For many businesses, January 1 marks the start of a new tax year. And while few, if any, people attend parties on December 31 to yell out "Happy New Tax Year," businesses should nonetheless be prepared to face the tax options offered when the clock strikes twelve. Because the start of a new tax year should be a time to reconsider your business tax strategies.
One of the more important tax questions business owners may want to ask themselves is this: Do I want to continue to file my businesses taxes using the IRS' Schedule C?
As many small-business owners know, people who operate their businesses as individuals are doing business as "sole proprietors" or "self-employed persons." When filing their annual tax returns with IRS, sole proprietors are required to list their business income and business expenses on a Schedule C, or possibly a Schedule C-EZ, of their individual tax returns, the famous IRS form 1040.
If you're currently filing a Schedule C or Schedule C-EZ, here are a few considerations that may help you decide whether you and your business want "to C or not to C" in the future:
Using a Schedule C or C-EZ for your business can be easier, faster and less expensive than having to file a corporate or other type of business tax return. You can generally prepare them yourself, without the added time and expense of hiring a tax professional to do it for you.
What's even better is that beginning with this tax-filing season, the limit on business expenses for sole proprietors using a Schedule C-EZ has been increased from $2,500 to $5,000. The IRS estimates that this change will allow 500,000 more businesses to use a Schedule C-EZ, thus saving taxpayers 5 million hours of paperwork.
Not everyone, however, can file a Schedule C-EZ. To be eligible to file a Schedule C-EZ, you cannot carry any inventory in your business, you cannot have a business loss (only a profit), you cannot hire an employee for your business, and you cannot claim expenses for the business use of your home, among other restrictions.
So why would any business owner want to consider changing their business structure and not file a Schedule C?
Perhaps the main reason is, numerous tax experts believe that persons who file a Schedule C as part of their 1040 form have a much higher chance of being audited by the IRS, particularly when the Schedule C contains a deduction for a home office or the income noted and expenses claimed on the Schedule C are significant dollar amounts.
While good record keeping, combined with obtaining solid tax advice, will allow you to successfully defend yourself in an audit, they can be time consuming, expensive--if you hire that tax professional to advise you--and nerve-wracking experiences that most people would rather not have to deal with.
In addition, if you're doing business as a sole proprietor or an "unincorporated business"--and therefore must file a Schedule C--from a legal standpoint, you have unlimited personal liability for anything that goes wrong in your business. That means not only can your business income and assets be in danger but so can your personal assets.
Fortunately, a relatively easy and practical way to guard against having unlimited personal liability is change the form under which you operate your business to either a corporation or a limited liability company (LLC). You would then no longer file your business taxes on a Schedule C, but rather by using the proper forms for a corporation or LLC.
But what if you like the ease of filing a Schedule C for your business taxes yet still want to guard against unlimited personal liability? If that's your goal, then perhaps the best solution for you is to form a single-member LLC. Using this format, the IRS will generally require that you record your business revenues and expenses on a Schedule C of your personal 1040.
Not sure what to do next? With several options available to you--and numerous tax, legal and practical considerations to take into account--be sure to review your particular situation with your tax professional or business attorney before making any changes so you can be sure you're making the right decision for you and your business.
Chris Kelleher is an award-winning small-business advisor and attorney and the founder of The Law Firm For Businesses, a boutique law firm that helps entrepreneurs solve their business and legal problems.
Chris Kelleher is an award-winning small-business advisor and attorney. He's also a sought-after speaker and the founder and resident legal guru of The Law Firm For Businesses, a boutique law firm that helps business owners creatively solve their business and legal problems.