Tax Implications of Starting a New Business

January 31, 2020 : Mike Slack

Editor’s Note: This article was originally published on November 17, 2017.

The launch of a new business comes with many startup tax questions. Let’s review some of the tax considerations when starting a business, including the big changes that come with becoming your own boss.

You can claim startup tax deductions for eligible expenses

Startup costs are amounts you’ve paid or incurred while creating your business or even in investigating the creation your business. As long as you actually started the business, you can elect to deduct up to $5,000 of eligible costs in your first year. Additionally, you’re eligible for the full amount of this startup tax deduction if your costs don’t exceed $50,000.

Your income is taxable even if you reinvest it into your business

Any profit your business makes each year will be taxable regardless of whether you withdraw it or reinvest it into growing your business. However, you’ll want to keep this startup business tax tip in mind — any deductible business expenses can be used to directly offset that income.

You’ll be subject to self-employment tax

Another tax consideration when starting a business is self-employment tax. Your net profit from your business will be subject to this additional tax. Self-employment tax pays for contributions to both social security and Medicare. Currently for 2020, you will pay self-employment tax at a 15.3% rate on your net earnings from self-employment of up to $137,700, and Medicare tax only at a 2.9% rate on the excess.

An additional 0.9% Medicare tax will be imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.

Though paying the additional tax may seem burdensome, it’s actually designed to act the same way as the social security and Medicare taxes that would normally be withheld from the wages of an employed individual. Furthermore, the social security portion of the tax increases your potential social security benefits you may receive at retirement.

If you choose to put your small business into a corporation you will not be subject to self-employment tax on your earnings. However, you will then be subject to payroll taxes as shareholders who perform services for their corporations are required to be paid Form W-2 wages subject to social security and Medicare withholding.

Your filing requirements will change

Normally, individuals with taxable income under certain amounts are not required to file a tax a return for the year. Generally, for 2019 taxes a single individual under age 65 only has to file if their adjusted gross income exceeds $12,200.

However, if you are self-employed you are required to file a tax return if your net income from your business is $400 or more. This is true even if the $400 is your only income and you are thus far below the normal filing threshold.  In other words, you may need to file taxes as a startup when you might not have met the threshold as an individual.

You will be required to make quarterly estimated payments

Most taxpayers satisfy their tax payment requirements when their employer withholds state and federal taxes from each paycheck. When you’re self-employed and starting a business, taxes are 100% on your own. Most self-employed taxpayers satisfy their tax payment requirements by making estimated tax payments quarterly online or via the mail.

If you also work as an employee for another business in addition to your self-employment, you may be able to satisfy your required tax payments by increasing the amount of withholding from your wages.

Should you fail to make your required payments, you may be subject to an underpayment penalty. The penalty can be avoided if you meet certain specified exceptions or waivers.

Penalty = Interest rate charged by the IRS on deficiencies (×) The amount of underpayment for the period of the underpayment.

You’ll be subject to new business tax scrutiny

Unfortunately, being self-employed will be in one of the IRS’ favorite audit target groups. Though being audited doesn’t mean you’re in trouble unless you’ve actually done something wrong, it is best for you to always be prepared for the possibility. In particular, you should carefully record your income and expenses in order to claim the full amount of the deductions to which you are entitled.

Certain types of expenses, such as automobile, travel, entertainment, meals, and office-at-home expenses, require special attention because they are subject to special record keeping requirements and/or limitations on deductibility.

See how H&R Block can help with starting a business and tax questions

While these tax implications of starting a business may seem daunting, we’re here to help. Find out how our tax professionals can help you with your small business taxes today.

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Mike Slack

Mike Slack

The Tax Institute, H&R Block

Mike Slack, JD, EA, is a senior tax research analyst at The Tax Institute. Mike leads research teams focused on business and investment tax issues.

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