Free Continuing Education for Small Business
Jennifer: Most of my clients have a small business in some way and during all these years of experience, I feel that it is usually not the business that determines the success or failure. It is usually the business owners lack of action and lack of knowledge. So today, I hope I can give you some knowledge and you can take the necessary action to save some money on your taxes.
Let's start with our tax tip number one: choose the correct entity for a business. One of the most important choices you make as a business owner is to select the best entity for a business. There are many options available, including sole proprietorship, LLC, partnership, C corporation, S corporation.
Sole proprietorship is the most simple entity. Usually there is only one business owner and there's no separate tax return required for that business entity. Basically, you just need to file a Schedule C with your 1040. But there are some disadvantages with the sole proprietorship. One of the disadvantages is that you have to pay the full self-employment taxes of 15.3% on the net profit.
LLC is limited liability company. If you are a single member LLC, you can choose to be taxed as a sole proprietorship and there are no separate tax returns required. But you can also make the election to be taxed as a corporation or a partnership. If you have more than two members in your entity, you can form a partnership. The same as the sole proprietorship, the partnership has to pay the full self-employment taxes of 15.3% on the net profit of their share and there is a separate tax return required. It's called form 1065.
S corporation is small corporation. You have to meet certain requirements to become a S corporation and, actually, S corporation is the most popular business entity nowadays for small business owners because it can avoid federal taxation as the C corporation and it can also save on the self-employment taxes.
C corporations are any corporation that is not an S corporation. Most of the big companies are C corporations, like Microsoft, Exxon Mobile. C corporation is double taxed because the corporation has to pay corporate tax at the corporate level and the shareholders have to pay personal income tax on the dividends they received.
Today I'm not going to do into detail on these business entities because, as I mentioned before, John Huddleston is going to give a detailed webcast regarding those business entities on November the 10th from 11:00-12:00. LLC's and S corporations is explained, using them to reduce taxes. So if you're interested, you can just register at the small business webcast to get your spot.
Tax tip number two: business versus hobby. If you have a business loss, usually you can deduct from your other form of income. However, if the IRS considers your business as a hobby, then no deduction will be allowed. There are several ways that you can protect your status as a bonafide business. The [inaudible 04:21] criterion is that you have to show a profit in three of the last five years. Then you're presumed to be engaged in a business. All is not lost if you have not had any profit so far.
Here's some ways that you can show you are a legitimate business. First, you can prepare a business plan with 5 to 10 years of estimated earnings. The overall key is to make sure that your business is showing a profit overall. Always referring to a business as "a business", never to say that, "I'm in a business to save on my taxes," and always devoting regular time to a business. It is important to work a couple hours a day everyday rather than working 20 hours a week and not work at all in the next two weeks. And conducting your activity in a business-like manner. You can hire a good accountant, keep excellent records, have a good marketing plan, doing advertising in a newspaper, seeking professional advices.
If you currently have a loss and try to prove to the IRS that you're working on it to change it. For keeping excellent records, I recommend you to open a separate bank account and credit card account so that your business expenses will be separate from your personal and that will show to the IRS that you are serious about being a business owner. The IRS requires you to record the expenses at or near the event. So it is better to hire a knowledgeable bookkeeper. If you don't have a bookkeeper, try to use a text diary, text organizer or a software like QuickBooks to record your expenses. Try to record your expenses at least weekly. Otherwise you will feel that record keeping is overwhelming and you will suffer from it.
Also, the IRS requires you to keep all the receipts that is over $75 but you should always keep all the receipts because you should always assume that you will be getting an audit and if you're even in an audit, a receipt is one of your best defenses. If you want to know more about QuickBooks and how to use QuickBooks, [inaudible 07:03] to get a webcast called "QuickBooks Overview: Essentials Every User Should Know". So if you're interested, you can also register for that webcast.