Self-employment is on the rise. Statistically speaking, the estimated total of self-employed individuals has been steadily increasing and will continue to do so over the next few years (some estimates claimed 42 million people would leave their jobs and start a business between 2017 and 2020). The timing does coincide with tax reform (the Tax Cuts and Jobs Act), but this movement is driven by a lot more than that. We could debate everything from personal reasons to the changing global economic landscape. However, for today, our focus is not on the “why”. Instead, let’s explore best practices and some of the tax strategies that may be considered.
In my years of consulting with small business owners, I always made a point to address risk. It didn’t matter if I was working with a brand-new startup or a thriving business. I had a series of questions and a general checklist of items that should always be addressed (a starter kit, if you will). I’ll clearly state that I am not an attorney and I do not give legal advice. However, if you have started or are planning to start a business, there are some things you should always consider. And if the task is not something you are able to complete on your own, then I recommend hiring a professional.
Some of my checklist items:
- Creating a legal business entity (i.e. an LLC)
- Registering for a tax ID # (EIN)
- Registering with applicable states (tax and licensing authorities)
- Researching sales tax and any other applicable reporting compliance
- Establishing a business bank account and merchant service solution
- Determining appropriate insurance coverage and types (professional liability, GL, key-man, etc.)
- If there are multiple owners of the entity, creating an operating agreement, buy-sell agreement, and employment agreements if applicable
- Creating a business plan
- Establishing a record-keeping and accounting system
Most of these (in my opinion) should be completed before conducting business or engaging with customers. Many entrepreneurs start with the product/service and the sales process as their focus, and I would strongly encourage them to make sure these other items are at least considered.
Now, let’s assume everything is in order and the business is thriving. There is an inevitable consequence to having a successful business: Paying taxes! I always told my clients that this was a good problem to have, and it opens the door for strategy. Some are in the more obvious form of maximizing deductions. Others are lesser-known or utilized, but often effective under the appropriate circumstances. This list is neither comprehensive nor applicable for everyone, but here are some examples of ways to keep the tax bill down:
- Mileage deduction (obvious, but not always utilized) The IRS allows 58 cents per business mile for 2019. This adds up quickly, but you must keep adequate records. A suggestion is to use a tracking app that keeps a log of all mileage activity
- Bonus depreciation – this was extended through 2022 currently, and allows assets like equipment to be expensed in the current tax year rather than spread out over future years (subject to IRS rules and limitations)
- S-Corporation: This is a self-employment tax filing strategy not to be taken lightly. Always consult your tax professional before making these elections.
- Maximizing contributions to retirement plans: SEP IRA and 401k plans are available options for business owners. An often-overlooked benefit is the ability to contribute more to these plans than a traditional IRA. For example, the IRA contribution limit for 2019 is $6000 (with a $1000 catch-up contribution if you are over 50), while the SEP IRA contribution is the lesser of 25% of employee's compensation or $56,000 maximum (for 2019). If you have non-shareholder employees, be certain to consult with a professional before establishing this type of plan.
- Small Business Health Care Deductions and Tax Credits: A survey of recent college graduates indicated health insurance coverage as a major factor in deciding where to work. Insurance premiums and coverage have been a big topic for businesses and individuals, so it may be a good idea to look into group coverage and any applicable credits. Again, consult a professional. Also keep an eye out for the new HRA options available January 2020.
Again, these are the more common topics when discussing taxes with business owners. There are many, many more out there and the tax code is always changing. The best way to stay ahead of the curve is to regularly consult with your trusted advisors (legal, financial, CPA). They should also be communicating with each other. A decision based solely on taxation may not be the best decision for your personal financial situation. Create a plan, and schedule times throughout the year to track your results while evaluating and updating that plan. Need help? Let us know how we can assist!