Key Takeaways
- If you're a sole proprietor without employees or if you’ve created a single-member Limited Liability Company, you usually can use your Social Security number as your tax ID number. Otherwise, you’ll need to get an Employer Identification Number from the IRS.
- You have to decide if you will use a cash or an accrual accounting method to report your business income and expenses. Each method has different rules and can affect which tax year some of your income and expenses fall into.
- You can calculate your driving deduction by adding up your actual expenses or by multiplying the miles you drive by the IRS’s standard mileage rate.
- You’re required to pay the employer’s half of the Social Security and Medicare taxes of your employees, even if you are the only employee (self-employed). However, you're allowed to deduct the employer’s share of the FICA taxes as a business expense.
You’ve come a long way
Whether you washed cars for pocket money, sold cookies to raise money for your organization, or did something else to earn money as a kid, you’ve probably had the entrepreneurial spirit your whole life. Now that you’ve taken your business dream into the marketplace, you’ll find that things are different than they used to be.
We’ve put together a few tax tips that will make things easier for you (and please Uncle Sam), including:
- how to choose an accounting method
- what to do about estimated taxes
- which expenses to track
When you’re launching a startup, you have a lot of things on your mind, and tax considerations probably aren’t among them. But there are a few simple things you can do right now and in the months ahead to make things easier on yourself and your startup at tax time.
Take a number
You’re required to associate your startup with an ID number so the IRS can process your tax return and any other forms and documents you file.
- If you're a solopreneur—a sole proprietor and have no employees—or if you’ve created a single-member LLC (Limited Liability Company), you can usually use your own Social Security number as your tax ID number.
- Otherwise, you’ll need to obtain an Employer Identification Number (EIN) to put on your IRS forms.
- To get an EIN, apply online at the IRS website, by mail, by fax or, if you're an international applicant, you can call 267-941-1099 to apply by phone.
Cash or accrual—the choice is yours—maybe
The two most used ways to report your startup’s income and expenses for accounting purposes are the cash basis and the accrual basis. Each has different rules, and the one you choose can affect which tax year some of your income and expenses fall into.
Cash: The majority of sole proprietors and other self-employed people who don't carry an inventory of items to sell use the cash accounting method. You could call the cash accounting method the “actual” method, because when you use it, you report income when you actually receive it and expenses when you actually pay them. The cash method becomes especially important when crossing over from one tax year to another.
- For example, if you bill a client in December but don’t receive payment until January of the following year, you report the client’s payment as part of your January income, not your December income. Because that’s when you actually received the money.
Accrual: The accrual method generally ignores actual payments you make and receive. Instead, you typically report your income when you do the work and record your expenses when you incur them, regardless of when money actually changes hands. This, too, can affect year-end reporting.
- For example, if you use the accrual method and perform a service in December, you would record the income for that service in December, even if you were not paid until January of the following year.
Quarterly tax payments
If your startup expects to owe at least $1,000 in taxes next year, you're usually required to make four estimated tax payments throughout the year. An exception is that you don't have to pay estimated tax for 2024 if you had no tax liability for the full 12-month 2022 tax year. These payments should add up to an amount that will cover your tax year’s federal income tax liability.
Usually, your estimated taxes need to be paid in quarterly installments on the following due dates:
- April 15 (Q1)
- June 15 (Q2)
- September 15 (Q3)
- January 15 of the following year (Q4)
If you plan to mail your payments to the IRS, enclose Form 1040-ES with your payment. If you prefer to pay electronically, you can enroll in the Electronic Federal Tax Payment System, known as the EFTPS. If you apply for an EIN for your startup (see “Take a number” above), the IRS will enroll you in the EFTPS automatically, but you'll need to complete the enrollment process to actually use it.
Social Security and Medicare taxes
If you were an employee before you launched your startup, you probably know that you and your employer each paid half of the Social Security and Medicare taxes referred to as Federal Insurance Contributions Act (FICA).
If your startup now has employees, you're now the employer and are required to pay the employer portion of their FICA taxes.
- If you pay an employee more than the Social Security Wage Base in a year, neither of you're required to pay the Social Security tax on income above that level.
- But, you both have to continue to pay the Medicare portion of the FICA tax. That amount equals 1.45% of the employee’s wages, again paid by each of you.
- FICA taxes have to be sent to the IRS periodically—how often depends on the how much you have to pay. The more that you have to pay in a year the more often you have to send in the payments.
- Fortunately, you're allowed to deduct the employer’s share of the FICA taxes as a business expense.
Paying self-employment taxes
If you're a sole proprietor (see “Take a number” above), you're responsible for paying self-employment taxes, including:
- all of the FICA taxes—typically 15.3%—on the Social Security Wage Base of your self-employment net earnings (calculated on Schedule C of your return).
- 2.9% of your net earnings above the Social Security Wage Base in Medicare taxes.
Rules for contractors
Many entrepreneurs hire independent contractors rather than employees during the startup phase of their business. One of the benefits of hiring independent contractors is that you aren’t usually required to withhold or pay employment taxes as you would for regular employees.
- At the end of the tax year, you'll report the amount that you paid contractors using Form 1099-NEC, (1099-MISC in prior years) instead of Forms W-2 and W-3 that you would use for regular employees of your startup.
- You're generally required to report payments to contractors that are not corporations, if the amount that you pay them in a year exceeds $600.
Keep in mind that some people you might think of as independent contractors may be classified as an employee, even if they work off site. The IRS has tests to measure the amount of control an employer has over their contractors to determine if they’re really contractors or if they’re employees.
For example, you may have a hard time convincing the IRS that workers should be classified as contractors rather than employees if your business:
- pays workers an hourly wage
- tells them where to perform their duties
- reimburses them for their work-related expenses
- provides them with work-related equipment
- trains them
Some states have even tougher requirements for being able to classify workers as independent contractors rather than as employees.
For details about this important topic, see: IRS Publication 15-A: Employer's Supplemental Tax Guide.
Purchasing business assets
Using the cash accounting method, you can generally deduct most of your business expenses in the tax year that you pay for them, and in the year that you incur them if you use the accrual method. However, the rules can be different for business assets you acquire and expect to be usable for more than one year.
Most businesses are required to depreciate such assets, spreading their costs over a period of years, but the IRS has some special rules that can allow for faster expensing of these costs.
- An IRS rule, often referred to as the “Section 179 deduction,” allows businesses to deduct all or most of the total costs of business assets in the same year they’re purchased.
- This practice is called "expensing" because you’re allowed to deduct the costs of business assets in the same way that you deduct other expenses.
Many types of property can be covered by first-year expensing, including:
- Vehicles,
- Computers
- Software
- Fixtures
- Tools
- Machinery used in your business
You're allowed to expense up to $1,220,000 of your business assets covered by Section 179 during tax year 2024. That amount may be reduced if you buy more than $3,050,000 in eligible business property during the tax year.
Another type of depreciation
There’s another kind of asset depreciation that might apply to your startup. It’s called bonus depreciation. It is different from Section 179 expensing and has different rules.
Under the Tax Cuts and Jobs Act, purchased items qualifying for bonus depreciation can be new or used. Bonus depreciation typically allows for 100% expensing of the cost of items put into service before January 1, 2024.
After January 1, 2023, the percentage is phased down to:
- 80% for items put into service in 2023
- 60% in 2024
- 40% in 2025
- 20% in 2026
- Under current law, there is no bonus depreciation after 2026.
This bonus "expensing" should not be confused with expensing under Code Section 179, which has entirely separate rules.
TurboTax Tip:
To help track your deductible business expenses, open a separate bank account or use a separate credit card to pay for your startup business purchases.
Tracking your business expenses
As a startup owner, you’re entitled to many business tax deductions, but you typically need to keep your receipts as evidence of payment.
To keep your startup company’s expenses separate from your personal expenses, you may want to:
- open a separate bank account
- use a separate credit card for your startup business purchases
If you incur expenses that are partially for personal use and partially for your startup business—a mobile phone bill, for example—you need to divide the expense and deduct only the portion used for business from your taxes.
Some business expenses require special record keeping, such as automobile expenses and business-related meals.
Automobile expenses
The are two distinct ways of calculating your startup’s automobile expenses: standard mileage and actual expenses.
Standard Mileage. Standard mileage is the easy way of figuring your auto expenses.
- First, you keep track of the number of miles you drive for your startup business.
- Second, you multiply the number of business miles drove by the amount per mile allotted by the IRS, known as the standard mileage rate.
For 2024 the rate is 67 cents per mile.
- Example: You drive 10,000 miles for your startup business in 2024. You can deduct $6,700 (10,000 x $.67 = $6,700).
Actual Expenses. The actual expenses method is more complicated, but it is also more precise, and it can yield a larger deduction in some cases.
- First, you keep track of the number miles you drove for your business.
- Second, you divide this number by the total number of miles you drove for the year – both personal and business. This gives you the percentage of automobile expenses you can allot to your business.
- Example 1: If you drove 20,000 miles and 10,000 of them were for your business, the percentage of your expenses you can deduct for business is 50% (10,000 ÷ 20,000 = .50).
Third, you add up all of the expenses you spent on your vehicle throughout the year. This includes:
- gasoline
- auto insurance
- license and registration fees
- oil changes
- tire purchases
- preventive maintenance
- repairs
- parking fees
- tolls
- vehicle depreciation
- anything else you spent on your car
Fourth, you multiply the total by the 50% that you used the car for business.
- Example 2: You spent $10,000 on your vehicle. You can deduct $5,000 ($10,000 x .50 = $5,000).
In the two examples above, the standard mileage rate yielded the larger deduction. It was also much easier to calculate. But if you paid for a major repair or drove fewer miles, the actual expenses method might yield a larger deduction.
Note: You might be able to deduct part of the interest you paid on your car loan (the percentage that you used the car for business) on your Schedule C. You also might be able to deduct the business percentage of the personal property taxes you paid on your vehicle.
Business-related meals
Generally, you're allowed to deduct 50% of the total expenses of any business-related meal. Keep in mind, you need keep careful records so you can identify the business purpose of any meals for the expenses to be deductible.
In general:
- A tax-deductible meal typically is with a client or other business contact.
- You should note on the receipts the name of the person you were with and the business purpose of the meeting.
- Save these annotated receipts along your other tax records.
Office in the home
If you use part of your home “exclusively and regularly” for running your startup, you may be able to take the office in the home deduction. To qualify for the deduction:
- Your home office has to be a specific area in your home that you use for business and nothing else.
- Sharing it with your kids or using it for an after-hours entertainment center will typically disqualify it as a deductible expense.
Here are a few details about claiming the home office deduction:
- In many cases, the percentage of your home that you use for running your startup will affect the amount of your deduction.
- You’re allowed to take the office in home deduction even when you perform most of your duties elsewhere, provided that you use your home office for all of your management and administrative activities. These activities can include customer billing, the scheduling of appointments, paying bills, and ordering supplies.
- You may be able to claim the home office deduction if you use the space to store product samples or inventory.
- If the gross income generated by the business use of your home is less than your total business expenses, your home office deduction may be limited.
For more information about the home office deduction, see IRS Publication 587: Business Use of Your Home and Publication 334: Tax Guide for Small Businesses.
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