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While there are many benefits of incorporation, including protecting your assets and saving money, one of the most important reasons to incorporate is for the favourable tax results. Running your business as an officially incorporated company provides distinct tax advantages and reduces the risk of being audited.Here are some easy steps to make incorporation beneficial to you and your tax liability.
1) Make the Decision to Create a Business Structure. The most important step in reducing tax liability and the likelihood of a tax audit is to take your business from a sole proprietorship to an official business structure. When you run a business without creating any sort of official structure, your business is automatically labelled as a sole proprietorship. This means that you list all of your business income and expenses on Schedule C of your personal tax return. Schedule C is the second most highly audited form you can attach to your tax return at 2.7%. While this may not seem like a big number, it’s almost twice the national average of 1.5%. By remaining a sole proprietor and filing a Schedule C, you are almost doubling your chances of being audited by the IRS. S Corporations, on the other hand, enjoy a very low risk of audit, 0.3%. By incorporating as an S Corporation, you lower your risk below the national average by 5 times and 9 times below the risk of filing as a sole proprietor! Creating a business structure will be beneficial both to reducing the potential of a tax audit and lowering your tax liability every year.
2) Find a Tax Friendly Business Structure. Next you should look at the type of business structure that works best for you. While all business structures are more tax friendly than a sole proprietorship, not all structures are as good as an S Corporation. In general, the corporation is typically the most tax friendly structure, but provides some inflexibility in operating. The LLC provides the most operation flexibility, but can result in some unfavorable tax results. Be sure to pay attention to the details. Some forms of business entities require that the business pay taxes on the money it earns throughout the year AND that the business owner pay taxes on the income he or she receives. This results in a double taxation scheme that costs the business twice. Most types of business entities, however, do not have to pay double taxes, and any tax owed is paid by the owner who receives the income. This is beneficial because it keeps money in the company and the business owner pays no more tax than would have been paid originally. When structuring your business then, make sure you choose a form of business that will avoid double taxation and help you meet your tax saving goals.
3) Plan Ahead. After structuring your entity, the next step is to build a staff of business professionals. Hiring an accountant to manage your taxes is a great idea and helps you itemize your expenses into the most tax efficient filing. Accountants are trained in tax preparation and are knowledgeable about little deductions that may make a big difference when it comes time to file your return. If you can’t afford an accountant, look into tax preparation software. The software will do many of the same things an accountant would and will keep you on track for a lower tax bill. Also consider hiring a bookkeeper to manage your financial statements and the budget. A bookkeeper with bookkeeping experience will help you budget appropriately, understand financial lingo, and generally relieve some of the anxiety that money usually brings. Having someone with financial experience on your team allows you to focus on running other areas of the business, like earning a profit.
4) Become an Excellent Bookkeeper and Learn your Deductions. Whether or not you have an accountant or a bookkeeper, maintaining extremely accurate records and learning the potential business deductions is key to paying lower taxes and avoiding a tax audit. There are many deductions for small business owners that the average entrepreneur may not know about it. For example, did you know that you can deduct car and gas payments for the time you use your car for work? Keeping tabs on the daily driving you do to visit clients or suppliers allows you to put a percentage on the part of your payments that go to work purposes, resulting in a deduction for your car. Learn the list of deductions and after that, write everything down. The combination of knowing what deductions are allowable and meticulous record keeping will make tax returns easier to manage.
5) Be on Time and Accurate. Finally, make sure your taxes are done properly and on time. As mentioned before, an accountant or tax preparation software can be good tools to ensure that you deduct what you can and pay what you must, all in a timely fashion. If for some reason you can’t have your taxes done by the deadline, filing an extension as soon as possible, and before the deadline, avoids any potential problems with the IRS. Making estimated tax payments too will reduce the burden when it comes time to pay the whole bill and will help guarantee that when that day comes, you will have the money available. If after all of your preparation, you don’t have money to pay your taxes, the IRS offers a variety of programs to help you out, including payment and settlement plans.
In addition to the tax strategies listed above, it’s also wise to be aware of the latest laws as they relate to small businesses. The small business jobs bill includes a number of important tax provisions, including liberalized and expanded expensing for 2010 and 2011, revived bonus depreciation for 2010, five-year carry back of unused general business credits for eligible small businesses and the removal of cell phones from the listed property category. Some of the tax penalty rules for small businesses have also been liberalized. While the most recent bill does not provide extensive savings for small businesses, it does provide some helpful tax savings opportunities.
optimising your tax liability and lowering your risk of audit by the IRS doesn’t have to be complicated. If you start by creating the business structure that’s best for your business and paying attention to small deductions that can save you big, a more joyful tax season will be waiting for you!
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