Small Business Tax Management Essential to Business Success
They say the only sure things in life are death and taxes. For small businesses, the adage should be if you don’t manage your taxes, they will be the death of your business! Failure to keep up with tax liability is a common pitfall for business owners, but there is no reason to fear the tax man. Setting your business up to stay on top of your federal and state responsibilities is not particularly difficult, and all entrepreneurs should be eager to develop internal systems to ensure that taxes are never a problem.
Depending on your type of business, your tax liabilities will vary. For most, the list includes state and local licenses and permits, sales and use tax, employment taxes, and, for corporations, federal and state income taxes.
Licenses and Fees
Licenses and permits vary according to where your business is based and include state entity registration fees (for LLCs and corporations), county or city business licenses, and any local permits your type of business requires. It is critical that you pay these fees on time. Failing to stay up-to-date will end up costing you more and putting the protection afforded by your LLC or corporation at risk.
Protect your business by calendaring the due dates for all fees due at least 10 business days before they are due. If your expected fees are high, as in the annual franchise tax in California or any sales-based fees, be sure to work those fees into your expense budget. You can set aside some each month or plan for the full amount the month it is due, but be sure you have enough cash to cover the bill when the time comes. Keep all license and permit information filed together — a 3-ring binder can be an excellent way to store these important papers — and develop a system for tracking the due dates of every fee.
Sales Tax
Paying the government their share of sales through state and local sales tax is a common problem for small businesses. Often, the sales tax collected in the daily receipts is deposited along with the store’s income and considered available cash by the owners. Once the due date comes around (usually once per quarter), the sales tax bill is much higher than anticipated and creates a serious cash flow problem. As in, there is not enough cash flow to cover the sales tax! A few sales tax periods later, the business is on the verge of self-destruction. These amounts add up quickly — just $100 of sales tax collected per day equals over a $9000 tax bill inside of three months!
There are a couple of easy remedies for this problem. First, consider opening a separate bank account to hold the sales tax receipts. Your accounting software or point-of-sale system will record the amount of sales tax collected each day, and you can deposit or transfer that amount to the tax account on a daily or weekly basis. This way, you are guaranteed to have the cash on hand when the tax bill is due and will be less tempted to spend the cash on other supplies or inventory. Also, you will earn interest on the deposits over the few months they sit idle. It’s not much, but it is your money!
A second method to avoid spending sales tax proceeds is to use your accounting system to determine how much cash you have available to spend. If set up correctly from the beginning, your accounting software will allocate the sales tax collected to its own account, separate from your cash on hand account. As long as you don’t rely on the actual bank balance to tell you how much you have to spend, the cash will still be there when the bill comes due.
Employment Taxes
Employment taxes are another common pitfall for small business owners. It is critical that you completely understand your responsibility as an employer before you hire your first employee. Tax liability for employees is divided between both the employee and employer — altogether, federal taxes due equal 15.3% of your employees’ pay; half is withheld from the paycheck, the other half the employer pays out-of-pocket. Therefore, the business is responsible for submitting both the amount withheld from the paycheck and the employer’s portion. If your area has a state income tax, you are liable for submitting those payments as well. Again, employment taxes are generally due quarterly, unless your payroll exceeds a certain amount or you have a poor record of paying on time.
Small business owners run into the same problem with these tax payments as they do with sales tax. Unless a system is established to set aside the correct amount due during the period, it is very difficult to come up with the full payment on time. In addition, some employers find the paperwork and withholding procedures to be confusing and just choose not to participate. As you probably have learned, ignoring a problem doesn’t make it go away! Before you hire employees, learn all you can about your tax-related responsibilities and set up your accounting software with the correct numbers.
Income Taxes
If you register your business as a corporation, you will need to file an annual federal, and possibly state, income tax return. Generally, you will be expected to submit quarterly estimated tax payments to the government so they can hold your deposits until tax time. Failure to submit the correct quarterly amounts or to file on time can result in significant penalties come tax time, so it is important to stay on top of these due dates as well. If you register your entity as an LLC, you will likely be required to submit quarterly payments for your personal income taxes. Self-employment taxes are 15.3% of your income — the same total as is normally paid by the employee and employer together. If you are taking regular distributions from your LLC, it is recommended that you set aside your 15.3% each pay period to cover your income tax due.
Bottom Line
The bottom line to tax management for your business is to understand the various types and amounts of tax due and develop a system for setting aside the cash and paying on time. Like anything else related to your business, good planning before taxes become an issue will save you a lot of headaches, and will increase your venture’s chances of success!
About the Author
K. MacKillop, a serial entrepreneur with a J.D. from Duke University, is co-founder of LaunchX LLC. The LaunchX System, a five Unit series of step-by-step startup procedures, key business software, and marketing reference books, is designed to assist entrepreneurs in developing a business idea into a successful company. Take the free Business Readiness Assessment and get on the road to business startup today.
California LLC Tax Trick