Tax, Accounting and Legal Considerations
When Starting and Operating a Small Business
Written by: Steven J. Fromm, J.D., LL.M. (Taxation)
The key to having a successful business is planning ahead. Attention to the details of the legal formation of the business entity can be critical as initial mistakes can cause headaches later. Continuous compliance with the operational and legal details of the business are also extremely important.
Here are some basic legal, tax and accounting issues to consider when starting a business:
Choice of Business Entity
One of the first decisions you need to make is what type of business you are going to establish. The most common types of businesses options are the following:
There are various tax, legal and practical limitations that need to be considered in determining the proper entity for your operations. For more information on this see Pennsylvania LLCs and Real Estate.
The type of business may bear heavily on the choice of legal entity chosen. For example, when real estate is involved an LLC may be the best choice. For more on this go to Pennsylvania LLCs and Real Estate.
Ultimately, the type of business you establish determines which tax forms you will need to file for the operating organization.
Taxes That Impact Your Business
The type of business you operate also determines what types of taxes you will pay and how you will pay them. Generally, the following are some but may not be all of the type of taxes that a business may have to incur:
- Income tax
- Self-employment tax
- Employment tax
- Unemployment tax
- Sales tax
- Excise tax
Additionally, entities may be subject to other federal, state and local income, franchise or net income and other taxes. For example, entites that operate in Philadelphia may be subject to the business privilege tax and the net profits tax.
Obtaining an Employer Identification Number
A business typically needs to get an Employer Identification Number to use as an identifier for tax purposes. In certain situations an EIN is not required.
Good records keeping is essential for any successful business. A well conceived record keeping method will facilitate the following benefits:
- Help you keep track of deductible expenses
- Help prepare your tax returns accurately and efficiently.
- Preserve the proper support items that you report on your tax returns.
- Assist in monitoring and measuring the progress of your business
- Aid in the preparation of financial statements.
You may choose any recordkeeping system that clearly shows your income and expenses. Obviously having a good accountant or CPA to assist you in both setting up these records in an efficient and user friendly manner is critical and essential. This is an ongoing and critical detail for running a successful business. For record retention guidelines for businesses, please read Record Retention Guidance For Business.
Every business taxpayer must figure taxable income on an annual basis called a tax year. Your tax year can be either a calendar year or a fiscal year. In most case the tax year will be a calendar year but not always. Once again a discussion with your tax advisor is essential.
Accounting Method and Tax Elections
Each taxpayer must also use a consistent accounting method, which is a set of rules for determining when to report income and expenses.
The most commonly used accounting methods are the cash method and accrual method.
Under the cash method, you generally report income in the tax year you receive it and deduct expenses in the tax year you pay them.
Under an accrual method, you generally report income in the tax year you earn it and deduct expenses in the tax year you incur them.
Special rules apply when inventory is involved with the business.
Corporations wishing to be treated as an S corporation must make such an election within certain time limits. For more details read S Corporation Election. In addition, they may need to elect such status not only with the IRS but with the state in which they wer formed. However, some states such as Pennsylvania no longer require a separate election.
Taxpayers may be able to elect various tax treatment for certain items of income or expenses. For example, Section 179 allows the direct write-off of certain depreciable property. Also special tax write-off ara available for start up costs. For details go to Start-up Costs For New Ventures.
Employee Health Care
The Small Business Health Care Tax Credit helps small businesses and tax-exempt organizations pay for health care coverage they offer their employees. A small employer is eligible for the credit if it has fewer than 25 employees who work full-time, or a combination of full-time and part-time.
Beginning in 2014, the maximum credit is 50 percent of premiums paid for small business employers and 35 percent of premiums paid for small tax-exempt employers, such as charities.
For 2015 and after, employers employing at least a certain number of employees (generally 50 full-time employees or a combination of full-time and part-time employees that is equivalent to 50 full-time employees) will be subject to the Employer Shared Responsibility provision.
Conclusion and Warning:
These are just the basics considerations. Each situation is unique and what may be the right entity in certain situations would be completely inappropriate in another situation. Get with tax counsel before doing anything that will result in a costly and sometimes irrevocable mistake.
Copyright © 2012, 2013, 2014 - Steven J. Fromm & Associates, P.C., 1420 Walnut Street, Suite 300, Philadelphia, PA 19102. All rights reserved.
If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.