Small Business Do’s and Dont's

(The Money Pros) - Record keeping is often not the strong suit for people who are starting their own business. What suggestions can you make for getting off on the right foot?

Answer: Things like keeping a separate checkbook for business income and expenses are critical. Don’t use personal accounts. Keep receipts. But also categorize expenses and balance your checkbook regularly. Software such as Quickbooks can be very helpful, and find a qualified accountant early in the process.

What is the difference between a business and a hobby and why is that important?

Answer: It’s important for a couple of reasons. First, be sure the activity you want to engage in is a viable business, not just a pastime. Just because you enjoy it, doesn’t mean you can make money at it. Second, it’s important for tax reasons. Many activities will lose money in early years, but only legitimate businesses can deduct losses. If the IRS determines your business is really a hobby, it can disallow losses and create taxable income.

When it comes time to hire extra help, many people are tempted to classify them as independent contractors rather than employees. Generally, what are the rules on this, and how can it become a problem?

Answer: The rules regarding independent contractors are very strict, and the IRS looks very closely at these issues. It is important to not misclassify workers as contractors if they are, in fact, employees. If they use your tools and equipment, if you direct their work hours and the manor in which they complete tasks, they are likely employees. Be sure to treat them as such. That includes withholding taxes and paying payroll taxes.

How does paying taxes as a sole proprietor differ from as an owner/employee of an S Corp?

Answer: This is a complex question, but generally, sole proprietors will figure income or losses on Schedule C of their personal tax return. Any income or loss will flow to their 1040 where they will pay income and self employment taxes. Owners of other business entities will often have to prepare a separate business return. As employees of their business they will receive a W2 for wages, and as owners they will likely receive a form K-1.

What are some of the advantages and disadvantages of each setup from a tax standpoint?

Answer: Again, this is another complex question, and it’s a good idea to work through the issues with a qualified accountant. Filing a Schedule C can be fairly straight forward for simple businesses. For more complex organizations, it may make sense to choose a different entity for both legal and tax reasons.