If you own a business, your business's tax situation has a tremendous effect on your personal or family tax situation.
At the simplest level, the tax you pay on your business income is unavailable for you to use, so obviously it's in your interest to reduce this tax burden as much as you legally can.
As an entrepreneur, you're likely to face many more volatile income fluctuations than you would as an employee of a large company, and you need to retain absolutely every penny you can to build up a cushion in case things get rough. Saving on taxes is one very important way to reduce your costs and to keep more of what you earn.
On the other hand, owning a business also presents numerous opportunities for you to reduce your tax bill by having the business pay for things -- for example, family health benefits, a retirement plan, and perhaps even some of the expenses of owning a home, a car, and a computer -- that you would otherwise have to purchase on your own. In addition, if your spouse or other family members work in the business, you may be able to reduce your total tax bill by spreading the income and benefits among more people.
There are limits to how far you can go with these strategies, and numerous rules to follow and records to keep to make sure you stay within the parameters the IRS will permit. But if you understand the rules and the techniques that work in your favor, you can save a lot of money.
In this section, we'll clearly and concisely lay out the income tax rules that apply to your business, to help you file your taxes as quickly and accurately as possible this year, and to tell you about planning strategies you can use to reduce your tax bill in the future.
As a small business owner, your primary concerns are usually expressed in terms of maximizing your revenue, minimizing your expenses, and ultimately, improving your bottom line. When it comes to taxes, however, the goal is usually the opposite: to defer income or receive it in tax-favored forms such as capital gains or employee benefits, to maximize your expenses by making sure you claim every deduction you're entitled to, and to minimize your taxable net income.
Because of these conflicting goals, which require very different approaches, business owners sometimes fall into the trap of making important business decisions based mainly on the tax consequences.
Don't let the tail wag the dog. Make sure that you consider all the consequences of a transaction or business practice -- from a tax, financial, and strategic viewpoint -- before finalizing your decision. What sounds good from a tax perspective does not always make sense in terms of your overall business objectives.
Our discussion of the income tax issues faced by your business is organized around seven key subjects:
- Selecting your business form provides an overview of how the way in which your business is organized influences your tax situation and the way in which you'll report your income. While this book focuses on the sole proprietorship, we briefly explain how forms such as the partnership, limited liability company (LLC), C corporation, and S corporation operate from a tax perspective.
- Defining your trade or business discusses the threshold issues you need to consider, including whether you need to file as a business, how to identify your business, how to select your accounting method and year, and other preliminary matters.
- Business income discusses the types of income that must be reported on your Schedule C, and for those who carry an inventory, how to compute your cost of goods sold.
- Business deductions provides detailed explanations of the most commonly used business deductions, including car and truck expenses, travel expenses, meals and entertainment, employee compensation, health insurance, and retirement plans.
- Capital assets and depreciation shows how to handle your costs for real estate, equipment, and other long-term business assets. It also explains what to do when you sell, trade, or dispose of an asset used in your trade or business.
- Net profit, loss, and self-employment tax wraps up our explanation of how to compute your taxable net income, explains how to handle a business loss if you have one, and shows how to compute and pay your self-employment (SECA) tax.
- Business tax credits explains the federal tax credits that are available for hiring disadvantaged workers, improving access by the disabled, operating in an Empowerment Zone, and taking certain other actions the government is seeking to promote.