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Some Tax Ideas For Start-Ups

by Jim Martin

For an entrepreneur, the tax decisions that must be made in the first few years can be confusing. For example, there are tax advantages to registering as a C corporation, but those differ from the tax advantages of an S Corporation. The key question that you have to address with your tax accountant is whether you will net more income with the lower tax rate of an S or with the broader range of acceptable deductions of a C. You must make this decision before you incorporate.

Another tax issue you should address early is the determination of which start-up costs are deductible. The expense of market research and product evaluation conducted before going into business is deductible. You can also deduct items like trade show attendance, supplier research, product advertising and employee training conducted before you open your doors. Make sure that you carefully document every expense when you are in the evaluation stage. Also, keep these expense separate from licensing and incorporation expenses; those can be deducted, but not as start-up expenses.

Another area in which you might need advice is capital equipment. While tools, fixtures and heavy machinery can be start-up costs, tax law may require that they be amortized over a specified period. When an item can only be deducted in a percentage per year, you can help your cash flow by financing the item over that number of years.

One break given to new businesses is that their owners need not file estimated taxes during the first year of operation. I guess the IRS is willing to acknowledge that few start-ups have much income during the first year. After the first year, you are required to file quarterly tax estimates and pre-pay those taxes. This requirement is more easily accomplished if your business plan includes a good cash flow analysis and projection.

If you don’t incorporate, all of your income will be subject to self-employment tax (although half of what you pay will be deductible on your personal income tax). If you form a corporation, you can pay yourself a salary, allowing the business to deduct that expense. This can get complicated, so you should also discuss this with your tax advisor. You absolutely need a tax advisor. Keep in mind, the tax laws are so convoluted that even IRS employees don’t fully understand them. An advisor can not only ensure you are compliant, but can often point out many deductions you might miss.