Starting A Business? 3 Steps To Avoiding A Surprise Income Tax Bill

Posted on: 14 April 2017

Starting a new small business venture comes with some new challenges and responsibilities. Dealing with the income taxes involved is one of those aspects that no one looks forward to. But, with a little advance understanding of how taxes will work and some planning, you can successfully meet the challenge. Here are 3 steps to doing so.

Meet With a Tax Preparer. To understand how your new business income will affect your income tax filings, you should begin by meeting with a qualified professional with experience in tax preparation early. Together, the two of you can work to determine what your income expectations are, what types of deductions and business expenses you will use to reduce your taxable profit, and how any credits (especially refundable credits such as the Earned Income Credit or Additional Child Tax Credit) will offset the added taxes. In particular, be sure to discuss the 15.3% self-employment tax, which is roughly equivalent to Social Security and Medicare payments taken from employee wages. 

Increase Withholding. The easiest way to pay any additional income taxes and the new self-employment tax is to have it paid from wage withholding. While you can't directly pay business withholding, you can have additional amounts taken out of any employee checks that you (or your spouse, if filing jointly) earn. Since income taxes and self-employment tax is all pooled into one lump sump in your final tax bill, it doesn't matter from what source payments are made. In addition, it's not unusual for a new business to make little profit or even have a loss after their first year or two due to high startup expenses and few customers. This means that you may find that your existing wage withholding covers what little added income you have. 

Pay Quarterly. The mechanism for paying taxes throughout the year when you don't have any source of withholding is called quarterly estimated payments. Using a voucher form or paying directly on the IRS website, you can send in money to help cover your expected tax bill at the end of the year. As their name implies, these payments are generally expected once every three months (generally due on April 15, June 15, September 15, and January 15 of the following year). It's best to keep these payments relatively uniform throughout the year unless you have a seasonal business that gains the bulk of its income at a particular time. If you're having trouble estimating annual business income, you can generally at least avoid IRS penalties by sending in the equivalent of last year's tax bill. 

Understanding how to pay your taxes during the year will help you approach entrepreneurship with confidence and use your money wisely to grow both your business and your personal finances. 

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