That first year or two of business can be a real boon from the tax perspective. If you make very little money or have a loss, you can be looking at a significant break on your taxes. The goal for any business, of course, is to turn a profit. Once that happens, things are quite different from the perspective of taxes.
When your business hits its tipping point and starts to turn a profit, there are some things you’ll want to do to make the transition easier from a tax perspective:
•Begin making estimated tax payments quarterly.
Some experts will tell you that you’re better off waiting to make estimated tax payments on a quarterly basis until you’ve actually shown a profit. While technically this may allow you to hold onto your money a little bit longer, it’s also been the downfall for many small businesses.
Let’s say, for example, that last year your business left you with no tax obligation. You’re not required to make quarterly estimated tax payments right away.
Let’s also suppose, however, that your business has had a very successful first quarter. It’s been so successful, in fact, that you’re likely to double your business’ income over the course of the year.
If you don’t start making quarterly tax payments now, you’re going to have more money to invest in your business and help it grow. However, when it comes to tax time next year, you’ll likely be faced with a tax bill that you simply can’t pay. At that point, you’ll be looking at penalty payments as well as the back taxes.
The rule of thumb is this: if you believe your business is going to turn a profit for any given quarter, you should make estimated quarterly tax payments.
•Start thinking about your business’ structure.
For many small businesses, a sole proprietorship really is the ideal structure, regardless of how profitable your business is. For other businesses, however, this kind of growth means an increased liability, whether that’s in the form of assets, inventory, equipment, or something else.
At some point, you might want to consider separating your personal finances from your business finances. A Limited Liability Corporation (LLC) lets you own your business and pay essentially the same tax bill that you’d pay as a sole proprietor, but it provides you with protection for your personal assets in case things in the business don’t go well.
•Start saving for retirement.
One of the most important things you can do as a self-employed individual is to begin planning for your own retirement. Even if Social Security survives until you’re ready to retire, you don’t want to be stuck trying to live on that limited income.
There are a number of different retirement plan options available for the small business owner. Most of these take the form of an IRA. IRAs can be a wonderful way to set aside some money for your golden years. Roth IRAs, in particular, give you the opportunity to set aside quite a nest-egg, and not have to worry about paying taxes on the other end.
Your choice of retirement investments will have a direct impact on your current taxes, as well. Some retirement expenses are deductible, while others are not. Be sure to check with your tax expert when you’re making your retirement account plans.
•Look for additional tax deductions.
Just because your business is profitable and paying taxes doesn’t mean you want to make more estimated tax payments than necessary. Now is the time to look at your business and see if there are opportunities for other deductions.
For example, it might be time to hire your children to do some work for your business. If the child is 17 or under, you don’t have to pay Social Security taxes. Depending on how much the child makes, they may not have an income tax obligation, either. The key here – as with other deductions – is to know what rules apply and to follow them carefully.
•Estimated tax payments are a good problem.
While having no tax liability has a nice ring to it, it probably means that you’re not making a profit. You’ve dreamed of the day your business would make money, and now it’s finally here. Take some time to look at your business, and decide what tactics you can implement that will help your tax situation today.
