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Taxing Requirements For A New Business Owner

The April issue of Sentinel described the various entities available for new business owners. (See "Organizing A Small Business Is A Big Job.") Now that your company is up and running, you have important administrative responsibilities. These include keeping track of business income and expenses, collecting and remitting sales tax and withholding and remitting employee payroll taxes.

Record-keeping

You must keep careful record of all income and expenses your business generates. If you have the proper system in place, it will simplify your life when tax filings are due, whether you prepare them yourself or hire an accountant.

First, establish a business bank account. Deposit all business income into this account and write all checks for business expenses from it. Avoid using your personal checking account for business transactions. Reconcile your monthly bank statement to verify the transactions that occurred during that period.

Second, purchase inexpensive bookkeeping software to help you maintain your records accurately. The program will help you categorize expenses properly, which is important because the Internal Revenue Service requires different tax treatment for certain expenses. For example, the IRS only allows a 50% deduction for business meals and entertainment expenses. A bookkeeping program will allow you to generate up-to-date financial statements, such as balance sheets and profit and loss statements, which can be used to create growth forecasts or to establish budgets.

Before establishing a record-keeping system, ask yourself:

  • What type of accounting method does my business require?
  • Is it necessary to follow Generally Accepted Accounting Principles (GAAP)?
  • Is it necessary to have my financial statements audited?

The type of business you operate typically determines your accounting method. Under the cash method, you recognize income when you receive payment and you incur an expense when you pay your bills. The accrual method recognizes income when you bill your customers and recognizes expenses when you receive goods or services, even though you have not yet paid. Most small service businesses follow a cash accounting method, while retailers who maintain inventory use the accrual method.

GAAP is a set of accounting principles established by the Financial Accounting Standards Board and other bodies such as the Securities and Exchange Commission. These principles were created to provide investors and creditors with a standardized picture of each business’s financial health. Unless you intend to take your company public or sell your business, it is probably unnecessary to maintain GAAP financial statements. Similarly, if outsiders will not view your company’s financial statements, it is probably unnecessary for them to be audited by a certified public accountant.

You should keep all receipts, bills, canceled checks and customer invoices for a minimum of three years, and possibly longer. The IRS has a statute of limitations for making an inquiry about information reported on a taxpayer’s filed tax return or assessing additional taxes for a certain tax year. The period is typically three years from the date on which the tax return was filed. If you neglect to file a tax return for a particular year, the statute of limitations never lapses.

Other Possible Business Taxes

Sales And Use Tax. Sales tax is a state and local tax. Both the rate of tax and the goods and services that are taxable vary greatly from state to state, and sometimes even within a state. You will need to find out whether your state requires you to collect sales tax on the things you sell to your customers.

Typically, you are not required to collect sales tax from wholesalers or retailers located in your state if they are purchasing your product or service for resale. However, each state has its own procedure for providing proof of exemption. New York and Connecticut require wholesalers or retailers to provide you with a resale exemption certificate.

In most cases, you are not required to collect sales tax from a consumer in another state, unless you establish a physical presence, or "nexus," in that other state. The following circumstances typically constitute nexus:

  • Maintaining a business location, such as an office, in that state.
  • Employing a sales representative within that state.
  • Maintaining inventory in a warehouse within that state.
  • Delivering merchandise to consumers within that state using your company’s vehicles.

If you purchase goods from an out-of-state vendor who ships the product to you and does not collect your state’s sales tax, you usually are required to remit an equivalent "use tax" to your state. In theory, this use tax obligation creates a level playing field between local bricks-and-mortar vendors such as office supply stores, and out-of-state sellers who operate via mail order, telephone and the internet. Any item you purchase that is consumed by your business, rather than being resold to customers, may be subject to use tax. Items acquired for resale to your customers generally are exempt.

Whether you are collecting sales taxes or paying use taxes, your business is typically required to submit a quarterly tax return to the proper state authority, along with payment if any tax is due.

Income Tax and FICA Withholding. As an employer, you will be responsible for withholding income taxes from your workers’ paychecks, depositing withholdings with the appropriate tax authorities, and filing quarterly tax returns at the federal and state levels, assuming your state has an income tax. First, have all employees complete federal Form W-4, Employee’s Withholding Allowance Credit. This will indicate how much federal and state income tax to withhold from their paychecks. You must also withhold Social Security and Medicare taxes (FICA), which have employee tax rates of 6.2% and 1.45%, respectively. You also are required to pay a matching contribution for these taxes out of your own pocket.

You must deposit these withholdings at an IRS authorized depository, typically your local bank branch. The amount of your withholding will determine whether you make deposits bi-weekly or monthly. As a new employer, you will be a monthly depositor for your first calendar year in business. Thereafter, your schedule will be determined by the total withholding tax liability you reported during a four-quarter lookback period from July 1 to June 30.

Your company also will be required to file a quarterly federal Form 941, Employer’s Quarterly Federal Tax Return, to report all monies withheld and deposited, and to determine whether additional payments or a refund is due. Your state will likely have an equivalent procedure for depositing withholdings and filing quarterly tax returns.

Unemployment Tax. As an employer, you may be required to make federal and state unemployment contributions on behalf of your staff. If your employee is laid off or fired after working for a certain period of time, he or she is entitled to unemployment compensation. The employer is solely responsible for making these contributions, which are collected as a tax.

The IRS has three independent tests (general test, household employee test and farm workers test) to determine whether you are subject to the Federal Unemployment Tax Act (FUTA) tax. Unless you employ farm or household workers, only the general test will apply to your business. The general test states that you are subject to FUTA tax in 2003 if in the current or preceding calendar year:

  • You paid wages of $1,500 or more in any calendar quarter.
  • You had one or more employees for at least some part of a day in any 20 or more different weeks.

The FUTA tax rate is 6.2% of the first $7,000 (federal wage base) you pay each employee as wages during the year. Unemployment tax deposits are due quarterly if your FUTA tax liability is $100 or more for the quarter. Deposits also must be made at an IRS authorized depository. For federal purposes, you will be required to file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. Your state will likely have an equivalent procedure for depositing state unemployment tax. However, your state may have a different wage base and state unemployment tax returns are typically due quarterly. If you pay state unemployment taxes, the federal unemployment tax will be reduced but not eliminated.

If these payroll requirements seem overwhelming, you may want to outsource them to a payroll service company. You will incur penalties, which can be hefty, if these various deposits are not made properly or timely.

Workers’ Compensation. All states require employers to carry this coverage. Workers’ compensation benefits provide employees with coverage for medical expenses and reimbursement of lost wages when injured on the job. It also covers the cost of defending your business against potential lawsuits filed by an employee or his or her family. Each state has its own statutes; therefore, you will need to contact your state insurance commissioner’s office to obtain this information. Premiums are based on the nature of your business, the work your employees perform and the hours they work.

Record-keeping and sales tax and payroll tax collection and reporting requirements do not come close to accounting for all of the administrative responsibilities of a new business owner. However, each is important to the success of your business and should not be taken lightly. Neglecting these responsibilities can literally cost you time and money.

Managing Vice President Shomari D. Hearn, based in our Fort Lauderdale, Florida headquarters, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 2, “Relationships with Adult Children;” Chapter 9, “Life Insurance;” and Chapter 17, “Retiring Abroad.”

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