Entrepreneurship Endeavors Part 3 of 4: Your Very First Taxes

Photo by Philip Taylor.

Photo by Philip Taylor.

Entrepreneurship Endeavors is our take on managing an entrepreneurs finances properly from launch to the end of their first year! Make sure to read part 1 and part 2 before diving into part 3: your very first tax season.

You’ve decided to start your own business! Your very first week went by smoothly, and so far, everything’s looking great. But in the back of your mind, you have a nagging thought – what am I going to do when tax season comes around?

Regardless of what people say, taxes aren’t always bad. Ignore whatever the media says on April 14th. Instead, understand that with a little work beforehand, a little preparation, and perhaps just a bit more than a “little” paperwork (or Microsoft Word work at least), you’ll be more than prepared for your first tax season. With a little foresight and some luck, you might even be confident enough to finish early!

Here are a couple steps to get you started on the path to understanding your very own taxes.

SBA_GovGetting Friendly with your Favorite Forms

Don’t wait until you’re actually filling out your taxes to look at the necessary forms for the very first time. Instead, once you’ve picked the type of business you want (LLC, Partnership…) go ahead and figure out what kinds of forms you will need to submit at the end of the year. A helpful list of business tax forms is available on the IRS website.

If you’ve made the jump from using contractors to having paid employees in your first year, congratulations! (Here’s a helpful 8 step guide to getting your first employee if you’re ready to start that process). It also means, though, that you’ve hopefully been withholding all the taxes required from your employees’ wages the whole time they have been employed. This can include, but not limited to Federal Income; Social Security; Medicare; State; and Local Taxes. They all go into the Federal Wage and Tax Statement also known as a W-2 form. Make sure you send those off to your employees by January 31st of the year following the tax reporting period, and send copies to the Social Security Administration by the end of February.

The Big Question: Cash or Accrual Basis

First, let’s define them. A cash basis for your accounting system means that income is counted when you receive the money itself, and your expenses are counted when they’re paid.

Accrual basis, on the other hand, recognizes income and expenses based upon when they’re incurred. Let’s look at the following example:

You send out an invoice for $500 on December 28th, 2013, and the payment is received & deposited on January 3rd, 2014. If you’re using a cash basis, that transaction and additional income is incurred in the 2014 tax period. If you’re using accrual basis, then it is recognized in the 2013 tax period.

Typically, for a small business, cash basis is the easiest to think about and use since it actually reflects what’s in your accounts. But for larger businesses, accrual is often a better judgment of what your numbers actually look like. In fact, businesses with inventory, annual sales exceeding $5 million, or corporations, must always use accrual method.

Once you choose your basis, you’ll be stuck with it for the life of your business (changes, while permitted, are difficult) – so pick wisely.

Appreciating Your Depreciation

Did you purchase equipment, furniture, or vehicles in the past year? If so, then you’ll want to depreciate it properly to ensure maximum tax benefits for your business. Understanding how to depreciate your purchases properly and efficiently is more than enough to fill entire textbooks, so we’ll just cover it briefly.

Under GAAP (Generally Accepted Accounting Principles), your depreciable items’ worth is dependent on a variety of factors, including:

  1. Basis: an item’s cost
  2. Recovery period: how long you’ll use the item
  3. Salvage value: its value at the end of its useful life

There are also several methods for calculating the depreciation value, including a straight line method (simple and easy to calculate – the same value every year) as well as an accelerated method that takes into account the fact that most assets are used more often during their first few years than their last. Microsoft Excel has a surprisingly detailed guide for those looking for more information on various methods and definitions concerning depreciation.

Going From Year 1 to Year 2

The first year you consider taxes for your business may be the most difficult (particularly if you’re lucky enough to have an accountant perform your taxes starting year two). Always remember to keep all of your forms and paperwork in place, though. Also, consider all of the helpful resources in your neighborhood. Small business associations, business chambers, and local banks are just a few of the resources that are available to business owners as tax season comes around. Stopping in to talk to one of them for a few moments can save you days of stress months from now.

This guest post was written by Patrick Rafferty in association with Hibernia Bank. The views expressed herein are those of the author and not necessarily those of any financial institution or bank. This article is intended to provide those reading it with information about matters of current interest.  It should not be construed as legal or financial advice concerning a specific topic and should not be acted upon without contacting the appropriate professionals.