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Starting a Small Business

Tax Implications of Starting Your Own Business

by
Sherri Hastings
on
2/28/2017
Tax Implications of Starting Your Own Business

When launching a startup, knowing the tax implications can save you money and a lot of headaches. Make sure you understand these basic tax issues. 

Deductions

Generally, business expenses are tax deductible. You can use tax-deductible business expenses to reduce gross income to net income and reduce taxable income. The operative word here is “legitimate.” The deducted expense must have a legitimate business purpose.

Keep in mind that just because an expense may be deductible doesn’t necessarily mean it’s a good idea. After all, you’ve got to spend money in order to claim the deduction. Taxes are only one part of the equation when deciding to incur a business expense. 

Depreciation

Depreciation is a complex issue. Sometimes, it’s known as amortizing an asset. If an asset has a useful life of more than one year, it’s looked at as a capital asset and will need to be written off over its useful lifespan. The IRS organizes the useful life of most assets into classes and lifecycle. Depreciation is used for more expensive items like carpeting and not insignificant purchases like staplers. 

Capital assets and depreciation go hand-in-hand with Section 179. This election allows a business to expense up to $500,000 ($510,000 in 2017) of capital assets in the year of its purchase instead of deprecation them over time. It’s a useful tax planning tool for all sorts of business entities. Section 179 can be used to reinvest in the business and avoid income taxes.

Startup and Organizational Costs

Taxpayers can elect to deduct up to $5,000 of start-up and $5,000 of organizational expenses in the first year of a business.  Each of the $5,000 amounts is reduced by the amount by which the total start-up expense or organizational expense exceeds $50,000.  Startup and organizational costs are incurred before the actual operation of the business. 

Startup expenses typically include surveys/analyses of potential markets, cost of training employees, advertisements related to opening the business and travel and related costs to secure prospective customers, distributors and suppliers and more.  

Organizational fees include the cost of forming the entity, license fees and accounting and legal fees entailed in the formation of the entity. Anything over that amount the two $5,000 amounts has to be amortized over 15 years.

Federal Income Taxes

There are a variety ways to tax business income depending on whether or not the business is a sole proprietorship, partnership, LLC, S corporation or C corporation. For example, sole proprietors file a Schedule C and pay self-employment and income tax on their net income.  Partnerships and S-Corporation are pass-through entities, meaning the business profit or loss is passed through the business owners and included on their individual tax returns. C corporations are taxed directly and pay dividends to shareholders who included the dividends on their individual tax returns.

State Income Taxes

Each state has its own individual regulations and rates for state income tax. You’ll need to check with your local and state governments to see what applies. Keep in mind that state income taxes tend to change often, so it’s important to stay abreast of any changes.

Starting a new business is always an exciting venture, but there’s a lot to know and consider. Be sure you understand the basic accounting, record-keeping and tax issues that will affect your company entity type.

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Sherri Hastings

Sherri Hastings

Tim Murphy is the managing member at Murphy & Murphy, CPA, LLC, a full-service certified public accounting firm, with emphasis on tax preparation, audits of governmental, educational, and non-profit entities, retirement planning, estate planning, business valuations, litigation support, and banking. He is a Certified Public Accountant in Maryland and Virginia. Tim is also a CERTIFIED FINANCIAL PLANNER professional, Personal Financial Specialist, Accredited Estate Planner, Certified Valuation Analyst, and Investment Adviser Representative.

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