Starting your own business can be equal parts exciting and intimidating. Complying with tax requirements and regulations definitely falls into the latter category. Good news is, with some professional help, it doesn’t have to be overwhelming. You can get started with this handy checklist of things you’ll need to consider when starting your business.
Are you a hobby or a business? This may seem basic to some people, but there are several factors that the IRS takes into consideration in order to make this determination:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Does the taxpayer depend on income from the activity?
- If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
- Has the taxpayer changed methods of operation to improve profitability?
- Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
- Has the taxpayer made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
A true business is generally run for the purpose of making money and has a reasonable expectation of turning a profit. The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current tax year.
Pick your business structure. When starting your business, you will have to choose how you want it to be taxed. Sole proprietorship, partnership, S corporation or C corporation? Each tax structure has its benefits and downsides-it’s best to discuss your options with your CPA to ensure that you are making the right decision.
Apply for tax identification numbers. Your business will have to apply for an employer identification number (EIN) from both the federal and state governments.
Select an accounting method. You have two choices when setting up your accounting method: cash or accrual. Generally speaking, the accrual method means your business revenue and expenses are recorded when they are billed. Cash method means that revenue and expenses are instead recorded when you collect payment. There are federal rules regarding which option you may use. You will also have to choose whether to operarte on a calendar year or fiscal year.
Create a plan. One of the biggest components of operating a successful business is creating a solid financial plan and continuously monitoring your financial condition. This includes forecasting your financials and tracking actual performance against your projections. This allows you to course correct in a timely and efficient manner before valuable money and time are wasted.
Prepare for your tax requirements. As a business owner, it’s important to plan for your tax liability and consult with your CPA quarterly to estimate tax payments to the IRS. You may not be required to pay quarterly but should make sure you are reserving the appropriate amount for when the bill inevitably comes due. If you have employees, you’ll have to pay your share of their Social Security and Medicare taxes. We highly recommend that you hire a payroll company to ensure that those payroll taxes are being filed and paid properly.