First-Year Business Owners: Are You Ready for Tax Season?

Many people in the United States consider starting a new business to be part of achieving the “American Dream.” Each state in the US has fairly simple processes for starting a business, allowing virtually anyone to begin operating a business by offering products and services for sale. In the ten year period from 2012 to 2022, the State of Idaho saw 376,390 new business registrations. 105,531 new businesses were registered in Idaho in 2021 and 2022 alone! But during this same ten year period, the state saw 99,647 businesses close up shop.

The failure rate of new businesses is high. The Bureau of Labor Statistics reports that 21.2% of new businesses fail in their first year. Almost half of these failures are caused by simply running out of cash, according to a 2022 Skynova survey. One of the biggest and unplanned cash outflows for new businesses is tax liability and compliance costs.

In my experience as a CPA, I have worked with hundreds of entrepreneurs in starting up their businesses. I’ve found that many new business owners enter their first tax season unprepared to face some common issues, such as:

• The importance of the entity type they have chosen to operate as (LLC, Corporation, Sole Proprietor, etc.)
• New taxes they have never heard of that now have to be paid (self-employment tax)
• Mistakes that may have been made regarding payroll taxes that now must be corrected (unpaid payroll taxes, preparing W-2’s, etc.)
• The cost of having an accountant help them with filing requirements.

These issues may have never even crossed the minds of new business owners. Or, perhaps, they don’t want to think about them and choose to keep that pandoras box closed until a letter shows up from the IRS. At that point, the owner may assume he/she can just plead ignorance and never have to truly deal with these new issues.

This is the very reason I entered the accounting industry in the first place. I’ve always wanted to help business owners achieve their dream. I understand the apprehension and anxiety a new business owner feels about addressing these topics. Rest assured; the reality is not nearly as dark as you think it is. But the sooner we can address these issues, the better, starting with the business entity choice.

Business Entity Choice

Many people thinking of starting a business simply choose to open a Limited Liability Company (LLC) because a friend told them to, or they read a book that talked about an LLC’s benefits, or they’ve heard of LLC’s before and they look less daunting than starting a “corporation”. When it comes to federal income taxes though, there’s no such thing as an LLC tax return. Instead, when you let the IRS know you’ve started an LLC, by applying for an Employer Identification Number (EIN), the IRS has some default ways of treating the new LLC. There are also options you may be unaware of beyond these “default” options. Depending on the entity type you will file a tax return as (single-member LLC’s are taxed as sole proprietorships by default, multi-member LLC’s are taxed as partnerships by default), there are a multitude of tax consequences that come into play. Making an election to be taxed as a different entity type may be more advantageous. What entity type should your entity be taxed as? As a CPA, I’ve addressed these same questions hundreds of times. Let me help. The choice of entity type may have exposed you to new tax types you didn’t even realize existed.

Self Employment Tax

Self-employment tax is often the biggest tax hurdle that is commonly overlooked by new business owners in their first year. To keep things simple, new business owners who have always self-prepared their tax return decide they can probably keep preparing their own tax returns. They will just have to answer some questions about their new business in the tax software (Turbo Tax, Tax Slayer, etc.) and provide the system with some information on business income and expenses. How hard could it be? The business owner may know that, after expenses, the business made $30,000. Their taxable income will simply increase by that much, they will pay the income taxes on that amount at around 12%, and they’re done. But self-employment tax rears its ugly head and tacks on an additional 15% on top of the 12% income tax. The business owner, who initially thought they would have to pay $3,600 in income taxes on this amount at most, is now faced with a bill for $8,100 for this $30,000 made in the new venture. Some simple planning with a CPA can pay huge dividends. Minimizing taxes to the greatest extent possible is what we do. If we aren’t doing that, then what does the CPA profession even exist for? Making sure that the tax return is accurate is priority number one. But helping a taxpayer to not pay a dollar more in taxes than is necessary is priority number two.

Side note: there’s a big difference between tax evasion and tax avoidance. Tax avoidance involves using the tax code to your advantage to utilize legitimate and legal tax provisions to minimize your tax bill. Tax evasion is illegal and includes employing tax provisions for which the taxpayer does not qualify to pay less in taxes than should be paid. Tax evasion can lead to fines and even jail time. The only thing that should be avoided in this case is a tax preparer enabling you to commit tax evasion.

Payroll Tax Compliance

The first year of operating a new business almost always means making mistakes and making lots of them. A common mistake new business owners make is failing to comply with payroll tax obligations. Normally, this isn’t because the new business owner is negligent, because “you don’t know what you don’t know.” Unfortunately, this excuse won’t preclude you from having to pay social security, Medicare, and unemployment taxes on amounts paid to your employees. And it won’t appease an employee who comes to you in January asking for their W-2. Getting out in front of this and knowing that you are in compliance with payroll tax laws, makes running a business so much easier. The government (federal or state) does not mess around when it comes to payroll taxes. Penalties are much higher and collection efforts are much more aggressive. You don’t want that headache, so use a professional to keep you on track with payroll taxes.

Accountant Fees

Like most professional services, accounting and tax help does not usually come cheap. In fact, I would argue that a business owner should be wary of unusually low fees charged by an accountant, as that accountant may be lacking in quality of service. CPA’s charge high fees because the dollars we are saving you in taxes (and potential penalties when you mess up) are almost always much higher than our fee.

The fees charged by accountants are not meant to take advantage of an individual or business. It’s a reflection of the value we provide. The hours spent studying for the CPA exam, and years spent in a bachelor’s degree program and a master’s degree program, did not come cheap or easy. But the result has enabled me to help business owners run their small enterprises more efficiently and at less cost than they could do on their own. I will admit that there are some individual tax returns where I cannot add more value than is receive from a self-preparer software like Turbo Tax, and I’ve told those individuals this. When it comes to business entities though, I can almost always save a business owner more in taxes than what I charge in a fee by a long shot.

Here we are in the last month of the year that for some businesses is the first calendar year of operations. These business owners are beginning to feel apprehensive about what lies in store for them when they prepare their tax returns in the next couple of months. Put your mind at ease, hop on a phone call, and let’s put together a tax strategy for your new business so you can enjoy the exciting adventure of being a business owner.