by T.M. Brehmer, VPTax, Inc.
Taxes are a cost of doing business and should be viewed in that context. If you make a reasonable attempt to follow the rules, most domestic tax authorities are reasonable. If you ignore the rules, or go to extremes to avoid taxes, the results can be either expensive or just plain painful.
Entrepreneurs need to know there are essentially four types of domestic taxes: income, payroll, sales & use and property. Foreign jurisdictions may also impose value added, consumption and withholding taxes.
Income taxes, payroll taxes and sales & use taxes are paid at the business level, the shareholder/member level, or both. Property taxes are paid at the business level.
The Internal Revenue Code says that all income from whatever sources derived is taxable. Conversely, expenses are deductible only if specifically identified in the Internal Revenue Code.
The type of entity within which a business operates dictates much of who pays the income taxes. A traditional “C corporation” pays income taxes. The default status for a newly incorporated business is a C corporation. You can elect “S corporation” status thereby transferring the income tax liability from the corporation to the shareholders. If your business operates in a limited liability company (LLC), the tax liability is generally incurred by the members.
Because new businesses generally do not pay much income tax, many entrepreneurs ignore filing requirements. However, income tax returns are required and there is a surprising level of complexity surrounding the initial years of business filings.
Only specified expenses are deductible. Consequently, proper accounting for business expenses is required. Research expenses are always deductible. But, unless incurred in “carrying on” any trade or business, office rent may not be deductible. The difficulty is that the definition of “carrying on” any active trade or business is not intuitive. The devil is in the details.
If a new business operates internationally, the ability to make tax mistakes increases exponentially. Conflicting claims as to situs of intellectual property by multiple countries can put the small business in a real bind.
The adage “pay me now or pay me later” is true in the context of income taxation. A modicum of up-front planning will pay back the successful entrepreneur in spades!
Payroll taxes are unique in that they are the ultimate responsibility of corporate officers. This means that if a business fails to pay to the government payroll taxes for the benefit of employees, the taxing authority can go after the personal assets of the officer. At the start-up level, if a business pays everyone as a contractor and the IRS later determines these individuals were employees, it can get ugly fast.
Payroll tax administration, including the payment of taxes and the filing of returns, is a complex assignment. Mistakes are heavily penalized. So, use a payroll service. There are many reputable payroll services available and most have preferential rates for small companies.
Beware of local payroll taxes. Many cities impose additional types of taxes and obligations on employers.
Sales & Use Taxes
Interestingly, most start-up companies have sales & use tax problems before they have income tax issues. If you sell tangible property, you are likely required to collect and remit sales tax. Sales tax returns are also required.
If you acquire tangible property for use in your business, you must pay either sales tax to the vendor or remit use taxes to the state. This is not a difficult matter when purchases are made from nearby vendors. But if you are purchasing tangible property from out of state vendors or on the internet, it is possible no sales taxes are collected by the vendor and the business has a use tax liability that requires the business to register, file use tax returns and remit tax payments. Delinquent taxes, interest and penalties can add up quickly!
Property taxes are generally required to be paid on all tangible property used in a business on January 1st of each year. Business property holdings are reported annually to the county tax assessor’s office, which generally sends out property tax billings in the middle of the calendar year. Many start-ups are unaware of this requirement and fail to report business assets. After a couple of years of non-compliance, the past due property taxes, interest and penalties can be very expensive.
With the federal, state and local governments looking for tax revenues, do not kid yourself that you will be able to talk your way out of tax deficiencies. The kinder and gentler tax collector is a thing of the past. A reasonable investment in bookkeeping and tax advice will keep this part of the government out of your way enabling you to stay focused on the important stuff.