Tax Planning for Startups & New Businesses Forming a Corporation
If you own a startup or have just formed a new corporation, you probably have a lot of questions about your company’s taxes. After all, the last thing you want is for your brand new business to start out in trouble with the IRS! For a bit of guidance, we spoke with Mike Zeiter, CPA/PFS, financial planner and owner of Foundations Financial Planning to go through some tax implications and offer a handful of tax planning tips for the newly incorporated.
Know How You Will Be Taxed
After you’ve formed a corporation, you need to understand how your business will be taxed. This will be different depending on what entity you formed:
Partnerships, LLCs and S Corps: For a partnership, LLC or S Corp, corporate profits and losses will be reported on the personal income tax returns of the shareholders. Because these types of corporations are known as pass-through entities, under the Tax Cuts and Jobs Act (TCJA) they’re eligible for up to a 20 percent deduction on qualified business income.
C Corps: C Corps are subject to corporate income tax. While partnerships, LLCs, and S Corps are considered pass-through entities and taxed accordingly, having a C Corp means your business will be treated as a completely separate taxpayer from its owners. This can lead to “double taxation:” where the company itself is taxed on corporate profits, and personal income of the owners is taxed separately on their own return.
Know Whether Income Is Subject to Self-Employment Tax
Many business owners aren’t aware that their business income may be taxed at the 15.3 percent rate for self-employment tax, and then taxed again as income at their normal tax rate, explains Zeiter.
However, there is an option for saving on your taxes (to an extent). If your business is set up as an S Corp, you can classify some of your income as a salary and some as a distribution. You’ll only need to pay self-employment tax on the income you earn as an employee; income classified as a distribution will be taxed at the ordinary rate.
Don’t Forget About Payroll and Sales Taxes
If you’ve set up your business as an S Corp with employees, you’ll need to get a payroll system set up to make payroll tax payments, advises Zeiter. And if your business sells a product (and/or offers a service in some states), you’ll also need to set up sales tax payments. The rules vary by city, county, and state, so make sure to do thorough research to see exactly what payments and rates you need to use.
Keep Detailed Records
Zeiter also tells us that it’s crucial to keep extremely detailed and organized records in preparation for tax time. “You cannot estimate your tax liability just by looking at your bank account and seeing if your balance is higher or lower than the last month,” he says. Make sure to save your receipts, either by keeping electronic copies or making a file for each year.
You’ll also want to keep your business and personal expenses separate. Open a separate business checking account, and put all your business-related expenses on a single credit card (different from your personal one). Mixing personal and business finances will only lead to headache-inducing confusion, extra work, a greater chance of error…and potentially missing valuable deductions.
Set Aside Net Income for Quarterly Taxes
If your startup or new business is set up as an S Corp, LLC, or partnership, remember that as a pass-through entity you’ll be taxed at your individual tax rate. But this doesn’t mean you’re off the hook for paying estimated taxes every quarter. Make sure you set aside some of your earnings to pay these, or adjust your payroll withholding to cover the additional tax you owe from your S Corp income.
“This would be similar to someone who has a job and a side business,” says Zeiter. “If the side business is going to cause them to owe extra taxes, instead of making quarterly payments, they could adjust their withholding from their paycheck to cover extra tax owed.”
A good practice is to set aside at least 25 percent of your net income each month to cover your quarterly taxes. “Twenty-five percent is not going to be your exact tax rate, but it’s a good estimate for most businesses,” says Zeiter. To keep your hands off of this cash, you can even keep it in a separate bank account. Make sure to send in your payment each quarter to avoid penalties!
Have questions about how to plan for taxes after your new businesses or startup has become incorporated? We’re here to help. You can speak to a representative at Incfile’s business taxes service for professional, personalized advice, and even get assistance filing your business taxes.