Thousands of laid-off workers have been pushed into self-employment and freelance work this year. A leap into entrepreneurship presents a new set of tax rules. Here are seven key tax issues to address in the first year of striking out on your own:
Find a CPA or tax accountant who has clients in your line of business. Accountants can offer far more than tax preparation services. Often, they share the best practices of other businesses they work with, say tax experts Thomas Ochsenschlager and Abraham Schneier of the American Institute of Certified Public Accountants. A bonus: They can provide leads to new clients.
Decide how you want to incorporate. Choose one of the following designations: sole proprietorship, partnership, corporation, S corporation, or limited liability company. Visit SBA.gov and click on “Choose a Structure.” Your choice determines how you set up record keeping and prepare annual taxes.
Set up a record-keeping system and accounting method. There are dozens of bookkeeping software packages for small businesses. Choose one, and have your accountant walk you through the initial steps. Most programs will also generate the financial statements you’ll need to present to potential investors, bankers, and business partners.
Create a daily record-keeping system. The Internal Revenue Service frowns on business owners who try to recreate expense records long after they’re incurred. Get in the habit of keeping a daily log of all your spending. During the first couple of years in business, you’ll rack up many miscellaneous expenses—mileage, business lunches, and office supplies. Maintain tidy, up-to-the-minute records.
If you’re working out of your house, set up a home office according to IRS requirements. Your home office space should be exclusively for business. Sitting on the couch with your laptop doesn’t qualify as a tax-deductible home business. Create a dedicated work space—apart from the home’s living areas—with all the equipment you need to do business.
Know the difference between startup costs and expenses from business operations. New entrepreneurs often experience a rude awakening at tax time when they learn that the investment they made in their startup is not deductible. The shock happens when the new business fails to generate revenue from operations during its first tax year. The IRS may not recognize your enterprise as a real business if all you have to show are start-up costs. To avoid that unwelcome surprise, earn at least some meaningful revenue during the first year.
Check in with your accountant several months before the tax filing deadline. Don’t wait until the week before the tax deadline to find out that you have a large tax liability. The earlier you get an estimate of your tax bill the better your accountant can advise you on how to possibly lower it.
For more tax tips, check out the the October 2009 issue of Black Enterprise magazine.