Starting a business is exciting, but it also comes with tax responsibilities that are important to understand from the beginning. Whether you're planning to launch a side hustle, become self-employed, or open a full-time business, setting things up correctly can save you time, money, and stress when tax season arrives.
Here are five key tax topics every new business owner should know.
Choose the Right Business Structure
One of the first decisions you'll make is how your business will be organized. Your business structure affects how you report income, pay taxes, and file federal tax returns.
Common business types include:
- Sole proprietorship
- Partnership
- Corporation
- S corporation
- Limited Liability Company (LLC)
Each business type has different tax filing requirements and may use different IRS forms. For example, a sole proprietor typically reports business income on Schedule C, while partnerships and corporations generally file separate business tax returns.
Choosing the right structure early can help avoid complications later.
Understand the Taxes Your Business May Owe
The type of business you operate affects the taxes you're responsible for paying.
The four most common business taxes are:
Income Tax
Most businesses must pay federal income tax on their profits. The way income is taxed depends on your business structure.
Self-Employment Tax
If you're self-employed, you may owe self-employment tax, which covers:
- Social Security tax
- Medicare tax
Unlike employees, self-employed individuals generally pay both the employee and employer portions of these taxes.
Employment Taxes
If you hire employees, you may be responsible for:
- Federal income tax withholding
- Social Security and Medicare withholding
- Federal unemployment taxes
Excise Taxes
Certain industries and activities may be subject to federal excise taxes. These taxes typically apply to specific goods, services, or business activities.
Determine Whether You Need an EIN
An Employer Identification Number (EIN) is a federal tax identification number issued by the IRS.
You may need an EIN if you:
- Hire employees
- Operate a partnership
- Operate a corporation
- Open a business bank account
- Meet certain IRS filing requirements
Even some sole proprietors choose to obtain an EIN instead of using their Social Security Number for business purposes.
You can apply online at IRS.gov apply for EIN. Review this online information to determine if you need an EIN and apply as needed.
Keep Good Records From Day One
Strong recordkeeping habits can make running a business much easier.
Good records help you:
- Track income and expenses
- Monitor profitability
- Identify deductible expenses
- Prepare financial statements
- Support deductions claimed on your tax return
- Respond to any IRS questions if they arise
Examples of records to maintain include:
- Receipts
- Invoices
- Bank statements
- Mileage logs
- Payroll records
- Asset purchase records
Whether you use accounting software, spreadsheets, or manual records, consistency is key.
Choose an Accounting Method
Every business must use an accounting method to determine when income and expenses are reported for tax purposes.
The two most common methods are:
Cash Method
Under the cash method:
- Income is generally reported when it is received.
- Expenses are generally deducted when they are paid.
This is the most common accounting method for small businesses because it is straightforward and easy to manage.
Accrual Method
Under the accrual method:
- Income is generally reported when it is earned.
- Expenses are generally deducted when they are incurred.
This applies even if payment is received or made in a different tax year.
Some businesses are required to use the accrual method, while many small businesses can choose between the two methods.
Additional Information
Looking for more information? Visit the IRS Business Tax Information page for resources on starting, operating, and managing a business. You may also find IRS Publication 583, Starting a Business and Keeping Records helpful. This publication covers important topics such as recordkeeping, business expenses, accounting methods, and tax filing requirements for new business owners.
If you'd prefer a printed copy of Publication 583, you can request one by calling 800-TAX-FORM (800-829-3676).