There is a myriad of business taxes, including home business taxes, to be paid. However, you are not obligated to overpay your taxes, and there are a plethora of deductions that reduce your taxable income.
As a new business owner, you need to know your federal tax responsibilities as well as your state tax responsibilities, and even your municipal tax responsibilities.
A great resource for basic federal tax information for people who are starting a business can be found at the IRS Small Business Website. When you get to the page, click on “A-Z Index for Business.” You will find a page called “Starting a Business.” This page provides information to assist in making basic business decisions. Although the list of topics is not all-inclusive, it is a good start to learning the issues every business owner should know about preparing their own taxes.
Related: Accounting 101
In addition to federal, state, and sometimes municipal income taxes, a business often needs to file state sales and use tax returns. See your stateÂ’s tax agency web page for more information. And look into tax software that will help you when you file.
Additionally, any business with employees is responsible for withholding, remitting, and reporting employment taxes, both federal and state. Before you become an employer and hire employees, you need a Federal Employer Identification Number (EIN) at no cost through the IRS. More information about employment taxes can be found on the IRS Employment Taxes for Small Businesses page. There are also state employment tax requirements. Your payroll service can take care of employment taxes for you as part of their service.
It pays to own your own home business
Home business taxes are favored by the federal government over employee taxes. That is because, despite the large and famous public companies, small business is still the engine that drives the American economy.
As a result, the government gives us, the taxpayers, large incentives to start our own home-based businesses by lowering our home business taxes.
Before going into specific business tax tips, it’s important to get an overview of the differences between the business tax system in general and the home business tax system specifically on one hand and the employee tax system on the other:
In the American tax system, the highest income tax rates are reserved for employees. As an employee, you can figure that about half your income will go to taxes. In addition to the amounts that are deducted from an employee’s paycheck, there are taxes that the employer pays.
From the employer’s perspective, however, all those taxes, as well as other benefits you receive, are considered part of your pay. In fact, from an employer’s point of view, you must generate value to cover not only your pay, the taxes, and benefits your employer pays for you, but also a portion of the overhead such as rent, office supplies you consume, and so on. In addition, the employer wouldn’t hire you if, in addition to that, you didn’t provide value to the managers and the owners/investors of your company.
As an employee, then, you only get paid a fraction of the real value you generate. Your real value may be more than triple what you’re paid, but most of that money you’ll never see. It goes straight into the government’s or other people’s pockets.
Keeping that in mind, here are the maximum employee income tax rates:
Consider an example of the difference in tax liability for two people, one of whom is a regular W-2 employee; the other one owns a business. Let’s assume for purposes of illustration that they both earn $1,000 and are in the 27% federal tax bracket. Only federal taxes are taken into account. State, city, and FICA taxes would make the differences even larger. They both buy a $900 computer during the year, but the business owner uses it for his business.
In the above illustration, the employee ends up in a negative cash position (-$170), whereas the business owner ends up with a positive cash position ($73). The difference in their cash flows is $243 on an income of $1,000. The reason for the difference is that the U.S. government allows the business owner to deduct the cost of the computer before calculating his taxes.
“The light at the end of the tunnel”…is the financial opportunity that starting your own business offers. Every North American taxpayer who works a full-time job and does not have a side business is probably overpaying taxes to the tune of $3,000 to $9,000 a year!”
–Sandy Botkin, former IRS tax attorney, CPA
Given that you can save thousands of dollars with the right tax preparer, choose your tax preparer carefully. I have set out various criteria for you. Find the tax preparer now that’s right for you!
Business Tax Tips for the Business Owner
Although every effort has been made to make this information accurate, be aware that tax information is not the same as tax advice, and you should not rely on the information given here. Such advice can only be properly given by qualified professionals who are fully aware of a user’s particular circumstances. You should consult a CPA or tax attorney at the proper time before you make any decisions.
Special note: The rest of this page consists of specific strategies and tips for the entrepreneur who owns a business. For those who own their own home-based business, look especially for the alerts which look like this: (home business taxes alert) in addition to the other strategies and tips that apply to all business owners.
Use a system that works best for you – one that accurately reflects your business income and expenses. Your records must support all income, credits, and deductions listed on your tax return. It’s best to keep all receipts, payment information, and tax information in one location to make filing taxes easier when the time comes. Don’t include any personal income or expenses. However, if you lend money to your business from personal funds, be sure to keep a record of the transaction to avoid including the money as taxable business income.
Although you are required to keep tax records for three years, you may want to keep them longer in some cases.
The more small business tax deductions your business can legitimately take, the lower its taxable profit will be, and the smaller your tax liability will be. In order to take advantage of the U.S. tax system, you must pay careful attention to the IRS rules as to what is deductible and what isn’t. In addition, valid deductions must have proper documentation. The bottom line is this:
- Proper Documentation is extremely important. Documentation includes your regular files such as receipts, invoices, and canceled checks. Be sure to have good documentation, especially for your business travel and entertainment deductions. ItÂ’s a good idea to keep a daily diary or appointment book which you can keep at the end of the year with the rest of your tax documentation. This diary should show appointments, where and when you travel, where you go by auto, and where and when you entertain business contacts.
- Valid Deductions are defined as ordinary and necessary business expenses. Although there are special rules when in doubt, start by asking yourself whether your deduction is ordinary and necessary in running your business. Be sure to take advantage of all business deductions your business is entitled to. It can be easy to forget some expenses when you’re filling out your tax return. The timing of booking your income and expenses depends on whether you choose the cash or accrual method of accounting when you start your business.
- With the cash method, you’ll record expenses when you pay for them.
- With the accrual method, they’re recorded when you incur them.
Records for property and equipment owned and used by the business should show the date acquired, cost, and records of usage.
Related: What does a business owner need to know about small business bookkeeping?
Special Business Tax Tips for Certain Expenses
Entertainment Expenses have special rules. 50% of your entertainment expenses are deductible if the entertainment is “directly related” to the business, and business is discussed, or it is “associated with” the business, and the entertainment takes place immediately before or after a business discussion. How much business is discussed is up to you. It’s a good idea to write the specific business purpose on the receipt.
Business Tax Tips for Entertainment Expenses:
- Discuss business when you eat
- Deduct theater tickets and other “associated entertainment” expenses
- Deduct season tickets by event (itemize each event—document who went and what was discussed)
- Feed and entertain your spouse—it’s deductible if your guest has a spouse there also. When deducting business meals, the meal must include someone other than you or your spouse. Even if both the husband and wife are in the business and discuss business at the meal it is not deductible.
- Deduct home entertainment for business purposes—if there are more than 12 people at your home, properly set it up and document it.
Business Tax Tips for Travel Expenses:
- When you travel for business, you can deduct many expenses. Among these expenses, don’t forget to deduct airfare, costs of operating your car, taxis, hotels, meals, telephone calls, tips, and cleaning your clothes.
- Transportation expenses are deductible when not staying overnight
- All on-the-road expenses can be deductible if you follow the proper rules
- Use the business car for family travel if you are driving towards a business destination
- If you combine business and pleasure, as long as you drive 300 miles a day toward your business destination, you can deduct your expenses for the day. If your family comes along, you can deduct only your own expenses unless they are helping you with the business.
- Don’t forget to deduct cleaning dirty clothes
- Take U.S. cruise ships—to be deductible, cruise ships must be registered in the U.S., all ports of call must be in the U.S., and you must submit supporting statements with your tax return
Here are some strategies to lock in and increase the amount of transportation deductions:
- Make week-ends deductible by working Friday and Monday
- Count travel days as deductible
- Add pleasure to your workdays, and the whole day is still deductible
Strategies that identify more reasons to combine business with pleasure travel:
- Visit colleagues
- Get educated out of town
Strategies for audit-proofing your travel deductions
- Keep proper receipts
- Write neatly and properly
- Keep a good daily appointment book
Business Tax Tips for Schedule C Parents with Children 7-17:
- Your children are exempt from social security and Medicare taxes when they work for you
- A small portion of their wages is tax-free and may change each year
- The standard is that you must pay your children reasonable wages for the work done
- Require a weekly timesheet
- Pay by check
- File proper forms (W4, W-2, 941, 940, SS4)
- Use a payroll service to make double sure it all gets done
Suggestions for work your children can do
- Clean office
- Clean car
- Stuff marketing packages
- Computer work
Business Tax Tips for Automobile Deductions
- If you have two cars, the newer, more expensive car will generally get you the most deductions if you use that one primarily for business.
- Convert personal cars to business use
- Pick the greater of actual expenses or IRS standard mileage rate
- Special note: In order for a business owner to have the flexibility of deducting actual expenses or mileage, the first year that deduction is taken, he must select mileage as his deduction. If he selects actual expenses in his first year, he is required to file actual expenses every year thereafter. If he selects mileage the first year, he can claim actual or mileage thereafter, whichever is to his benefit.
- If you use the actual expense method, you can also deduct depreciation on the vehicle. If you use standard mileage, it is included.
- (home business taxes alert) If you work from home, your home is the principal place of business, so deductible mileage starts at home. If you have a principal office outside the home, you must deduct the commuting mileage from home to office to determine the mileage you can deduct.
- You may keep a 90-day daily log of car use and apply the same percentage to the whole year
- When documenting automobile use in your daily log, use the following guidelines: Who, What, When, Where, and Why. It doesn’t have to be elaborate; a concise entry including the 5 WÂ’s is required.
- (home business taxes alert) If you have a home office and no other office location, then when you drive to a business appointment (meeting with a prospect, conducting business activity, purchasing supplies, going to the bank, etc.), then even if you make personal stops along the way to or from the appointment or activity, the entire trip is counted as business miles.
Business Tax Tips for Home Office Deduction (home business taxes alert) (typically worth $2,000-$5,000/yr):
Determination of your principal place of business can be made by answering these questions:
- Do you regularly see prospects in your home office?
- Do you close sales in your home office?
- Do you principally use your home office (do you not have another office you use more)?
A list of typical home office expense deductions for the business use of your home (home business taxes alert):
- Mortgage interest
- Real estate taxes
- Homeowners insurance
- General repairs and painting
- Pest control
- Depreciation of furniture
- Depreciation of your home
- Lawn service and snow removal
Home office-related deductions are based on the percentage of your home used for business. To calculate this number, divide the square footage of your office space by the total square footage of your home. Some expenses, such as office repairs, can be deducted 100%.
If your office is in a small space (300 square feet or less), you can use the simplified method to calculate the deduction, which is $5 a square foot.
Strategies for documenting home office deductions (home business taxes alert):
- Photograph your office and business get-togethers
- Prove in other ways that the space is used for a home office
- Display your home telephone number and address where appropriate for your business
- Have guests register in a logbook
- Keep a record of home office use in a diary book
- Retain receipts
Health Insurance Premiums
Self-employed business owners can deduct health insurance premiums, including health, dental, and qualified long-term care (LTC) insurance premiums unless they are eligible to participate in a plan through their spouse’s employer.
Business Tax Tips for Educational expenses:
Although as an employee, you could not deduct the cost of an education that qualifies you for a new job, as a small business owner, you can deduct educational expenses if they are related to your business. Strict rules must be followed, however.
Business Tax Tips for Business Losses:
- If your business produces a loss, the loss can be applied against any form of income
- You can carry your losses back 2 years and carry them forward 20 years
- You never lose a valid business deduction
Business vs. hobby:
- To prove your business is not a hobby, try to show a profit in three out of five years, although this is not mandatory.
- Document your business intent
- Create a business plan with projected income and expenses
- If you retail and carry inventory, have enough on hand to make it look like a business
- Work your business
- Document business trips
Business Tax Tips for deducting new equipment
Generally, equipment has to be capitalized and depreciated over a number of years. However, there is a large amount (different in different years) that can be immediately deducted under Section 179 of the Internal Revenue Code.
Business Tax Tips for deducting interest
Personal interest expenses cannot be deducted unless they are for your home mortgage. However, interest expense to finance business purchases is fully tax-deductible. That is also true if you take out a personal loan and use the proceeds for the business. Be sure, as always, to keep good business records so that the deduction is not disallowed because it is considered a personal expense.
Business Tax Tips for miscellaneous deductions
Some expenses don’t lend themselves to getting receipts. They can still be deducted if you keep records. Among these expenses, don’t forget to deduct business gifts, tips, coffee and beverage service, petty cash funds, postage, taxi and bus fare, and telephone calls away from home. Don’t forget to deduct bad debts.