Tax Information

Need to Know: Tax Information

Types of Business Entities
1. Sole Proprietorship: A sole proprietorship is the simplest and most common form of business entity. You and your business are
considered one and therefore your business assets and liabilities are not separate from your personal assets and liabilities. Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.

2. Partnership: A simple business entity in which two or more people own a business together. As in a sole proprietorship your
business assets and liabilities are not separate from your personal assets and liabilities. The two most common types of partnerships are limited partnerships (LP) and limited liability partnerships (LLP) which can offer some protection for personal
assets. Partnerships can be a good choice for businesses with multiple owners.

3. Limited Liability Company (LLC): A business entity that is a mix between a partnership and corporation. A benefit of this structure is protecting yourself from personal liability, in most instances your personal assets won’t be at risk in case your LLC faces bankruptcy or lawsuits. LLCs can be a good choice for medium- or higher-risk businesses, owners with significant personal assets they want to be protected, and owners who want to pay a lower tax rate than they would with a corporation.

4. Corporation: A legal entity completely separate from its owners and offers the strongest protection to owners from personal liability. Corporations can be a good choice for medium- or higher-risk businesses or businesses that need to raise money.

5. Cooperative: A cooperative is a business or organization owned by and operated for the benefit of those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners.

Starting a Business
“If you plan to do business under your full legal name you do not need to register your business name. However, in order to start a sole proprietorship in which you will not be using your name or only using part of your name as the business name”[1], you will need to file for DBA (Doing Business As). Sole proprietorships will have to file their Fictitious Name Resolution with the local county recorder in the county where their business operates.

An Employer Identification Number (EIN) is not required unless you hire employees, have a Solo 401(k) retirement plan, buy or inherit an existing business that you will operate as a sole proprietorship, file for bankruptcy, or incorporate. However, obtaining an EIN in the beginning is a good idea, it can help to avoid identity theft and establish an independent contractor status. Applications can be completed online on the IRS website.

Paying sales tax is another aspect of doing business. If the state, you are doing business in has a sales tax you will be required to collect sales tax on the service or product you provide and remit it to the state regularly throughout the year. (to see if your business is exempt from sales tax visit Iowa Department of Revenue) State Sales Tax Registration, in Iowa, is free of charge. The form can be found here. To begin the registration, visit Iowa Business Tax Registration website. In order to alleviate this expense, you may consider including sales tax in your pricing.

It might be beneficial for you to explore opening a business bank account. Reasons for doing this include protection, professionalism, preparedness, and purchasing power. Business banking offers limited personal liability protection by keeping your business funds separate from your personal funds. Customers will be able to pay you with credit cards and make checks out to your business instead of directly to you. Business banking usually comes with the option for a line of credit for the company. This can be used in the event of an emergency, or if your business needs new equipment. Credit card accounts can help your business make large startup purchases and help establish a credit history for your business.

Businesses should also consider obtaining business insurance. Business insurance can fill in the gaps to make sure both your personal assets and your business assets are fully protected from unexpected catastrophes. The most common types of business insurance are general liability, professional liability, home-based business, and business owner’s policy.

1. General Liability: Available for any business. This coverage protects against financial loss as the result of bodily injury, property damage, medical expenses, libel, slander, defending lawsuits, and settlement bonds or judgments.

2. Professional Liability: Used mainly by businesses who provide services to customers. This coverage protects against financial loss as a result of malpractice, errors, and negligence.

3. Home-Based: Used mainly by businesses that are run out of the owner’s personal home. Coverage that’s added to homeowner’s
insurance as a rider can offer protection for a small amount of business equipment and liability coverage for third-party injuries.

4. Business Owner’s: Used mainly by small business owners, especially beneficial for home-based business. A business owner’s policy is an insurance package that combines all of the typical coverage options into one bundle. They simplify the insurance buying process and can save you money.

Tax Considerations
1. What is income? Business income may include monies received from the sale of products or services.

2. What are my tax obligations? As a self-employed individual, generally you are required to file an annual return and pay estimated tax quarterly.

3. Self-Employment Tax breakdown. If you are employed by a someone else your employer withholds taxes from every check,
as a self-employed person you will now be responsible for paying these taxes. The two taxes you are now responsible for paying are Social Security tax (old age, survivors, and disability insurance) and Medicare tax (hospital insurance)[2]. Currently the self-employment tax rate is 15.3%, 12.4% for Social Security and 2.9% for Medicare. At this time, you are allowed to deduct the “employer portion” of self-employment tax, 50%, when filing your taxes.

4. Professional Tax Preparation: Up until now it is probable that your tax returns have been fairly simple, and you might have done them yourself, but you might consider working with a tax professional to complete your tax returns now since they are slightly more complicated.

Examples of Taxes
Photography:
As a self-employed photographer you take three jobs during the year. For each job you charge $350, for a year-end total income of $1050. This amount of income would require you to file a Schedule C along with your Individual Income Taxes. When filing your taxes, you will be able to deduct expenses relating to your business. Throughout the year you purchased a new lens, advertised in the local newspaper, and used your personal vehicle to get to job sites. By keeping good records, you will be able to deduct these expenses from your income, thus lowering your total taxable amount. Say your expenses totaled $400, after deducting that from your income your new taxable amount would be $650.

Your total self-employment tax of $92 is comprised of $74 Social Security tax and $17 Medicare tax. The tax-deductible portion for Form 1040 is $46.

Lawn and Yard Services:
During the year you make money by raking leaves, shoveling snow, and doing general maintenance for various individuals around town. Your year-end income was $2300. This amount of income would require you to file a Schedule C along with your Individual Income Taxes. When filing your taxes, you will be able to deduct expenses relating to your business. Throughout the year you purchased miscellaneous lawn tools ($40) and a new mower ($2400), bringing your expenses for the year to $2440. Because your expenses exceed your income you would be operating at a loss and not be subject to self-employment tax.

Music Performers:
Throughout the year you are hired to perform at various events. Your total year-end income is $375. All income is considered taxable by the IRS but because it falls below the $400 mark you will not have to pay self-employment taxes on this amount. If you had made more than $400, expenses that could have been deductible include advertising, mileage, and equipment.

Pet Walking/Sitting
As a dog sitter you earn income of $1000 by walking and pet sitting for people in the community. This amount of income would require you to file a Schedule C along with your Individual Income Taxes. When filing your taxes, you will be able to deduct expenses relating to your business. Throughout the year you purchased supplies relating to your business such as leashes, collars, and poop bags. During the year you also advertise your business for a small fee online. When completing your taxes for the year you are able to claim $150 worth of expenses as well as a portion of mileage you used to get to your clients. Your taxable income from your business is now $850.

Your total self-employment tax of $120 is comprised of $97 Social Security tax and $23 Medicare tax. The tax-deductible portion for Form 1040 is $60.

Logo Design
During the year you decide to start a business creating logo designs. In order to start your business, you invest in a new computer and purchase a monthly design software subscription. You also begin advertising your business for a nominal fee. At year end your profits total $1700 and expenses total $2100. You will need to file a Schedule C with your Individual Income taxes for the year. Because your expenses exceed your income you would be operating at a loss and not be subject to self-employment tax.

Helpful Resources
U.S. Small Business Association: https://www.sba.gov/

Internal Revenue Service: https://www.irs.gov/businesses/small-businesses-self-employed

Iowa Department of Revenue: https://tax.iowa.gov/starting-business

Square (Sales Tax): https://squareup.com/townsquare/9-crucial-things-to-know-about-sales-tax

Sales Tax: https://www.taxjar.com/states/iowa-sales-tax-online/#do-you-have-sales-tax-nexus-in-iowa

Business Taxes: https://www.irs.gov/businesses/small-businesses-self-employed/business-taxes

Disclaimer
The information contained on this module is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice.

Taxation, legal and other matters referred to on this module are of a general nature only and are based on our understanding and interpretation of laws existing at the time and should not be relied upon in place of appropriate professional advice. Those laws may change from time to time.

[1] The American Bar Association. Legal Guide for Small Business. 2nd ed. New York: Random House, 2010. Pg. 23.

[2] Internal Revenue Service. “Self-Employment Tax (Social Security and Medicare Taxes)” irs.gov
https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes (accessed November 21, 2018)
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