This guest post was written by Josh Bauerle, Founder of CPA On Fire.
Maximizing Your Tax Advantages As An Entrepreneur
In the United States, there are two different tax codes for two different groups of people. While many of you may assume these groups are the “rich” and everyone else, they are actually employees and the self-employed.
Employee vs. Self-Employed
As an employee, the government gets paid first, and you get paid last. Every time your employer pays you, they are required to withhold various taxes that eat away your take-home pay. By the time you receive your check, you have likely lost 20% or more of your income to the IRS and other Government agencies.
On the other end of the tax code are the self-employed. If you fit into this category, then you receive income, your pay yourself first and your taxes last. Before you ever pay a dime in income tax, you are allowed to deduct nearly any expenses incurred while conducting your business. While employees are allowed to deduct some unreimbursed expenses in connection with their job, the type and amount of expenses they are eligible to deduct are extremely limited.
Maximizing Your Tax Advantages
In short, being an entrepreneur offers significant tax perks that simply aren’t available to employees.
From the timing of tax payments to the number of deductions you can take, entrepreneurs have the ability to greatly reduce the portion of their income going to good old Uncle Sam.
But all these great tax breaks don’t come easily.
The IRS will still try to take as much as they possibly can from the self-employed. Making the most of your tax advantages requires significant planning.
Here are three tips for maximizing your entrepreneurial tax advantages (and minimizing your tax liability):
1. Choose the right business entity
The business entity you choose will have a significant impact on both your legal liability and your tax liability. While many new business owners will either a) never form a separate business entity, or b) jump into an LLC because their Uncle told them it was the way to go, I highly recommend working with a CPA or attorney to determine the best entity for you and your business.
A few of the areas affected by the entity you choose are:
- Legal liability: Different entities come with varying levels of personal liability. The more risk involved with your business, the more you will want to factor this quality in your decision.
- Tax liability: The business entity you choose will likely have a huge impact on your business and personal tax liability. Choosing the wrong one could result in you paying significantly higher taxes.
- Tax forms filed: Some business entities are treated as an extension of your personal tax return and no separate return is necessary. Other’s require a separate tax return for the business which then “flows through” to the owners taxes.
- Additional steps required: I’ve had several clients who chose a business entity for the tax benefits, only to find out they didn’t follow all the steps required to become that entity. This usually results in paying much more in penalties than they saved with the entity. It’s important to know all of the required steps with each business entity.
If you are a new business, do the research necessary to choose the best entity for your business. If you are an experienced entrepreneur, periodically review your business entity to be sure it is still your best option.
2. Begin thinking of every expense as a potential business expense
As a business owner, everyday expenses suddenly become potential tax deductions. Your cell phone, your meals and entertainment and even your vacations can be written off on your tax return, in part or in whole, if they meet the IRS requirements of a business expense.
We will talk more about what constitutes a business expense next time, but if you are a business owner you should be thinking of every expense as a possible tax deduction.
3. Keep extensive records
With all these great tax advantages comes a bullseye from the Internal Revenue Service. According to IRS statistics, small business owners are audited six times more often than salaried employees (don’t let this scare you too much, as the chances of an audit are still very low: six percent for self-employed vs. one percent for employees).
The increased threat of an IRS audit should not stop you from taking every deduction you are entitled to. But you should keep this threat in mind with your record keeping. There are said to be three rules when it comes to dealing with the IRS:
At the very least, you should be keeping all your receipts and organizing them into various categories. A giant shoe box filled with thousands of receipts isn’t going to cut it. The more organized you are, the better off you will be.
Whether you use accounting software, a bookkeeper or a simple excel spreadsheet, keeping extensive records will both maximize your tax deductions and protect you in the event of an audit.
Enjoy the Ride
No one wants to spend all their time thinking about taxes. You didn’t become an entrepreneur to waste your days adding up receipts and checking the mailbox for letters from the IRS. By following these three tips, you will be able to minimize your tax liability, protect yourself from an audit and still enjoy the crazy ride of an entrepreneur.
This post was written by Josh Bauerle. Josh is a CPA and the Founder of CPA On Fire, which specializes in providing tax and accounting services for small business owners.