Many workers have been pushed into self-employment and freelance work this year. A leap into entrepreneurship presents a new set of tax rules.
Here are 10 key tax issues to address in the first year of striking out on your own.
1. Find a CPA or tax accountant who has clients in your line of business.
Accountants can offer far more than tax preparation services. Often, they share the best practices of other businesses they work with, say tax experts Thomas Ochsenschlager and Abraham Schneier of the American Institute of Certified Public Accountants. A bonus: They can provide leads to new clients.
2. Decide how you want to incorporate.
Choose one of the following designations: sole proprietorship, partnership, corporation, S corporation, or limited liability company. Go to http://www.sba.gov/smallbusinessplanner and click on “Choose a Structure.†Your choice determines how you set up record keeping and prepare annual taxes.
3. Set up a record-keeping system and accounting method.
There are dozens of bookkeeping software packages for small businesses. Choose one, and have your accountant walk you through the initial steps. Most programs will also generate the financial statements you’ll need to present to potential investors, bankers, and business partners.
4. Don’t forget about your self-employment tax, estimated tax, and other business taxes.
When you were an employee, you paid half of your Social Security and Medicare tax, or 7.65%, while your employer paid the other half. Now that you are self-employed, you’re responsible for the entire 15.3%.
5. Create a daily record-keeping system.
The Internal Revenue Service frowns on business owners who try to recreate expense records long after the expenses were incurred. Get in the habit of keeping a daily log of all your spending. During the first couple of years in business, you’ll rack up many miscellaneous expenses–mileage, business lunches, and office supplies. Maintain tidy, up-to-the-minute records.
6. Don’t lowball your business.
Business owners sometimes try to lower their taxable income in order to lower their taxes. They often forget that they’ll use the very same tax return to show a banker or investor that the business is profitable. Talk with a tax expert to determine your best strategy.
7. If you’re working out of your house, set up a home office according to IRS requirements.
Your home-office space should be used exclusively for business. Sitting on the couch with your laptop doesn’t qualify as a tax-deductible home business. Create a dedicated work space–apart from the home’s living areas–with all the equipment you need to do business.
8. Know the difference between startup costs and expenses from business operations.
New entrepreneurs often experience a rude awakening at tax time, when they learn that the multithousand-dollar investment they made in their startup is not deductible. The shock happens when the new business fails to generate revenues from operations during its first tax year. The IRS may not recognize your enterprise as a real business if all you have to show are startup costs and no revenues. Be prepared to deduct those expenses in later years.
9. Check in with your accountant several months before the tax filing deadline.
Don’t wait until the week before the tax deadline to find out that you have a large tax liability. The earlier you get an estimate of your tax bill, the better your accountant can advise you on how to possibly lower it.
10. Check your 1099-Misc statements against your business records.
Make sure the amount shown on the statement is the amount you were actually paid for your services.
This article originally appeared in the November 2009 issue of Black Enterprise magazine.