Here's a happy thought: The more money your new business makes, the more income tax you will have to pay. And that's just the beginning. You get to be your own boss, but you also turn into a tax collector for sales tax on your retail products and payroll taxes from your employees' wages.
If you choose to incorporate as either an S or C corporation, or form a partnership or limited liability company (LLC), you must file a separate business income tax return: Form 1120, U.S. Corporation Income Tax Return, for a C corporation; Form 1120S for an S corporation; or Form 1065, U.S. Partnership Return of Income, for either a partnership or an LLC. (LLCs are taxed like partnerships.)
"I do my own personal income tax return," says S corporation owner Jim Flaherty of Tosone Electric Inc. in Montclair, New Jersey, "but my accountant does the corporate tax return. Corporate taxes get so complicated, most start-up companies are afraid they'll do something wrong."
Jane Wesman, president of her own public relations firm in New York City and author of Dive Right In--The Sharks Won't Bite (see sidebar for ordering information), also recommends getting help upfront. Aside from the fear of running afoul of the IRS, Wesman points out another, more pragmatic, reason: "Doing taxes is not an effective use of a business owner's time."
If you're up for the challenge, software is available to create corporate and partnership tax returns. If your motivation is eliminating the cost of hiring a professional to do your business taxes, here's a compromise: Do your own business taxes, but have your accountant look at the final return. You may be able to cut costs without sacrificing the safety of having an accountant review your numbers and supporting work papers.
Whether you get help or go it alone, be aware that only a C corporation actually pays tax. All other business structures are "pass-through" entities that calculate the income from your business, which then "flows through" to your 1040 and is taxed at your individual rate--just like the income from a sole proprietor's Schedule C. You may also have to file a state business tax return.
If you plan to run your business as a sole proprietor, you will attach Schedule C, Profit or Loss From Business, to your federal Form 1040, due next April 15th. If your business nets $400 or more on Schedule C, you must also pay a 15.3 percent Self-Employment tax on 93.35 percent of your Schedule C income. Calculated on Schedule SE, Self-Employment tax is the sole proprietor's version of the Federal Insurance Contribution Act (FICA).
Flaherty does all the payroll and payroll tax returns for his seven full-time employees. "I also use a lot of union electricians on a project-by-project basis, and I like the flexibility of being able to cut the checks the day the job is done," he says. Most employers, however, use a payroll service, even if they have only a few employees.
Whatever your choice, you are responsible for withholding federal and state income taxes, as well as the employee's 7.65 percent share of FICA taxes from all wages. As the employer, you must also pay another 7.65 percent FICA tax on behalf of the employee, and deposit the full 15.3 percent FICA plus the income tax withholding with the IRS in a federal deposit bank.
Employer Identification Number
If you are going to incorporate or form a partnership or LLC, you must file Form SS-4, Application For Employer Identification Number, to alert the IRS that you are in business. Sole proprietors do not need an EIN unless they have employees or a Keogh retirement plan. There is no charge to file Form SS-4.
A customer should only have to pay sales tax once. That is why retailers must collect sales tax on products sold to "end user" customers, while a wholesaler does not have to collect tax from sales to retail establishments or factories that use the product in a manufacturing process. A fabric store, for example, must collect sales tax on sales of buttons to retail customers, while buttons a wholesaler sells to a dress manufacturer are exempt from sales tax, since the tax will be collected when the finished dress is sold. Consulting services provided by attorneys, accountants or public relations firms are exempt in some states. Call your state's department of revenue for information on how to register for a sales tax permit.
Small-Time Operator: How To Start Your Own Small Business, Keep Your Books, Pay Your Taxes & Stay Out Of Trouble, by Bernard Kamoroff (Bell Springs Publishing, $16.95, 800-515-8050).
Dive Right In--The Sharks Won't Bite, by Jane Wesman (Dearborn Financial Publishing Inc., $19.95, 800-621-9621, ext. 3650).