1. Deductions – Make the Most of Them

While reviewing your expenditures, remember that ‘ordinary and necessary’ business expenses aren’t just equipment and rent. Business losses can be deducted from the business owner’s personal income taxes. In addition, if you are on a business and pleasure trip, the transportation costs are deductible if you spend more than 50% of your time doing business. Check with your accountant to find out if you are making the most of your deductions.

2. Check out Tax Credits

There are a variety of valuable tax credits available that can reduce your tax liability. These tax credits include Employer Social Security Credit, Disabled Access Credit, Work Opportunity Credit, Research Credit, Investment Credit, and more. Ask your accountant what credits are available for your business.

3. Quarterly Estimated Tax

If your business has a tax bill of more than $500, you should be paying quarterly estimated taxes or you may be hit with IRS penalties which can severely impact your business’s cash flow.

4. Don’t Forget to Give

Charitable contributions can be claimed as deductions!

5. Meet Your Deadlines

Annual returns are due on April 15 for unincorporated companies and S corporations.
C corporations must file within 2 ½ months from the end of their fiscal year.
Estimated Taxes are due 4 times a year: Jan. 15th, April 15th, June 15th & Sept. 15th.
Sales Tax is due quarterly or monthly, depending on what state your business is located in.
Employee taxes are due either weekly, monthly or quarterly, depending on the size of your payroll.

6. Update Your Accounting

Spend time each year reviewing your accounting practices to ensure that your books are up-to-date and accurate. Speak with your accountant about your procedures and ask if your current computer accounting system is the right system for your business.

7. Always Keep Your Tax Documentation for Seven Years

Although no one is looking for an audit, it is better to have your documentation ready if it happens.

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Issues of liability, taxation, ease of transfer of ownership, and access to capital will help determine your optimal business structure. The decision is important and depends upon your personal goals, so you probably want to consult your business and tax attorneys.

Sole proprietors file Schedule C (or the easy version C-EZ) with their 1040 Individual Income Tax Return to report their earnings or loss from operating a business. Schedule C is just like any other attaching schedule to the 1040. You follow your nose. When the IRS says “subtract,” you do. When the IRS says, “Enter the amount here and also on line 12 of Form 1040,” you do. In the end all of your hard work is summarized by one line on your 1040 tax return showing your net profit or loss from running a business. Profits are taxed as ordinary income.

If your business earnings are above $400, you also need to file Schedule SE (SE for Self Employment) with your personal tax return. This is the point at which new entrepreneurs get a queasy feeling and start thinking, “Hey, this sort of sucks. I’m going to be paying other taxes than just income tax on my earnings.”

As a business owner, you will learn about many, many taxes of which the average employee has little knowledge. Your self-employment tax is the equivalent of employee/employer Social Security and Medicare Benefits tax, better known to employees as FICA (Federal Insurance Contributions Act). On the positive side, these contributions give you future Medicare and Social Security benefits. On the negative side, these taxes reduce the amount of money you can take home today.

Becoming aware of the taxes and tax rates you face under the different business structures is crucial to minimizing your overall taxation.

The disadvantage of being a sole proprietor is that you and your business are considered the same legal entity. If someone falls in your retail store and wins a big judgment against your retail company, structured as a sole proprietorship, that judgment is also against you as an individual. All of your personal assets are at risk. For some businesses, that is acceptable. For other businesses, it is not. Unless you form some other business structure for your company, you are a sole proprietor if you are the sole owner of your company.

If you enter into a partnership with others, unless you form a corporation or some other business structure, you will be deemed a partnership. Partnerships also offer little liability protection for entrepreneurs. Your personal assets are at risk.

To get liability protection, many entrepreneurs incorporate their business. Corporations are considered separate legal and taxable entities from the owners of the corporation. Most corporations are C-corporations, taxable under Subchapter C of the IRS code (Don’t confuse C-corporations with Schedule C to the 1040 above. They are entirely unrelated). Just as you file a Form 1040 personal income tax return and pay taxes on your earnings, so too, a C-corporation files Form 1120 and pays taxes on its earnings.

C-corporations have employees, and they have shareholders. Shareholders own the corporation. Employees render services for the corporation. You will likely be both a shareholder and an employee of your corporation. If you are an angel investor in a company, you might be a shareholder without being an employee. But, you could be on the board of directors.

There are two primary ways to withdraw money from your corporation. As an employee of the corporation, you are entitled to just compensation for any services you render the corporation. As the president of your corporation, you are entitled to a salary. So, you may have the corporation pay you a salary. This is the first way most entrepreneurs remove money from an incorporated business.

The disadvantage to paying yourself a wage is that wages are subject to various employment taxes, for example, Social Security and Medicare taxes, in addition to income tax. While corporations don’t pay self-employment taxes (you’re an employee of the corporation and not self-employed), paying yourself a wage lops off about 16% of the wage in employment taxes.

The second primary way that a corporation passes money to its shareholders is with dividend payments. Because you are a shareholder of your corporation, you can receive corporate dividends.

A corporation is a separate taxable entity. So, if the corporation earns $1,000, it pays taxes on the $1,000. Suppose $850 remains after paying corporate income tax. Suppose that this $850 is paid to you as a corporate dividend. Then, you, as an individual taxpayer, must also pay income tax on the dividend received.

After paying income tax at your personal marginal tax rate, you maybe have $600 of the original $1,000 in your pocket after all taxation. So, you effectively paid 40% of your earnings in income tax. And, this assumes relatively low tax brackets at both the individual and corporate level!

This is what is meant by “double taxation.” Double taxation usually means that a corporation has earnings which were taxed as income to the corporation. Then those earnings were paid as dividends to the shareholders. The shareholders need to pay personal income tax on the dividends received. Needless to say, you don’t want to pay an effective 40% income tax rate or more on money withdrawn from your company!

Because of the heavy tax hit, smaller C-corporations hesitate to pay dividends. The goal is often to retain the profits within the company to fund further growth and profitability. Sometimes, the long-term goal is to create a company of sufficient value so that it can be sold to another company or taken public. This provides a very profitable and tax-efficient exit strategy for entrepreneurs and angel investors alike.

Incidentally, we should notice that in many situations double taxation of corporate dividends is much more punishing than paying added employment taxes. So, some entrepreneurs try to increase their wages to very high levels. The IRS frowns upon “excessive wages” paid from a C-corporation which it feels are dividends in disguise. The IRS can reclassify ultra-high salaries as dividends.

To relieve small businesses from the burden of double taxation of dividends while at the same time offering small business owners the liability protection of incorporation, the IRS adopted the S-corporation status. By filing Form 2553, you can elect to have your corporation taxed as an S-corporation. This means it is taxed under Subchapter S of the IRS code. Unless you elect to become an S-corporation, a corporation is automatically a C-corporation.

Because S-corporation status is intended for smaller businesses, you must meet certain requirements to be eligible. For example, your corporation can only have one class of stock, have at most 75 shareholders, and have no non-individual-non-people shareholders (remember, corporations as separate legal entities can own shares in other corporations).

The difference between C-corporations and S-corporations is how they are taxed. While C-corporations are taxed as separate taxable entities, S-corporations are treated as a “pass-through entity.” In other words, S-corporations typically pay no income tax. Rather, S-corporation income flows through to the individual shareholders.

So, if an S-corporation pays dividends, those dividends will be taxed to the individual shareholder at his or her personal income tax rate. Such dividends are only taxed once. In this way, S-corporations are taxed like partnerships.

While C-corporations file Form 1120, S-corporations file Form 1120-S (S for S-corp). Form 1120-S is usually only informational in nature. There usually isn’t any tax due with the filing.

To record the flow of income to the S-corporation shareholders, two other forms are filed. Schedule K and Schedule K-1, Shareholder’s Share of Income, Credits, Deductions, etc. Schedule K-1 is shareholder specific taking into consideration the shareholder’s percentage ownership of the S-corporation. Schedule K-1 is given to each shareholder and helps the shareholder prepare his or her individual income tax return.

Because of the “pass through” nature, S-corporations are a good structure for profitable businesses from which you wish to remove most of the earnings.

Many start-up companies aren’t profitable right away. Just as income from an S-corporation flows through to the individual shareholders, so do any business losses. Such losses can offset other sources of income to reduce the shareholder’s personal income taxes. This is one reason investors with other sources of income often favor the S-corporation structure for newer businesses which anticipate losing money until the business becomes established.

Finally, while investors can divide their investment in your company into an equity portion and a debt portion and while you can create voting and non-voting shares in your corporation, the fullest variety of financial structuring can be achieved through the newest Limited Liability Company structure or the older Limited Partnership structure. (Old joke: “Why do they call them limited partnerships?” Answer: “Because you’ll only get a limited part of your capital back!”)

For example, suppose you decide to produce a film. You raise $15 million. Amazingly, your film manages to breakeven and earns your company $15 million. Suppose, you and your investors each own 50% of the corporate shares. While you might like earning $7.5 million, your investors wouldn’t be too happy about losing $7.5 million on their investment!

Yet, you might not like giving up 95% of the return and ownership of the corporate shares as a just compensation for the large risk the investors are taking. That tremendously limits your financial potential from the endeavor in the event that it is a smashing success.

So, you could imagine the investors asking for a deal like this: Until the investors receive their initial investment back, 100% of the profits of the endeavor go to the investors. Once the investors have recovered their initial investment, profits will be split 50-50 between the investors and the production company. For this deal and for more complex financing terms, a Limited Liability Company (LLC) might be your best structure.

Entrepreneurs and angel investors should study and learn about basic business structure. As the old financial saying goes, “It’s not how much you earn, but how much you keep that matters.” The wrong business structure can cost you extra tax dollars, hinder financing availability, and subject you to unanticipated risk exposure.

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I hate small business. When I think of “small business,” I imagine a couple working away to earn $50,000 a year running their own shop. Maybe a coffee shop. They have no company-sponsored health insurance, so they buy their own, paying through the nose. They have no company-sponsored disability insurance, so they buy their own. Retirement 401(k) plan with company-matching contributions and pension plans? No way. Paid vacation and sick leave? Nope, again.

And, for all this, what does the small business owner do? A lot. Running a small business is a lot of work. Many people put more time into their small business than they would put into a conventional job.

Worst of all, what happens if the owner gets sick? Each owner’s effort is central to success. The company cannot continue to function as it once did. The owners will need to sell the business (and no knowledgeable buyer will pay much for it) or abandon it. Or, if the owner remains well, maybe, for whatever reason, sales will fall and the couple will lose money or make far less.

The above is enough reason to avoid starting a small business. Starting a small business offers a poor risk-reward combination. The risks are high, but the reward is minimal. You can pat yourself on the back for being your own boss, but in reality, you will not be doing nearly as well as many employees of larger companies.

Most small businesses employ a few people, but huge job growth has never come from small business. Nor has it come from the larger public companies (Fear of getting laid off in the 1980′s was one reason some people started their own small businesses). Employment comes from fast-growth companies. Those that are medium size growing their way to larger.

There is one and only one offsetting factor to compensate the small business owner for the loss of all the above benefits and perks. That is growth. More income. More retained earnings within the company. More wealth.

But to achieve wealth demands growth of the business. It cannot remain “small” in the mom-and-pop sense. It must offer substantial sales growth potential. That is not to say that operationally the business must occupy a huge plant or office. But, the potential for growth must be intact.

This is entrepreneurship. Entrepreneurs often know a bit about small business, because when they started their companies, the companies started as small businesses. Most small business owners do not know entrepreneurship. They do not evaluate risk-reward. They do not seek to grow their business.

The lesson is never to start a small business which lacks growth potential. Always ask yourself, “What is the potential of this business?” Learn small business, yes. Learn about taxes and record keeping and all the other small business topics. But, allow for financial upswing. Seek to become an entrepreneur, not a small business owner. Entrepreneurs are well rewarded for their efforts. Small business owners are usually not.

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Business to Business hubs have sprouted up to help business buyers and sellers find each other and negotiate pricing more effectively. The Internet should make purchasing more efficient as it closes the information-pricing gap.

While some small business owners benefit from an information-pricing gap when selling their products or services, many business owners are victims to the gap when purchasing supplies, services, and raw materials.

The information-pricing gap is created when disparities in information allow some vendors to charge substantially more for the same product or service than other vendors. Ultimately, all buyers don’t have full access to all sellers. This raises the price for some buyers. And, when you pay more than you need, that extra money could have gone straight to the bottom line of your business.

Most business buyers partially overcome this gap by hound-dogging out the best deals. Making calls or paging through catalogs is part of any business. But, that takes time. And, time is money. The Internet will streamline and automate this process in the future.

With any business purchase, ask yourself if the Internet offers a more time-effective and less costly way to make the purchase. Think about how the Internet can save you money as a business buyer. Seek out small business hubs as a buyer.

Repetitive effort is another huge waste of time in small business. Whenever the same action is repeated many times for little extra benefit, time is squandered.

Consider applying for a small business loan. Each bank has its own application. If you apply for five loans in an attempt to enhance the chances of getting a loan, you fill out five different applications. Plus, maybe the sixth bank would have given you the best deal on your loan, if only you had applied to them!

Yet, the useful information you provide to each bank is substantially the same. It is largely a matter of applying different formats to the same information. However, today, sites such as livecapital.com can send out the same small business loan application to many banks simultaneously.

Whenever you find yourself repeating the same information in multiple formats, see if you can find an Internet solution that lets you streamline the application process. Try to enhance your options and selection with less work. Let intermediaries handle reformatting data!

This doesn’t imply that you never want to customize a presentation or that you don’t have vendor preference. You certainly do, and you must take this into account. Relationship building is valuable. For example, you will probably favor your current bank for your small business loan, as it helps solidify your existing relationship.

If you are a contractor, or if your business serves other businesses, seek hubs as a business supplier. Contractors can’t pursue business opportunities they don’t know about.

The Internet makes opportunity more available to all small businesses. Rather than depending upon the customer to find your web site via a search engine, seek leading, niche-based, portal sites to generate business for your company.

Today, many larger companies which outsource contract work have online request-for-quote programs, and, in the future, this will be an explosive growth area. Similarly, many Internet hubs help match freelancers and consultants with businesses needing specialized services. Currently, however, many of these sites seem little more than a posting place for resumes.

New consultants benefit from online hubs matching consultants with companies not only because it is an outlet for their services, but also because it shows them what other consultants are doing. The Internet shows new entrepreneurs business opportunities by profiling what other entrepreneurs are doing.

The Internet is great for industry research. For example, if you contemplate starting a new business, you can go to hbsp.harvard.edu and see if any there are any business case studies relevant to the industry you contemplate.

Many of the new business hubs are constructed with XML, Extensible Mark-Up Language, which is designed to allow the seamless sharing of information between different companies and databases. While HTML encouraged companies to develop information-rich, static web pages, the newer XML will encourage industries to establish their own standards for the exchange of information. XML will encourage industry collaboration. Eventually, every major industry will have at least one or two hubs effectively serving it. The key words are eventually and effectively!

Nick Earle and Peter Keen, authors of From .com to .profit: Inventing Business Models That Deliver Value And Profit, write that the business hubs that succeed will become powerful brands, largely supplanting the power of product branding. But, to succeed, the authors write that these portal sites must be value-adding intermediaries, not value-taking intermediaries.

Earle and Keen write, “…invention today pushes toward new forms of intermediation: becoming a value-adding middleman, coordination point, or broker. The many companies applying it often target an entire supply chain, distribution system, or manufacturer-consumer relationship chain that is anything but value-adding. The existing intermediaries in that context are value-taking, gaining high commissions because of the fragmentation of communication, lack of coordination, and information gaps between buyer and seller.”

To see if a business hub is value-adding, Earle and Keen pose the question: “Where do we become indispensable to customers and business partners?” That’s a good question for entrepreneurs developing the thousand or so new business portal sites.

Unfortunately, many of these portals fail in several key areas. First, they are not nearly effective at seeking out the best prices as they might be. Too many key companies aren’t participating or aren’t listed at some of the portals.

While it’s relatively easy for consumer sites such as mysimon.com to do a great job of querying multiple, established booksellers and finding the best price on a book, many of the new business portals fail dismally when seeking value buying standard office supplies. Partially, this may be due to the wide range of possible product alternatives. But, there is no reason for major office supply players, such as quill.com, not to be included. If the site only lists its own products, that’s not value-adding!

Second, the sites which offer many vendors often fail to give the potential buyer insight into the quality of the firm offering the product or service. It seems the portals will need to develop some method of objectively rating the quality of little-known suppliers, especially of business services and custom contracting work. Some small business owners pay more for established reputation and quality. We all like to do business with established companies we trust. Portals which deliver quality are value-adding.

In addition to trusting established brands, small business owners also have networks of people and companies they respect and trust. It will be difficult for portals to transfer this community of personal trust and reliability to larger, online communities.

So, until someone creates your dream business portal, this means that in addition to making calls and paging through catalogs, you will now also want to spend some time clicking around on some business portal sites.

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Before you barter, make sure you research how your transaction will be taxed. For example, the owner of an apartment building who exchanges free rent for goods received should report the barter as rental income on Schedule E, which is different from other types of bartering, Barger says.

If you’re not sure how to barter for business, sign up with a bartering organization that can connect you to other businesses that might need your goods or services. “But above all, keep good records, and report any barter transactions on your income tax return,” he says. ”If you don’t, you may be guilty of tax evasion, and nobody wants to find themselves in that mess.”

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