A major key to a successful business is understanding your tax obligations. Before you decide to become a booth, open a salon suite, or open a salon, there are a few tax matters you should be familiar with.
Listed are five tax tips that will help you stay out of trouble with the IRS and help your business get off to a good start:
1. Choosing Your Business Structure
Once you decide to start a business, the next step is to select a business structure. The most common structures are sole proprietorships, partnerships, and corporations. The business structure you choose will become the basis of how the IRS and state treat you for tax and compliance purposes, so choose carefully.
2. Employer Identification Number (EIN)
Getting an EIN is optional for certain business structures. Partnerships and corporations are required to have an EIN. A sole proprietor or single-member LLC is only required to have an EIN if they have employees; otherwise, it is optional. However, I strongly advise all business owners to obtain an EIN regardless of their legal structure.
3. Accounting Method
Accounting methods are rules used to determine when to record income and expenses. The business must use a consistent method. The two most common methods are the cash and accrual methods. The difference between cash and accrual accounting lies in the timing of when income and expenses are recorded. Cash accounting recognizes revenue and expenses only when money changes hands. In contrast, accrual accounting recognizes revenue when it's earned (not when it is received) and expenses when they're billed (but not paid). Most small businesses use the cash method of accounting.
4. Business Taxes
The type of taxes your business must pay depends on the type of business structure you choose. Generally, there are four types of business taxes that beauty professionals should be familiar with:
a) Income tax – Income tax is paid on the net income of a business. Net income is the remaining income your business has after all expenses have been paid. Gross income minus total expenses equals net income.
b) Self-employment tax – Self-employed people generally pay self-employment tax and income tax. Self-employment tax, also known as SE tax, is Social Security (FICA) and Medicare tax paid by the individual. This is the same tax that your employer (if you were an employee) would automatically withhold from every paycheck you receive. This tax is not optional. Everyone is required to pay FICA and Medicare tax. SE tax is 15.3% of your net self-employment income. It is due and should be paid every quarter. If you do not pay your SE tax every quarter, you will be slapped with a penalty when you file your tax return at the end of the year. Remember, booth renters and independent mobile stylists are self-employed business owners just like any other business owner, so all these requirements pertain to you also.
c) Employment Tax – Employment tax is paid by employers on behalf of their employees. Employers withhold FICA and Social Security tax from their employee's paychecks. The employer is responsible for remitting employment taxes to the IRS. Not doing so can create serious problems for the business. The penalties for not complying with employment tax requirements can be as high as 100% of the undeposited amount.
d) Sales Tax - Sales taxes are taxes imposed by your state on product sales. Some states also impose sales tax on services. Ensure you contact your state's Department of Revenue to determine their sales tax requirements and when your sales tax return and payment are due.
5. Quarterly Estimated Taxes Payments
Anyone in business that files a tax return must pay quarterly estimated taxes. If your self-employment tax and your income tax combined is $1,000 or more ($500 for C corporations), you are required by law to make quarterly estimated tax payments. You can base your estimated payments on your prior-year tax liability or calculate your payment based on your current year's income. Payments are due on the 15th day of April, June, September, and January. If the 15th falls on a holiday or weekend, payments are due on the next business day.