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By Mark Oldberg: July 21, 2016: Blog
Probably the most common area where new business owners get in trouble is taxes. If you know the tax implications of your decisions when you start a business you can save money and headaches.
Let's learn a few basics of how LLCs with a sole member are treated for tax purposes.
When you start a small business, you have to think about a thousand different things. Tax planning may be forgotten in the beginning, especially as you are just trying to turn a profit. Remember these basics and that Uncle Sam is always looking for his cut and you will be started on the right foot.
LLC as Pass-Through
In its default state an LLC functions as a "pass-through entity" for tax purposes. A pass-through entity is one that is disregarded by the IRS (This doesn't affect the liability protections gained when you formed your LLC, you are still protected from liability as a limited liability company). The practical effect of this is that you will report all profits and losses on your personal tax return (1040) using "Schedule C." You will pay taxes on the net earnings of the LLC at your personal tax rate. You will also pay employment taxes, Social Security and Medicare, on the net earnings.
Paying Estimated Taxes
Four times a year you will be required to cut a check to the Federal Government (and likely your State Government also). Paying estimated taxes is the equivalent of your employer withholding a certain portion of your earnings. If you do not pay estimated taxes you will be charged a penalty. You file your estimated taxes on or before the dates below and do so by filing form 1040-ES.
Estimated taxes are due:
January 15 of the next year
For more information, links to all the forms, and a link to pay your taxes online visit: http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estimated-Taxes
Make sure to check your state's rules on filing your estimated taxes, especially because state deadlines can differ from the federal. You will have to do 2 filings, one for state and one for federal.
Advice for the Small Business Owner
Keep a separate savings or checking account for saving taxes. When you are self-employed you will have to actually pay taxes instead of just waiting on that refund check. You should periodically be putting money aside to pay your taxes. Personally I keep a checking account nicknamed Tax Account. Each month when I am paying myself, I put a certain percentage into the Tax Account. When it comes time to pay those estimated taxes I have the money ready to go.
Keep records and keep receipts for tax deduction purposes. Categorize it as you go, advertising, rent, salaries, etc. You can buy software that will help you with all of this. If you are somewhat tech-savvy, a cheap and easy way to keep track of this is to set up spreadsheets in excel. At the end of the year export it to Access and run a query on your data. You will know exactly how much you spent on each category. You can then easily translate this to your taxes and create a profit/loss statement. If this seems to be too much, it is never a bad thing to hire a good bookkeeper.
Remember one of the most important traits of a successful small business owner is being proactive. Be thinking 2 steps ahead and you will be fine when it comes to taxes.
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