With tax season right around the corner, I can feel the fear/worry/annoyance start to creep in from the self-employed. I’ve seen a ton of questions pop up in the FTF community group around taxes, business entities, and bookkeeping. I had these fears at one point too. Trying to work things out on my own, but constantly worried I wasn’t doing anything right.
I realized of all the things I should be outsourcing to someone else, taxes is the most important!
So I did.
I was so so relieved when I found Josh Bauerle from CPAonfire.com. Not only does he have some pretty well-known online entrepreneur clients, but checking out his website and blog, I could tell he knew what online entrepreneurs go through and was clearly specializing in us!
So I’ve asked Josh to come here to FTF today to answer some of the most common accounting questions. I hope this will help those of you just starting out understand what you need to be doing to make sure your business is protected & stress-free at tax time.
Did you know there are two different tax codes written for two different groups of people? No, no, it’s not the rich and the poor. The two groups I’m talking about are employees and the self-employed.
Maybe you define yourself as a freelancer. Or maybe you call yourself an entrepreneur. Or solo-preneur, or business owner or independent contractor.
Regardless of how you define it, it all means the same thing when it comes to taxes; you are self-employed. And with that there comes a whole slew of advantages and also difficulties. The key is knowing what they are and preparing accordingly.
Being self-employed comes with significant tax perks that simply aren’t available to employees. From deductions, to when your taxes are paid, the self-employed have options employees don’t.
Unfortunately, the IRS doesn’t make these advantages easy to take. In fact, without the right game plan, you can end up significantly worse off tax wise than an employee.
Here are three tips for creating a plan to maximize your entrepreneurial tax advantages (and minimize your tax liability)
1. Begin thinking of every expense as a potential business expense
As a business owner, you are suddenly entitled to tax deductions on items and experiences you took long before you ever became an entrepreneur. Here are some examples:
Phone and Internet- Although you probably had a cell phone and Internet service long before you started your business, and have continued to use them for personal reasons after starting your business, you can still deduct a portion of your bills on your tax return.
Simply estimate your business versus personal use and deduct that portion of the bill.
For example, if you spent $2,000 on cell phone charges last year, and estimate you use it 75% of the time for business reasons, then you can deduct $1,500 on your taxes.
Travel- Any travel done for business purposes is fully deductible on your tax return. For most of you, traveling for your business probably involved some type of conference, which is completely deductible.
But here’s a tip to take this deduction to the next level. The next time you want to take a vacation, plan it around a business related conference. Doing so will likely make most of your trip completely tax deductible. For example, if you are planning a vacation to Hawaii, find a conference you can attend while you are there.
Your Home- For most of you, your office and your home are one in the same. If that’s the case, a portion of your home is probably tax deductible.
Simply take the square footage of your home office or storage area, divide it by the square footage of your entire house, and you can then deduct that percentage of your mortgage interest, property taxes, property insurance, utility bills, cleaning bills and even depreciation on the home.
Or, if you like to keep things even more simple, you can deduct $5 per square foot of the room, up to a total of $1,500.
The big key here is your home office has to be a room in your house that is dedicated solely for work purposes. So no putting a computer in your guest bedroom and calling it an office.
The bottom line is, as an entrepreneur you need to begin asking yourself this question with every dime you spend; “Is this related to my business?”. If the answer is yes, chances are you can deduct at least a portion of it on your taxes.
2. Keep extensive records
Because you are entitled to so many great tax benefits as an entrepreneur, the IRS is going to keep a close eye to make sure you are doing things properly. This means you need to make sure you are documenting your income and expenses properly so you are always ready to show the IRS if any questions are asked.
Generally, you have three options when it comes to record keeping:
- Do your own bookkeeping on a spreadsheet- If you have very little activity involved in your business finances, a simple spreadsheet categorizing income and expenses would work just fine. (Download my free “Know Your Net” template here)
- Do your own bookkeeping using accounting software- If your business involves a bit more in the way of income and expenses, you can go to the next level and purchase accounting software such as Quickbooks Online or Freshbooks. This will automatically import your bank information and you can go in and easily classify it into the proper categories.
- Outsource your bookkeeping- If bookkeeping isn’t something you want to do yourself, you always have the option of outsourcing the task. You can find qualified bookkeepers for as little as $50-$150 a month, depending on how difficult your situation is.
Regardless of which option you choose, proper bookkeeping is the foundation of your businesses finances. Get this right and everything else is easy.
And one last tip, open up a separate bank account and/or credit card for your business. This will make your bookkeeping exponentially easier. If you only take one piece of advice from this article, open separate business accounts today!
3. Choose the right business entity
The business entity you choose will have a significant impact on both your legal liability and your tax liability. While many new business owners will either never form a separate business entity or jump into an LLC, because their Uncle told them it was the way to go, I highly recommend working with a CPA or attorney to determine the best entity for you and your business. (Note from Leah: it doesn’t have to be as scary as it seems! Getting set up right is seriously worth the piece of mind!)
For most of you, your choice of entity should generally come down to these three options:
- Sole Proprietor- If you are making less than $35,000 per year in net income (income after expenses) and you have no risk of being sued in your business, a sole proprietor is just fine for you. Nothing has to be done to form this entity, you simply operate under your personal identity.
- Limited Liability Company- Generally speaking, an LLC separates you from your business, so if someone sues the business, they can’t come after your personal assets. If you make less than $35,000 in net income and ARE concerned with legal liability in your business, an LLC could be a good choice for you.
- S Corporation- Like the LLC, an S Corp will protect your personal assets from legal troubles in the business. But the major benefit of the S Corp is that unlike the LLC or Sole Prop, the profits in the business are not subject to the 15.2 percent self-employment tax. There is a lot of regulations that come with an S Corp, but if you make $35,000 or more in net income, it could save you significant money on taxes.
If you are a new business, do the research necessary to choose the best entity for your business. If you are an experienced entrepreneur, periodically review your business entity to be sure it is still your best option. It’s an extremely important part of your business.
Get it Right From the Start
As we enter tax season, you are probably feeling anxious about your taxes. The good news is that these three tips will help you make this years tax season as stress free as possible. The better news is, if you implement them right now, next years tax season will be a breeze for you.
By following these tips, you can be sure you are maximizing your tax advantages as an entrepreneur while staying in line with the rules and regulations involved.
Got more questions when it comes to taxes, business entities or bookkeeping?! Let us know in the comments! Maybe I can convince Josh to come back for a follow-up Q & A 🙂