (AMT) to ensure that higher-income earners with relatively high amounts of itemized deductions pay at least a minimum amount of taxes on their incomes. When it was added to the federal income tax code in 1969, the AMT affected a mere 155 high-income taxpayers; today, it hits more than 4 million taxpayers!

If you have a bunch of deductions from state income taxes, real estate taxes, certain types of mortgage interest, large miscellaneous itemized expenses, or passive investments (such as limited partnerships or rental real estate), you may fall prey to the AMT. The AMT is a classic case of the increasing complexity of the U.S. tax code. As incentives were placed in the tax code, people took advantage of them. Then the government said, “Whoa! We can’t have people taking that many write-offs.” Rather than doing the sensible thing and limiting some of those deductions, Congress created the AMT instead.

The AMT restricts you from claiming certain deductions and requires you to increase your taxable income. So you must figure the tax you owe both under and out of the AMT system, and then pay whichever amount is higher. Unfortunately, the only way to know for certain whether you’re ensnared by this second tax system is by completing — you guessed it — another tax form. Form 6251, “Alternative Minimum Tax — Individuals” is a bear of a form, so if you’re confronting it for the first time, you may wish to enlist the support of a qualified tax advisor. Also, be aware that if you don’t calculate the AMT on your return and you should have, the IRS will calculate the bill for the additional tax, interest, and possibly late payment penalties.

Corporate income tax rates

As I explain earlier in this chapter, the vast, vast majority of small business owners pay income taxes on their business earnings at the personal income tax rates. That’s because most small businesses are organized as sole proprietorships, which have income taxed as personal income. Also, many other small businesses that are organized as partnerships, LLCs, and S corporations pass through their income to the business owners in such a way that it, too, is taxed as personal income.

Thus, only a small percentage of small business owners have their income taxed as regular, so-called C corporations. Corporate income tax rates (see Table 1-2) differ from personal income tax rates. Corporate income tax rates are generally lower for incomes up to $75,000 and then are generally higher up to incomes of $335,000. For incomes above $335,000, corporate income tax rates are a bit lower again compared to personal federal income tax rates.

Table 1-2 (Federal) Corporate Income Tax Rates

Taxable Income

Tax Rate

$0 to $50,000

15%

$50,000 to $75,000

25%

$75,000 to $100,000

34%

$100,000 to $335,000

39%

$335,000 to $10,000,000

34%

$10,000,000 to $15,000,000

35%

$15,000,000 to $18,333,333

38%

$18,333,333 and up

35%

Chapter 2

Making Important Business Decisions

In This Chapter

Understanding why many businesses go “solo”

Assessing the incorporation decision

Surveying S corporations, partnerships, and limited liability companies

Recognizing the value of employee benefits

As a small business owner, you face many important decisions. This chapter deals with two big ones that come up in the early days, months, and years of your venture.

First is the type of business entity you’ll operate under — sole proprietor, C or S corporation, limited liability company (LLC), and so on. This decision impacts the liability exposure you have, tax-reporting requirements, and tax-saving opportunities.

The second is the benefits your business might consider for yourself and any employees.

Choosing Your Business Entity

Many small business owners don’t fully consider (or aren’t even aware of) the options they have for the entity under which they conduct their business. Most entrepreneurs default into sole proprietor status for a variety of reasons. But you should be aware of all your choices — such as C corporations, S corporations, partnerships, and LLCs. That’s what I discuss in this section.

Sole proprietorships

If you’re interested in running your own business, odds are you’ll do so as a so-called sole proprietor. About 70 percent of self-employed folks operate their businesses as sole proprietors because setting up a business this way is easier and generally less costly than other options. In this section I discuss the advantages and disadvantages of operating your business as a sole proprietorship.

Understanding the “solo” advantages

For sure, the pros of operating as a sole proprietor (going solo) greatly outweigh the cons for most small business owners. Consider the following advantages:

Simplest tax rules and record keeping compared with other business entity options: You report your business income and expenses on Schedule C of IRS Form 1040 (discussed in detail in Chapter 8