‘Tis the season to be… Thinking about tax. For many nascent entrepreneurs tax is just one more monkey lurking in the closet and waiting for a moment to jump on your back. When you have so many logistical, managerial, operational and strategic concerns when it comes to your business, the last thing you probably feel like thinking about is your tax, but (as with most things) forewarned is fore amed. If this is your first year in business, you won’t need to think about settling your tax bill until next year, but now is the perfect time to start getting your affairs in order.
Hence, we’ve provided this handy checklist for first year entrepreneurs to help them navigate the perilous minefield that is their year one tax return. While parenthood brings with it certain tax advantages (especially when the new tax law comes into effect) it can seem like the IRS has stacked the deck against entrepreneurs…
Know the form
Few entrepreneurs regard the paperwork as the most edifying part of running a business, but it’s certainly among the most important. Thus, so it is with your tax return as any mistakes could inadvertently increase your chances of an audit. You must decide whether you want to fill in the form on a cash or accrual basis depending on the nature of your business and the inherent expense of starting up.
Under the cash basis, income is recognized when it is collected and expenses are recognized as and when they are paid. In other words, whenever money changes hands. Under the accrual basis, income is recognized when earned expenses recognized as they are incurred. This makes the accrual basis a favorite of many businesses due to the lead time between earning, invoicing and receipt of payment. New businesses often have more unpaid expenses than uncollected income at the end of the first year so accrual basis is the best choice for most nascent businesses.
Knowing your expenses
Your first year expenses are often many and various, and its important that these are adequately factored into your return to ensure that your growth isn’t impeded by an enormous and unfair tax bill. For course, if you find yourself with an unpayable tax bill you can get in touch with a lawyer and get them to help you with a Form 656 Offer In Compromise, but let’s try and ensure that it doesn’t come to that. When it comes to expenses, while disproportionately huge expenses can be a red flag for an audit, but the IRS recognizes that startup costs may affect new businesses in this way. There is a $100,000 first year allowance for expenses like furniture and equipment which can either be taken up front or written off over 5-7 years. So long as you can prove it with a receipt or invoice, don’t be afraid to claim for it.
Don’t forget self employment tax
Many new entrepreneurs don’t recognize the difference between income tax and self employment tax and as such, fail to make adequate provision for both. Don’t let yourself be caught out and ensure that your business has sufficient cash flow to allow you to set aside your quarterly deductions.