For small businesses, this can be especially worrisome. When faced with the high tax burden that comes with running your own business, you want to make sure that all of your I’s are dotted and T’s are crossed. But, even as tax season rears its ugly head, the best way to arm yourself against financial worry is to know what you’re paying and how you can prepare for the future.
Where the money goes
While it’s easy to simply hand over your information to a corporate tax filer or an online system, there’s always that question of, “Where is all this money going?” As a business owner, you should definitely have an idea of what goes on during the tax process. Obviously, you don’t need to study tax law for years to know all the ins and outs of what the IRS does, but a working knowledge is an advantage.
Plus, knowing where your taxes are going and what they’re paying for can take away some of the sting of watching those dollars go off to the government.
So here are the basics of what you pay. First, there’s your self-employment tax, which is 15% of your income. Then there’s federal income tax, which, depending on the size of your company, can run between 15% to 28% of your income.
And then there’s state income tax, which varies depending on which state you live in.
While you already probably know these terms, it’s important that you know where each of these taxes end up. Federal taxes (also called FIT or FED) go toward federal institutions, including Medicare and safety net programs like food stamps and unemployment. State income tax, meanwhile, goes toward funding state institutions, like education and public transportation. Both of these taxes are paid by every company, regardless of whether it’s one man in a self-employed job or a mega-corporation.
The difference between the self-employed man and the mega-corporation is the self-employment tax.
Initially, this sounds like a punishment for being self-employed, but it really isn’t. Your self-employment tax works the same as an employee’s social security tax; it puts funds away for your future use after you retire.
Why you should keep track of your taxes
Knowing where your income tax is going is great, but it’s only half the battle. You also need to know where you are spending your money. Throughout the year, you should be constantly aware and recording where the money for your business is going.
“Good recordkeeping is crucial,” says Kathleen Kiely, an enrolled agent in Los Angeles, California. “Because, at the end of the year, you can’t remember what you did in January or February. Good recordkeeping is going to be the best way to keep track of all the little expenses that actually add up.”
Any purchases must be recorded at the time that you buy them, in order to find out what will be deductible when tax time comes. Also, if any of your equipment is used for personal reasons, be sure to log the miles or hours used in both business and personal use, to get your deductibles. For example, if you use your personal vehicle to go to and from jobs, then you could deduct the costs used for business and get a deduction from it. But, if you use your work vehicle to drive your kids to school, you’ll have to subtract those costs when filing for a deduction.
The most important thing you can keep track of, though, is your employees’ pay. Not only are employees your most important (and often most expensive) asset, but they also have strict protections in place when it comes to their money. You, as their employer, are responsible for filing the taxes you have withheld from their paychecks to the government.
“If you have employees, you are withholding taxes out of their paychecks and then you’re paying it to the government. You’re just kind of acting as a middleman,” Kiely says. She adds that there can be disastrous ramifications if you do not pay their taxes.
“If you don’t pay them to the government, it means trouble, because that’s not your money. It’s someone else’s money that you’ve taken from them and that you’re supposed to send to the IRS,” she says.
Michael Lyons, a certified public accountant (CPA) with the Matthews, Carter and Boyce firm in Fairfax, Virginia, echoes Kiely’s concerns, saying that withholding taxes from the government is considered fraud. And, depending on your intent, doing so could lead to your business shutting down.
“There are certain IRS codes with criminal penalties, and failing to pay the taxes would be one of them,” he says. “However, there are differences between actively intending to withhold taxes and doing so because your business is in a tight situation.”
“There are very few people who actually withhold the money and just don’t pay out of ill intent. Usually, things are too tight, and they use that money to pay the bills instead of giving it to the IRS,” said Lyons. “So if there isn’t any criminal intent, generally the IRS will just demand that the company work out a payment plan.”
Even with a less severe sentence, the penalty for not paying withheld employee taxes will be still another fee to pay in upcoming years. So you’re much better off if you follow the rules and send in the taxes on time. And with your employees’ or independent contractors’ taxes, take extra care to file them correctly. While the ramifications of an improperly filed tax return aren’t as severe as not paying the IRS any taxes at all, they can still be costly.
“Owners are supposed to track all of their independent contractors and employees and they need to file proper statements on them, either quarterly or annually,” says Kiely. “And if they don’t, then the financial penalties can be excessive.”
How you can save money in the future
Most purchases for your company are deductible, especially expensive ones like snow plows and computer programs. The “179 deduction” (which is a tax deduction on a large business purchase, such as new equipment) is especially applicable to landscape businesses. Even if your current equipment is still working, it may be better to buy a replacement in December, even if you won’t need it until June, so you can get that big deduction sooner.
“I rarely recommend that people buy things just to get out of paying the taxes,” Kiely says, “but if it’s something that you’re going to need anyway, it’s better if you buy it early. For example, if you’re going to need a new snow plow, or if your computer system is getting a little old, and you’re having a good year, you might want to go ahead and buy that equipment this year. Your interest is deductible on business-related equipment, and you can write it off.”
Aaron Blubaugh, a client of Kiely’s, owns LifeScape Designs, a landscape contracting firm in Los Angeles, California. He follows her advice of not buying things solely to write them off. “I focus more on the deals than the taxes on it,” he says. “But when I do buy things to depreciate them, I pay for them with money I have, instead of credit.”
Neither Kiely nor Blubaugh are big fans of buying things just to get the 179 deduction. But she’s helped him find other ways of getting money back through his business. Oftentimes, it’s in ways that have nothing to do with landscape work.
“I’ve gotten total tax write-offs for buying meals while I’m entertaining clients or treating my staff, as a reward for a good job,” he says. “It’ll get you about a $2,000 writeoff.”
To keep taxes under control, Blubaugh also suggests managing your company’s payment schedule. “We make sure we pay quarterly. That way, the costs don’t build up and we’re not at any risk of falling behind,” he says. “Making sure that you’ve got the money before you need it makes things a lot less stressful.”
What you can do right now
While there’s not much time left before this year’s tax deadline, that doesn’t mean you can’t start saving money now. If you haven’t yet, establishing a new Individual Retirement Account (IRA) will reduce some of your income taxes for this year. You’ll still have to pay your full self-employment tax, but every bit saved will count.
Most importantly, though, is that you start planning for next year right now. Start getting organized! Go back and look at your purchases, starting in January, and keep careful track of what else you purchase throughout the year. The traditional way of doing this is to keep a ledger, either a physical one, or by using a computer program like QuickBooks. But, if you want something a little more convenient and a little less costly, there are other ways to track your purchases.
“I think the easiest thing to do, at the very least, would be to use one credit card for all purchases,” Lyons says. “Most credit cards can give you an annual statement that makes it easier to see what you’ve bought throughout the year.”
For the more techno-savvy, Kiely says that your smartphone can end up being the best method of keeping tabs on your purchases. “Most banks have mobile apps you can download for free. With those, you can check your bank statement at any time,” she says. “So you can always keep track of what you’re spending and when.”
In addition, there are also plenty of apps to help with the taxes themselves. IRS2go, the official (and free) app of the IRS, allows you to interact with the IRS itself to ask tax questions and have them explained. Other apps can keep track of your deductibles. For instance, iDonatedIt helps you figure out how much you can deduct from charitable giving.
Even the tax filing itself can be done online! But, while the convenience of using an online company may be tempting, nothing really beats the resources offered by a real-life tax preparer.
Blubaugh, for instance, swears by Kiely. “Her service, for me, has been vital, because she’s been there from the start,” he says. “I don’t like paperwork; I don’t like figuring out any sort of financial plan. I just want to sign checks and go play in the landscape with the guys. Because of Ms. Kiely, we’ve never gotten out of whack with our finances.”
Who can help you
Depending on which services you want, you have your choice of a CPA, an enrolled agent, a tax attorney, or a licensed tax preparer. Any one of these people will be able to help you file your taxes and give advice on what you can do in terms of deductions and financing, but they differentiate in what they offer, in terms of education.
Tax attorneys specialize in income tax and the legal ramifications of running a small business.
An enrolled agent, on the other hand, is focused on tax law and dealings with the IRS, while a CPA has a wider, if more general, knowledge of accounting and taxes.
So, although any tax preparer— even an automated one on a website—can get the job done, it might be worth the extra few dollars to work with an expert in a financial area you want to know more about. Plus, that year-round availability to discuss any questions you may have about payment and purchases is indispensable.
There is plenty of work to be done before April 17, 2018. And, with the new information you’ve learned, you’ll know exactly what the government wants when the next tax season rolls around. With this knowledge, and a little extra care in your filing, you’ll be able to save as much money as possible when the tax man comes around again.