Understand your business taxes with these seven questions
Your tax situation can vary from year to year depending on your business activity. Review these questions to assess which areas of your business could impact your taxes.
In the aftermath of the 2017 tax reform, many businesses are responding to significant modifications in the tax code. The changes may seem overwhelming, but the first step to making sense of them? “Slow down and do the math before making any brash decisions,” says Aaron Schwartz, CPA at New York firm Nussbaum, Yates, Berg, Klein & Wolpow, LLP.
Schwartz notes that revisiting a business’s legal structure may be a top concern, due to the implementation of a 20% deduction of qualified business income from pass-through entities such as S corporations, partnerships, and sole proprietorships. The reform also lowered the flat corporate tax to 21%, which may make a C corporation an appealing structure. “There is no one size fits all plan that will work for every business. The best structure can be different in every case depending on your individualized circumstances and long term plans for the business. Work with your accountant to find the best option for your business,” says Schwartz.
Ask yourself these questions to help understand your tax requirements and plan for any responses to the new tax laws.
What kind of expenses do you have?
Expenses and costs that result from operating your business may be deductible if they qualify as ordinary (common and accepted in your field) and necessary (helpful and appropriate). Here are a few examples:
Car or truck use: You might be able to deduct vehicle operating and maintenance costs based on a standard mileage rate. For 2019, the standard mileage rate is 58 cents a mile.
Travel: You might be able to deduct business travel expenses such as lodging, hotel, and meals.
Entertainment: You might be able to deduct some amounts for entertainment, amusement, recreation, and meals.
What’s your accounting method?
The accounting method you choose will determine when you report business income and expenses. The two most common methods are:
Cash method: Reporting income and deducting expenses in the year that you receive or pay them. Most individuals and many sole proprietors who have no inventory use this method because it’s easier to keep cash method records.
Accrual method: Reporting income and deducting expenses in the year that you earn or incur them, even if you get the income or pay the expense in a later year. Business owners that use inventory to account for income most likely use this method to account for sales and purchases.
Who owns your business?
Businesses are typically classified as C corporations, S corporations, LLCs, partnerships, or sole proprietorships, each of which has distinct advantages, disadvantages, and tax treatments. Here are a couple nuances to note:
Sole proprietorships and partnerships require pass-through taxation. This means the owner(s) directly bear all the tax responsibility of the business.
C corporations are taxed twice: once on their profits at the corporate level and again on dividends paid to shareholders. “C corporations that don’t pay out a significant portion of earnings via dividends and salary can potentially defer tax on that income by investing it back into their business,” explains Schwartz. “That can be very useful for growing your business.”
Do you have employees?
As an employer, you have tax obligations not only to yourself, but also to your employees.
You must withhold federal, state (if applicable), and — in some jurisdictions — local income tax, as well as Social Security and Medicare tax, the cost of which you split with employees.
You also have employer tax liability around Federal Insurance Contributions Act (FICA) and Medicare taxes. To ensure you pay these taxes appropriately, clarify how your employees are classified.
In which states does your business operate or sell?
Sales tax: Some states require you to collect and pay sales tax for transactions in the states in which you do business.
Franchise tax: You could be required to pay a franchise tax to do business in a state.
Did you make a large asset sale, purchase, or repair?
Qualified business property can potentially be expensed up to 100%. “Businesses that have been waiting to invest in new property or equipment may be able to get an immediate tax benefit from the reform as a result of the 100% bonus depreciation and expanded Section 179 provisions,” says Schwartz.
If you plan to purchase, lease, or repair assets, you may be able to deduct or depreciate (i.e. deduct in stages over time) all or a portion of the costs for tax purposes. This can include transactions related to capital equipment, furniture, and software.
If you obtain property that you anticipate to last more than one year, you generally must depreciate or deduct the cost over the course of more than one tax year.
If you sold a property and plan to reinvest the gains, it can be considered a 1031 exchange, which means you may be able to avoid taxation. However, there are new restrictions from the Tax Cuts and Jobs Act that may impact this.
Did you conduct any research and development?
A credit is available for businesses that increase their spending on research and experimental activities, such as energy research. However, Schwartz notes that after 2021, certain costs related to this credit will be subject to capitalization and amortization requirements, so discuss this credit with your advisor.
As changes due to tax reform take effect, it’s key to prepare a long-term plan for your business. Review these questions with your accountant or tax advisor so you can strategically approach your taxes and business structure.