First-Time Filing: The Entrepreneur’s Guide to Taxes
Getting started as an entrepreneur is exciting, but even with this thrilling career path, you still have to face the annual challenge that befuddles millions of Americans: taxes.
Taxes are often perplexing, but you’re capable of learning the intricacies of this necessary part of business. Although it’s challenging, becoming knowledgeable about your taxes can help you on your journey to financial security and entrepreneurial greatness.
In this article, we break down important information you need to know when getting started with your taxes, including the different legal entities and essential tips for saving money. Let’s dive in!
Filing Business Taxes for the First Time as an Entrepreneur
Filing your taxes as an entrepreneur may seem incredibly daunting at first, but the reality is that being an entrepreneur doesn’t differ from standard tax filing as an individual or business. The Internal Revenue Service (IRS) doesn’t officially define entrepreneurs in its tax codes, and they don’t have unique rules for entrepreneurs.
So what does this mean?
It means that the way in which you file your taxes depends on your business’ legal entity. Your business can be a sole proprietorship — which is common for entrepreneurs — partnership, Limited Liability Company (LLC), S corporation, or C corporation.
We’ll discuss each of these categories in detail in a later section, but first, let’s discuss what you need to know when filing as a sole proprietor.
How to File Taxes as a Sole Proprietor
When you start out as an entrepreneur, you’ll default as a sole proprietor until you register your business as a different legal entity.
The IRS defines a sole proprietor as someone who “owns an unincorporated business by himself or herself.” If your business’ earnings net more than $400, you are legally required to file Schedule C with Form 1040, and you must also file Schedule SE with Form 1040. With Schedule C, sole proprietors report their profits and losses to the IRS, and sole proprietors use Schedule SE to calculate self-employment taxes that are due on net earnings. The Social Security Administration then uses the information on Schedule SE to calculate social security benefits.
If you net less than $400, you’ll still need to file an income tax return if you meet any of the requirements in the IRS’s Form 1040 and 1040-SR instructions.
Another essential thing to keep in mind is that you’ll need to pay estimated taxes if your business will likely make more than a $1,000 profit after subtracting tax credits and withholdings. If you’re filing your taxes on a standard tax calendar, your filing dates will be around April 15 (first quarter), June 15 (second quarter), September 15 (third quarter), and January 15 of the following year (fourth quarter).
The typical calendar year filing tax date is April 15, but if you’re operating on a fiscal year basis, you’ll need to file before the 15th day of the fourth month after your tax year concludes.
This may sound complicated, but it’s actually quite simple. The calendar year filing tax date is April 15, and that’s four months after December, the final month of the standard tax year. If your business operates on a May-April schedule, your tax date will be August 15 because August is four months after April.
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When to File Taxes as a Different Legal Entity
Choosing to file as a different legal entity than a sole proprietorship may provide you with distinct tax benefits. There are pros and cons to filing as a partnership or corporation, so it’s important to take the time to understand the differences before filing.
When two or more people operate a business, they form a partnership, and all of the partners share the business’ liability and profits.
If you partner up with one or more people, you are required to file an annual information return, form 1065, U.S. Return of Partnership Income. This form reports the partnership’s profits and losses, deductions, and credits.
All of the tax deadlines are the same as sole proprietorships, and the partnership itself doesn’t pay income taxes. Instead, partnerships are considered “pass-through” entities, meaning that the profits and losses of the business go to the individual partners, and it’s the responsibility of partners to pay income taxes if the business is profitable in a given tax year.
Limited Liability Companies (LLCs)
Filing as an LLC is a big step for entrepreneurs. This means that the business itself is considered a separate entity, and the owner and any partners are not legally responsible for company liabilities.
When filing as an LLC, you get to decide whether to file as a sole proprietor, partnership, an S corporation, or a C corporation.
When filing as an S corporation, you’re technically both an employee and an owner of the business. Rather than retain all of the profits, the owner of an S corp and any partners instead pass on the profits and losses, deductions, and credits to the company’s shareholders.
In order to qualify as an S corporation, your business needs to be domestic, have fewer than 100 shareholders, only have one class of stock, and the shareholders can’t be partnerships, corporations, or foreign shareholders that live outside of the United States. Additionally, certain kinds of businesses are not eligible for S corp status, including insurance companies, domestic and international sales corporations, and some financial institutions.
If you file as an S corp, you and other owners of the company need to file Form 1120S, U.S. Income Tax Return for an S Corporation.
S corp filing deadlines differ from sole proprietorships. The calendar year deadline for an S corp is March 15, and the fiscal year deadline is the 15th day after the third month of the end of the tax year. For example, if the end of your S corp’s tax year is April, its filing deadline is July 15.
C corporations are essentially standard corporations that are usually owned by shareholders and traded on the stock exchange, like Apple or Microsoft. The shareholders of the business are taxed separately from the corporation itself.
These businesses must file Form 1120, U.S. Corporation Income Tax Return, and the deadlines are the same as with the S corporation.
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Taking a More Proactive Approach: Tax Preparation Tips
Although filing as an entrepreneur doesn’t inherently qualify you for special benefits, you have certain advantages because you’re in control of how you file and how you pay yourself.
Separating your personal finances and business finances is a great way to become more organized and find opportunities to save money on your taxes. You can even do this while being a sole proprietor by simply opening a new business account.
You can save money while doing your taxes by getting incredibly organized with your personal and business expenses, and that organization also helps you take advantage of all of your available deductions.
Tracking Tax Deductible Business Expenses
Tracking your deductible business expenses is critical for saving your company money. DO NOT wait until tax season to start figuring out your deductible expenses.
You may think that you’ll be able to remember every business expense or track down the potential deductibles, but developing a system for recording your deductibles throughout the year is a far more effective way to save the most money. Fortunately, there are tools you can use to easily track business deductions, such as Expensify.
What Business Expenses Can I Deduct?
The IRS states that in order for your business to deduct an expense, it must be both “ordinary and necessary.”
They define “ordinary” as something that is “common and accepted” in your field and state that “necessary” means that the expense is “helpful and appropriate for your trade or business.” Fortunately, “necessary” does not mean that the expense is indispensable.
The IRS’s emphasis on your distinct trade or business is important because an entrepreneur may deduct one item that’s completely appropriate, while another entrepreneur may deduct the same item and get audited.
For example, if you open a music recording studio, deducting a $10,000 drum set makes sense. It’s part of the trade. Alternatively, if an entrepreneur opens up a food truck and attempts to deduct the same drum set, the IRS may have some questions about the legitimacy of their deductions.
Although entrepreneurs can deduct equipment purchases, such as the drum set, they’re limited to a maximum of $25,000 on business-related equipment.
In addition to new equipment, some common business expenses include legal and professional services, renting a workspace, utility costs, employee wages, professional association fees, advertising, and employee benefits.
Deducting Automotive Expenses
To qualify for an automotive expense deduction, you need to use your car for business. You can claim the standard deduction when filing, or you can calculate your exact driving deduction by multiplying your business miles by the IRS’s standard mileage rate.
One great tool you can use to track your miles is Stride Tax, and you can also track additional deductible motor expenses, such as parking fees and tolls, that you pay while conducting business.
If you calculate your auto expenses and find that it’s worth less than the standard mileage rate, you can choose the IRS’s standard deduction.
Deducting Meals and Entertainment
In order to qualify for entertainment or meal deductions, the expense needs to be directly related to your business or closely associated with it. You need to be able to prove that the main purpose for the meal or entertainment was to conduct business.
If the meal or entertainment is not directly related to business, you need to be able to prove that you conducted business either right before or after the meal or entertainment.
Additionally, you need to have a clear business purpose for the expense, so you can’t just go out to eat with someone and deduct it unless there is a clear purpose, such as meeting with a potential client.
The meal or entertainment should also not be especially expensive, and it must also comply with the IRS’s definition of “ordinary and necessary.”
Finally, the deduction will only cover 50% of the cost of the meal or entertainment.
Deduct Your Home Office
If you conduct business from your home, you can deduct your home office. In order to qualify, you must use the home office space exclusively for business or use it for business on a regular basis. You can either deduct it with the IRS’s simplified option or the regular method.
With the simplified option, you get a deduction of $5 per square foot of your workspace within your home, so if your workspace is 100 square feet, that’s a $500 deduction. This deduction maxes out at 300 square feet. The simplified option also includes itemized deductions claimed on Schedule A of Form 1040.
When using the regular method of deducting your home office, you deduct your actual home office expenses. You do this by calculating the percentage of your home that you use for the office, a depreciation deduction for the home office, itemized deductions from Schedule A, Schedule C, and Schedule F, and more.
For the full list of potential deductions using the regular method, visit the IRS’s home office deduction page.
Saving to Reduce Taxable Income
Finally, entrepreneurs can save money on their taxes by saving toward retirement. When you save toward a traditional IRA, you can deduct your contributions up to $5,500 if you’re younger than 50 and up to $6,500 if you’re over 50.
One important note is that this only applies to traditional IRA contributions. Although there are obvious benefits to investing in a Roth IRA — tax-free withdrawals after age 59 — they are not tax deductible.
Hire Someone to Do Your Taxes to Simplify the Process and Save Money
Although you’ll likely save money by calculating your own deductions, a skilled CPA will likely save you more money. Utilizing a tax professional is also important when getting started because there are many nuances when it comes to deducting business expenses.
Consider the meals and entertainment deductions for a moment. The language outlined in the IRS’s tax code is somewhat subjective. A conversation that one person considers purposeful and necessary to the business could be considered unnecessary by another individual.
Working with a CPA helps you navigate the trickier areas of tax law so that you stay compliant with the IRS. Having trouble with the IRS early in your entrepreneurial career can be incredibly detrimental to your business ventures, so when in doubt, consult with a tax expert.
Learn More About Taxes and Other Critical Financial Resources
Taxes can be tricky, to say the least, but you don’t need to stop your tax education here. There’s an abundance of helpful resources available online to help you learn more about legal entities, deductions, and getting the most out of your money.
A few great resources for paying taxes as an entrepreneur include Investopedia, Entrepreneur, and the IRS’s website. You can also discover more helpful guides on Greatness.com for enhancing your personal finances and money mindset.
Even though getting started with taxes can be daunting, YOU are capable of learning all about the process and growing in your tax expertise.