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First-Time Filing Help

Tuesday, December 22, 2009

Q: I am a first year sole proprietor (home bakery). I very much want to start preparing myself for tax season. Honestly though, being completely new to this, I'm not sure where to start. What can I claim? What documents should be ready for my tax advisor? My company also has donated a lot over this year. Would you at least be able to point me in the right direction?

A: Thanks for your question and for using NASE TaxTalk. Congratulations on your new venture and don’t forget that most of the economic growth in this country comes from small-business owners just like you. As you might guess, the answers to your questions can fill several tax volumes. Keep in mind that as you go through the rest of this year and prepare for your first tax return as a self-employed individual, that I will still be here to help if I can. So as other things come up or as you need more detail, just drop me a question and we can go from there. Also, it can certainly be a good idea to schedule an appointment with your tax professional now, before the end of the year, to go through some planning ideas. They most likely have an organizer process, which is kind of like a check list of things they would typically need or look for.

Believe it or not, the best place to start looking for possible deductions and for information to help you with your taxes is the IRS. They have a very good Web site with some very good publications to help you stay on top of things. You can download forms with instructions and informative publications for free from their Web site at www.irs.gov.

Some key publications to review are as follows: 

Publication 334, Tax Guide for Small Business
Publication 463, Travel, Entertainment, Gift, and Car Expenses
Publication 505, Tax Withholding and Estimated Tax 
Publication 587, Business Use of Your Home

You might pay particular attention to the Home Office Deduction, Publication 587, and the costs related to the use of your car, Publication 463, since these items are common to most small-business owners and are often overlooked.

As for paying and filing taxes, you will include the income and expenses related to your business on an IRS Schedule C, Profit or Loss from business. If you have at least $400 in net income from the business you will also need to complete a Schedule SE, Self Employment Tax. Both of these forms are then attached to your personal income tax return, form 1040. So even though there are separate forms for the business there is no separate tax return, but the forms are part of your regular tax return.

As you probably already know, the IRS has a “pay as you go” policy for Federal income taxes. Most individuals accomplish this through withholdings on their payroll checks. For the self-employed individual, no such withholding typically exists and therefore, estimated tax payments are required to meet the “pay as you go” system. Therefore, if you have enough earnings from your business, you may very well have to make quarterly estimated tax payments. If you have enough withholding from the other jobs in your family to cover your tax position then you would not have to make the quarterly payments. In other words, whether or not you need to make the quarterly payments is a function of your total family's tax position and not just the business.

You may be required to make quarterly tax deposits in estimating your tax liability. However, there is no “filing” requirement on a quarterly basis and therefore, no reporting procedure that would allow the IRS to determine if indeed an estimated tax payment was due. That is, however, until the annual tax return is filed. If you do not make the required estimated tax payments, there will be a penalty that will be due with your tax return. The penalty is a function of the amount that should have been paid.

By definition, your estimated taxes should reflect your family’s expected tax liability. That tax liability will depend on a great many things such as how much money the family makes, do you itemize deductions, do you own a home, do you have children, what business expenses do you incur, etc.

The best way to determine how much your estimated tax payments should be is to prepare a comprehensive tax estimate. Try to determine how much money you will earn for the year, what deductions and other expenses you might have and estimate the tax liability for the year. This is kind of like preparing a tax return for the year based on estimated numbers. After you have completed the estimate then your estimated tax payments should be structured so that you have paid enough in estimated tax payments to avoid any underpayment penalties that the IRS might impose. Don’t forget any withholding payments that may be generated from another employee job where the employer withholds taxes and sends them to the government, including your spouse’s income. Also don’t forget that as a self-employed individual, you will be responsible for self-employment tax as well, which should be part of the estimated tax return.

Estimated taxes are typically paid on a quarterly basis with one payment due April 15th, the second on June 15th, the third on September 15th and the fourth on January 15th. (The fourth quarter estimated tax payment is due on January 15th of the following year.) Again, the IRS also has some good publications to help you with this information. One is called Publication 505, Tax Withholding and Estimated Tax.

I hope this gives you a few things to think about and a few resources to call upon. If you have other questions or a specific question on your situation, or would just like to discuss any of the above in more detail please don’t hesitate to contact me again and I will help in anyway I can.

 

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