Taxes are a fact of life for all of us. Whether you’re a newly divorced mom looking to generate some income to support yourself and your family or a long-time businesswoman looking to build your own business instead of working for someone else (or maybe both) you’ll need an approach to managing – and paying – your taxes for your small business.
Taxes and small businesses can be confusing. There are a few basics every small business owner should know. These include:
- What kind of business are you?
- What kinds of taxes do you need to pay, and when?
- What kind of support do you need?
We’ll cover the first question in this article, with the remaining questions addressed in a forthcoming post.
Note: I’ve run my own small business for over 10 years, and I handled the basic taxes for my former husband’s small business for about 15 years, so I know the basics. However, I’m not a tax accountant, so please consult your CPA or tax professional for guidance on your specific circumstances.
What kind of business are you?
Deciding what type of business structure you want to use is the first thing you’ll need to consider when it comes to taxes because the types of taxes you file and the timing of tax filings varies by type of business. The 3 main kinds of small business structures are:
- Sole Proprietorship
- Limited Liability Company (LLC)
- Sub-chapter S Corporation (S-Corp)
1. Sole Proprietorship
This is the most basic and simplest type of business structure and is often the best type to start with when you first begin. In a sole proprietorship, you own the company and are responsible for its assets and liabilities. You don’t have to do anything special from a tax standpoint to establish this type of business, though you may need to comply with state and local business requirements, depending on the type of business you operate.
Example: Many freelance writers, designers, and consultants are sole proprietors. You can have a sole proprietorship even if you have a job with an employer if you do consulting or other income-generating work on the side. I have operated my freelance consulting and writing business (www.sayitwrite.net) as a sole proprietorship for more than 10 years.
2. Limited Liability Company (LLC)
An LLC is a mix of structures that offers some of the liability protection of a corporation with some of the benefits of a sole proprietorship or partnership, including simpler taxes than a corporation. There are some relatively simple steps required to form an LLC, but there are no special tax requirements. All federal taxes are passed through to the LLC members and handled on their personal tax returns. You can be the sole LLC member, or several partners can jointly form an LLC. Oftentimes, an LLC is a good choice for businesses with partners as the LLC offers some protections that a partnership alone does not.
Example: Many small business owners in areas where the potential liability is great choose to operate as LLCs to limit the exposure of their personal assets such as their homes. One divorced mom I know runs a manhole rehabilitation business as an LLC. As the owner, she makes the sales and handles the paperwork. She hires out the work, which has extensive potential liability for injury, to contract teams.
3. S-Corporation (S corp)
This special type of corporation must be created through an IRS tax election. You must first create a corporation and then apply for S corp status. The key advantage of an S corp is that its profits and losses pass through to your personal tax return. As a general rule a small business should think about becoming an S corp once its sales reach about $250,000. This is the point at which it may make economic sense to take on the added overhead and tax filing requirements to maximize overall profits.
Example: My former husband operated his entertainment business as an S corp. He paid himself a salary (a requirement for S corp status) which he was able to deduct and which qualified him to maximize retirement contributions. This status also provided liability limits, which was a plus in dealing with the many entertainers he booked in a variety of venues.
The Small Business Administration (SBA) website has more information about each of these business structures, as well as some other less commonly-used possibilities. You can find more information here. From this overview page on the SBA website you can find out more details on each business structure, including tax requirements.