Tax Considerations for New Business Owners

Have you ever considered running your own business? Parsec Director of Tax Services Brad Burlingham outlines some key tax considerations.
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Have you ever considered running your own business? Turning a dream into reality is truly one way to thrive. It can be very appealing to think about creating your own work environment and following your interests on your terms.

As an example, let’s consider the case of a retiree, Mr. Tilt A. Whirl, who desires to mix business with pleasure by putting his experience to work as an amusement park consultant. It has been his lifelong dream to get paid for riding roller coasters. His first steps to making this happen should include asking himself several important questions.

Are there legal liability considerations?

Since accidents while pursuing fun are not unheard of, Mr. Whirl would want to consider running his business as either a limited liability company (LLC) or corporation to protect his personal assets from claims against his business. If he takes the path of forming a corporation, he will likely desire to file small business corporation election documents with the IRS. “S-corporations” more easily avoid double-taxation of business profits than other corporations.

Do I need a partner or co-owner?

Mr. Whirl may decide he wants a co-owner to provide cash, share liabilities, give creative input or assist in running the business. Getting this help would require an LLC operating agreement or corporate documents laying out the owners’ respective responsibilities. It would also mean filing either a partnership tax return (Form 1065) or S-corporate return (Form 1120-S). If Mr. Whirl runs his business alone as a single-member LLC, he can forgo the cost of an additional tax return and report the income and expenses on his personal tax return, as a sole proprietor, on Schedule C.

Will the business require debt?

If Mr. Whirl conducts business with a briefcase and a laptop, he may not need any financing. But if he incurs debt to buy property or provide capital, this can affect both the deductibility of his business expenses and the tax treatment of money he withdraws from the company. If he expects either business debt or years of loss before recognizing income, filing as a partnership rather than an S-corporation can provide beneficial tax treatment due to the complicated IRS “basis” rules.

How much profit will be subject to taxation?

Business profits may be subject to not only income tax, but self-employment tax. Self-employment taxes are Medicare and social security taxes imposed at a rate of 15.3%. Partnerships and sole proprietorship profits are subject to this additional tax; however, S-corporation taxes are not. (Rental operations also avoid self-employment taxes.)

However, S-corporation owners are required by the IRS to pay salaries to their owners – which means filing quarterly payroll returns, making payroll deposits and filing Forms W-2. In the end, the cost and hassle of payroll reporting may outweigh the benefit of avoiding self-employment tax. Typically, incorporating for this reason alone only makes sense when larger profits are expected. If the business is going to require employees, Mr. Whirl will need to undertake payroll reporting anyhow.

Am I in it for profit?

Whatever the legal form of his business, Mr. Whirl would need to be prepared to show the IRS that he is engaging in his business for profit, or risk losing all business deductions. Without an arguable profit motive, the IRS can decide a business is actually no more than a hobby. Thus, Mr. Whirl should be careful to keep a separate set of books, formulate a business plan that shows how he expects to show a profit at some point, and avoid comingling business assets and funds with personal ones.

You may have a dream business in mind – be it running a bookstore, being a travel guide, opening a winery, starting a goat farm, or any other pursuit. The Parsec Tax Services team can assist you in taking advantage of tax opportunities and avoiding tax pitfalls along the way.

Brad Burlingham, CPA
Director of Tax Services

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