3 Tax Accounting Concepts that Every New Entrepreneur and Small Business Owner Should Know

It is no secret the new entrepreneurs and small-business owners need to wear a lot of hats. While they don't need to be a CPA, there's some key accounting concepts that should be at the back of their mind while operating their business. By keeping these concepts in mind while operating the business, the owner and have a better view of the business and be more prepared with respect to the financial and accounting aspects of their operation. In this series we're going to look at three different areas of accounting and what small business owners and entrepreneurs can learn from each area.

We went through 3 managerial accounting concepts in our last blog. Now we come to my favorite LEAST area of accounting when we bring you 3 tax accounting concepts that every new entrepreneur and small business owner should know.

Tax accounting deals with the collection, organization, planning, and reporting for financial information for income tax reporting purposes. While there are many concepts in tax accounting that are simply brought over from financial accounting, there are some key distinctions that tax accountants utilize to ensure accurate and appropriate reporting within the tax accounting framework. There’s a saying that states “It’s not about how much you make, but how much you keep,” and this is 100% true, especially when it comes to commonly overlooked expense like income taxes. So taking the extra time to understand how taxes work could be very beneficial in the long run. Without any further delay, let’s get into 3 tax accounting concepts that every new entrepreneur and small business owner should know:

Key Tax Accounting Concept #1 – Classes of Taxable Income

What many people don’t know when they start their new business is that the income could be taxed differently depending on how the business is set up and how the taxes are filed. We won’t get into too many details today, but if you would like more guidance, please let us know! In general, the three types of income are: Ordinary Income (Wages/Salaries/Contracting), Income Earned from Investments, and Income Earned from Businesses. A brief explanation of each can be found below:

• Ordinary Income: Income from W-2 and 1099 documents, taxed on the gross amount at your determined tax rate.

• Investment Income

  • Short term capital gains – taxed as ordinary income (see above)

  • Long term (>1 year) capital gains – taxed at a reduced rate

• Business Income

  • Pass through entities – Net business income taxed as ordinary income

  • Taxable entities – Taxed at both the corporate level and the individual level (not recommended for those businesses who are just starting out)

For most of you reading this, the key information to note is that businesses are taxed on net income if they are a pass-through entity. This means the most (not all) expenses to run the business can be deducted against the business income before the net amount is taxed at your ordinary income rate.   

Key Tax Accounting Concept #2 – Filing Deadlines

You are likely to establish your new business as an S-Corp or an LLC taxed as a Partnership. If this is the case, you should be aware that the dreaded tax filing deadline will come sooner for your business. For Partnerships and S-Corporations, the annual tax filing deadline is March 15th, one month before the deadline for C-Corporations and individuals. Be sure to keep this in mind if you ever elect either of these tax statuses.

Key Tax Accounting Concept #3 – Employee Taxes and Self Employment Taxes

 Many companies initially underestimate the costs of having employees working for them because there are additional costs beyond an employee’s salary that contributes to their overall price. Among these taxes are Social Security and Medicare Taxes. For most employees, the employer is responsible for withholding and matching 6.2% (for Social Security) and 1.45% (for Medicare) of each employee’s pay. This means that 7.65% of an employee’s salary should be considered as an additional cost of having the employee. It’s important to keep these costs in mind as your business grows and starts to utilize employees.

 But what if you are a sole proprietor and just operate on your own? These taxes still spring up when filing your tax return in the form of self-employment taxes. When filling out the Schedule SE for self-employed income, you required to remit an 15.3% of the self-employed income to cover these taxes. You may also deduct one half of that amount against your total ordinary income. See below for the relevant sections of the Schedule SE:   

As a practicing CPA I can tell you that taxes can sometimes be difficult and unintuitive. While these three areas are not all you need to know about taxes as a business owner, they provide an excellent starting point. By keeping these basic concepts in the back of your mind while you conduct your business can save you a lot of trouble down the road. Interested in hearing more about taxes and how they may affect your new business venture? Let us know in the comments or by using the contact tab!