The government has created some special types of corporate entities for small and medium sized businesses called pass-through entities. These types of organizations pass their profits on to the owners every year, so they don’t have to pay any income tax as a corporation.
The main reason this can work out to your advantage is because the money that is passed through to the owners isn’t subject self-employment taxes because it is treated as passive income. This means you don’t have to pay Medicare and Social Security taxes on the profits from the company.
If you run a business as a sole proprietor under your own name or as a DBA, you’ll have to pay self-employment taxes on the money you make because it all shows up as your salary. By using a pass-through entity you can pay yourself a reasonable salary (which you’ll pay all the regular taxes on) and then take the rest of the profit out as investment income (which you won’t pay self-employment taxes on).
The two types of pass through corporations are Limited Liability Corporations and S Corporations. An S Corporation is similar to a regular corporation, but it is structured for smaller businesses. There are specific rules about who can own and S Corporation and the number of owners allowed. However, it can work quite well for a small to midsized business. Another advantage of an S Corporation is that it can easily be converted into a regular C Corporation.
LLCs are a newer type of corporate entity and they aren’t available in every state. Usually LLCs require less record keeping and fewer corporate formalities than a corporation. In many states the cost to file for an LLC is slightly higher than that of a corporation. LLCs allow you a bit more flexibility in how voting rights and ownership is assigned.
Pass through entities aren’t always the best choice. There are some restrictions placed on these types of organizations especially in the area of fringe benefits. As always it is best to talk with an experienced tax advisor in order to make the best choice.
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As we’ve previously discussed, the basic idea behind business is exploiting differences in pricing. With this concept in mind, technology becomes a way to enable businesses that couldn’t exist without technology.
For example, websites that offer free classified advertising for individuals and are supported by a few ads from large businesses or an advertising network like Google Adsense, couldn’t have existed before the internet. The cost of printing and distributing newspapers containing just classified ads was high enough that a free model just wouldn’t work. However with the Internet, the cost of “printing” and delivering the ads becomes close to nothing.
There are other businesses that are using technology to lower there prices because they are able to get efficiencies that were never before possible. One example of this is the growing number of businesses that consist of just one or two people. In the past, many of these businesses would have needed a large support staff to handle accounting, billing, etc. With modern technology, these businesses are able to do much of the work themselves using specialized software and outsource parts like payroll to companies that rely on technology to offer services at a lower price that would have ever been possible before.
When working on your own business, try to identify the work done by employees that could be done by technology instead. Sometimes it is more cost effective to use real employees. For example, getting a computer to answer your phone will probably not help your bottom line. But setting up a computer that automatically keeps track of inventory based on data from your point of sale machines could reduce the need for costly manual inventory audits.
The key thing in choosing technology is to make sure you are focused on a realistic payback. A technology investment that has a payback of 10 years, is probably not a good investment because your processes will have changed in that time.
Most businesses have many areas that are “low hanging fruit” where a very modest investment in technology can create tremendous savings. The successful business person practices identifying these areas.
An automobile is one of the most common tools for use by business. Since it represents such a large expense, it is good to understand how the IRS allows you to pay for the business use of your car.
If your business buys a car and uses it exclusively for business, then all of the car expenses can be classified as business expenses. However for most small businesses, it is rare that a vehicle is used exclusively for business use.
The IRS allows you to keep track of all the vehicle expenses on your personal vehicle and then divide them between your business and personal expenses based on how much the vehicle was used for each category. For example, if you used the car for 25% business and 75% personal, and you spent $5,000 on the car for the year, you can deduct 25% as a business expense, but the other 75% is considered a personal expense and is not deductible.
If you use a vehicle owned by your business for personal use, the IRS requires that you pay taxes on the business use of the vehicle as if it were income to you. There are several ways to calculate the value of personal miles on a business car. The most used method is to use an IRS table to determine the leased value of a vehicle. The employee would pay taxes on the leased value based on the percentage the car was used for personal use. The employee could also use the cents-per-mile valuation where they would pay taxes on the personal use based on the IRS standard mileage deduction rate.
If you use your own vehicle for business use, your business can reimburse you for the vehicle expenses at the standard mileage rate. If you drive a lot of miles for business and have an older vehicle, this can be a very good arrangement because often the reimbursement more than covers the cost of gas and maintenance on a vehicle. Since the payment is a reimbursement, you aren’t required to pay any taxes on it.
For more information on how to account for business use of vehicles, visit the IRS website, or ask a reputable accountant. With a little planning, you can find a method that will work out to the best advantage for you and your business.