In this UNLAWYERLY. Tax Special: Ramin gives a short premier on taxes for small business sole proprietorship and single member LLC.
In this UNLAWYERLY. Tax Special: Ramin gives a short premier on taxes for small business sole proprietorship and single member LLC.
00:01
So we're going to do a short primer on small business taxes, and specifically, this is going to be related to those individuals who are considered sole proprietors, or single member LLCs without any election, which is pretty much the same thing as a sole proprietor. Now, one of the first things to discuss is whether or not, there is a need for an EIN, an employee identification number.
00:32
And the thing about EINs is you may or may not need it, Are you going to set up a an LLC or an entity in this case a single member LLC and we have had another discussion on, you know whether setting up an LT LLC helps from a tax standpoint and of course it goes without saying that general disclaimer that we're not giving any tax advice or legal advice and any questions you have should be vetted through your own CPA, your own tax lawyer, your own accountant, but as far as an EI in this concerned, if you do have an LLC, a limited liability company set up, you will get an EIN through the IRS, But if you don't have an employee identification number, you may get what is a tax identification number, which is really used in place of your social security number.
01:25
It's just a way to prevent someone having your Social Security number but in any case, a single member LLC or a sole proprietor is going to do the tax filing through the individual income tax return. In other words, the 1040, Now this is different from. Let's say, if you had a S corporation, you have a partnership or you have a corporation, there's going to be a separate tax filing.
01:54
Because one of the things that I get from people who ask me are, will I be doing a separate tax filing for a single member sole proprietor and the answer is no, it's all going to be a part of your individual income tax return to return through the schedule C, which is a separate page in the filing and it has the related information about your income and expenses.
02:19
So before you go into filing, a tax return, one of the things that is important to be aware of is Schedule C file or the average taxpayer who's doing a Schedule C fileing. Whether single member or sole proprietor. They're going to be what is called a cash basis taxpayer, which is different from an accrual basis, taxpayer a cash basis taxpayer.
02:47
Very simple. Money comes in the door. Your generally recognize it. As income money goes outdoor for ordinary and reasonable expenses. Related to your business, is money, out the door and expense of course, there are rules for expensing items and for the average taxpayer as well. The, the calendar year is going to be from January 1st until December 31st.
03:16
So it is a calendar year taxpayer. So basically what that means is any money that comes in during the year, for your sole proprietor or your schedule, C, that money is going to be part of the revenue stream part of your income stream. Now, if you had a situation where, you know, let's say you worked and it's December.
03:38
31st, you didn't receive that income. Let's say you're supposed to get $1,000 from a particular job that you did question. Do you recognize that $1,000? As part of your income stream for that, let's say x1 year tax year. The answer is no. You would not The reason being is that you didn't necessarily receive the money until let's say, January 1st of your X2 so that money did not come as part of that particular tax here.
04:11
Now the thing with a cruel accrual tries to match the expenses related to the revenue and for you know the average small business owner, it's a lot of work to be able to do a cruel accounting and it requires a certain level of expertise. But with a cash basis, it's made to be easier for the taxpayer in terms of recognizing.
04:31
So the very forefront. One of the things that I often advise people is when you're thinking about a small business and you also think about how are you going to keep track of your related revenue and expenses enough seen a spectrum of it? I've seen people who create a spreadsheet and they have the revenue and the related expenses to other people who do a little bit more sophisticated through various accounting software platforms that are over there.
05:01
Now, the whole old adage of, you know, putting receipts and shoebox. I don't know if people still do that, I don't necessarily work in that type of manner. What I usually advise special particularly clients is to make sure that very early on. They're keeping track of their related revenue and expenses and when they ask for suggestions I ultimately tell them.
05:24
It depends on how sophisticated you want to get. If ultimately you do see the business as something that's going to be long-term for you. It would make sense to put in a little bit of the time and effort to learn as much as you can during your first year, for the accounting side of it.
05:43
And if that means that you invest a little bit more time effort and money into a particular software and establish your chart of accounts. Early on, it's likely going to help you down the road. And so that's one thing you can do. The other thing is maybe you don't need to get that sophisticated.
06:00
Maybe you just need to keep track of your you know related revenues and expenses through some type of very basic spreadsheet. The one thing though that I will say is the whether or not you should create a separate bank account, get a separate credit card. I think it would be prudent to do so and the reason for that is it will allow you to keep track of your business items separate from the personal.
06:24
And the other thing also, with having a limited liability company is, you want to create a division between the business side and your personal assets. You don't want necessarily seem like the money from the LLC is ultimately you know, commingled with your personal assets. Now, of course, with a single member LLC, it's passed through a flow through and so everything at the end of it, revenues mind is expenses will flow through on the personal side, but I think it is prudent to have a separate bank account and separate credit card for your business.
07:00
So that this way easier to manage easier to keep track of at the year end. And that's one of the things that the IRS will inquire about is whether or not you had separate bank account or if you're using the same bank account, same credit card, what is the way that you're able to man?
07:15
Your your books and records? So I do I typically recommend But I do understand that not everybody early on especially will have a separate bank account or a separate, you know, books and records as it relates to credit cards, etc, but it does make things easier down the road.
07:35
So now that you have some of these things related to, you know, the revenue and expense side, you know, how does ultimately the taxes work? Well, as I had alluded earlier, the tax side of it is it's fairly straightforward. And of course, there are various nuances. Let's say, for example related to the home office deduction or related to, you know, creating self-employed retirement account.
08:02
I'll talk about that a little bit, too, or health insurance. But for the most part, it's the amount of money that comes in. Mine is the related expenses and the net amount is going to be your profit. Now, what happens with that net profit, two things, really One that net profit is going to be subject to self-employed taxes self-employed taxes are the taxes that if you are a W2 employee, your employer is going to pay half of the Social Security and Medicare.
08:35
And also the unemployment insurance port, apportion of it, as a single member LLC. Sole proprietor, you don't have to worry about the unemployment side of tax of it. But then the other half of its paid by the employee, you know? So when you get your W-2, or when you get your paycheck, you'll see that there's amounts taken out for Social Security for Medicare, and then for federal withholdings.
08:58
And then on the employee side, you'll notice that there's also similar amounts, taken out. Well, as a single member or sole proprietor, what happens is, you're pretty much paying the employer and employee portion of it and then that net profit also flows in through your ordinary income taxes. So, you know, your ordinary income tax.
09:22
Let's say, for example, you're in the 20th percentile that, 20th bracket for tax bracket, You'll also have your ordinary income taxes. Go through that. That was that double taxation IRS. Won't think so iris. Looks at it, that you're paying just two different types of taxes. You're paying the self-employment taxes for having a self-employed business.
09:41
And then you'll also have the ordinary income taxes that you pay. Now, the thing is that there is an adjustment that is made and that adjustment is called, and above the line adjustment. In that above, the line, adjustment will give you the half of the self-employed taxes to ultimately reduce your adjusted gross income.
10:06
So in a way, it helps to reduce that amount and then the other part of it, which came from the tax cut. Jobs act is the QBI qualified business deduction income deduction and that will allow you to deduct up to 20% of your related, net earnings, net profits but are certain exceptions depending on certain professions where after in certain income threshold that that amount will get reduced.
10:40
But that was something that was negotiated from tax cut jobs act, which did help The small business owner for the most part which was nice to see because it was something that was needed, especially when corporations were getting, you know, more of a flat tax rate at that point in time.
10:57
But you, you pay those certain taxes related to the self-employed portion of it. And then what you'll notice is once you have that schedule Created, the net profits of it will show up on your 1040, which is a face of your personal tax return. And then you'll have a separate schedule SE for the self-employment tax portion of it and then one related to the to the QBI.
11:25
Now, one of the other things that you need to take into account is if you are looking to sort of small business, you're looking to be self-employed, You should take advantage of certain tax laws out there as it relates to. For example, if you are paying insurance self-employed health insurance, that is able that's a deduction that is able to be used.
11:50
And, you know, the way that works it's really, you're paying for insurance through private insurance. If you are getting the the premium tax credit from the, the marketplace there are other rules related to. But so for a self-employed health insurance, you can use that as a deduction and it look insurance is not cheap, especially from health insurance.
12:13
So it is a nice way to be able to deduct that, of course, business insurance also is another type of insurance that people get. But that is for, you know, things related to errors or missions related to general business liability, umbrella policy, etc. We can take into account is the ability to create, you know, a self-employed IRA or a solo 401k or self-employed type plan.
12:38
And there are various types that are out there. But typically, when I see people who are starting their own businesses, and I do understand that hesitation especially in the first year to create some of these retirement plants were, and you're not sure how the business is going to do.
12:54
But one thing I will typically say is it does help to create a self-employed type retirement, plan a, you know, pension profit, sharing type plan, depending on the nature of your business and the ability for it to be done. So And the reason for that is one, it allows you to take a deduction and also it will allow you to save for retirement.
13:22
So that of course in itself is is an easy way to start building for, you know, retirement, whenever that may be and also be able to use some of your money. Now, one of the questions I often get related to the self-employed or small businesses is remain. You know, can I go ahead and take that money and instead of it being passed onto my bank account?
13:47
Can I just go ahead and continue to invest it In? The answer is no not with a, you know, self-employed type business single member or sole proprietor whatever amount of money you make is going to be taxed. So let's say, for example you had a hundred dollars that came in.
14:02
You had expenses of $20, what happens from that? Well, you have a net profit of $80 and that $80 regardless if it stays in the business bank account or goes through your account, it's going to be considered taxable and you're going to be taxed on it. Another question that I get as well, you know, can I give myself a salary from that For a single member our sole proprietor?
14:27
There is no giving yourself a salary, Whatever amount of money comes in, is the amount of money that you're going to be taxed on. Ultimately Now could you have other, for example, independent contractors or employees of a single member LLC Certainly. Yes. And for, you know, the self-employed, for the independent contractors you'll issue a 1099 NEC, non-employee, Compensation.
14:54
And you will be able to take a deduction on that or for W2 ages for employees. You'll be able to, you know, give them that and they'll be deducted. And of course, there is a distinction between who independent contractors are and who employees are. And I'll tell you this, there was one company that I was hired to work on their their taxes.
15:20
And one of the things that I noticed was some of the independent contracts really should have been treated as employees. And you know, I told them about the distinctions between the two and the reason why you'd want to make sure that you get those distinctions, right? Because ultimately for somebody who's an employee of course there are employment laws that goes into both of these.
15:41
But you know you are responsible for the employer portion of the Social Security Medicare and the unemployment tax. So that is something important to to take into account and then really, you know, once you have started your your business got the EIN or TIN started keeping track of your revenues and the related expenses and, you know, as businesses progressing you want to make sure you get those in order.
16:08
One thing that I often will tell clients is when it comes down to, you know, close to December timeframe, get your ducks in a row for beginning of tax season. And the reason for that is tax season, it's already a busy time period. But you want to make sure that you're being proactive rather than reactive when it comes to taxes so that your already prepared.
16:31
So if you don't already have a prepare ready or somebody that helps with taxes, Earlier on the better, it's good to interview a couple. See what they can help you with. See if they understand your business and see ultimately if it's a good fit because you know at the end of the day it's a relationship in what I with with clients that I have, I always tell them it's a relationship that extends beyond taxis that's not necessarily here.
16:55
Are my numbers crunch out the return and that's the end of it. It's an ongoing relationship because, you know, as life happens there's typically a tax implication. I always say that. And so you want to make sure you maintain a relationship with someone who able to help you navigate through the changes that your business is going to experience.
17:16
You know, the growth that it might have or even it may contract and you want to be able to find ways to, to help in that regard from a tax stamp point. So earlier, the better to prepare for tax season is important but really look when it comes to small businesses.
17:33
I've always been a fan of working with entrepreneurs working with startups because at the end of the day from the business side of it, it's fascinating. It's seeing something that you've created seeing something that grows hopefully into something that's prosperous. And there are certain administrative things that needs to be done.
17:52
Ie that the tax side of it, the accounting side of it. And those are just, you know, the things that just comes along with having your own business, But it's not something to dread. It's not something to prevent you from starting your own business. I think it's just a matter of finding the right person to work with who can help you through that side of it.
18:13
Because I do understand that a lot of people like to handle the counting and attack side of it. But, you know, from a single member of sole proprietor, it is fairly straightforward. But they're going to, I say that because I've been doing it for such a long time, but I think it's something doable and I think that I always have admiration for those people who are willing to take a risk and to start their, you know, own businesses, even if it's something that's a side hustle or side business because look, you never know where it's gonna grow Anyway.
18:44
Hopefully this has been informative Again. This was just a very short primer on single member, sole proprietor LLCs, and how the tax side of it works.