It’s such a helpless feeling. I sit watching an accountant thumb through pages of documents I prepared the day before, trying to determine from his facial expressions if I messed something up. I know I’m being irrational, but I secretly wonder if my business and even me as a person is being judged based on my financials.
Mistakes during tax time can be both embarrassing and costly, and I’ve made many of them, including waiting a year to track and organize sales receipts! But, I recently discovered the biggest mistake I made came before my first sale.
The entity structure of your business will determine how much you pay in taxes, and in some cases, setting up the wrong structure can unnecessarily cost you and your business thousands of dollars.
For an example of how big this mistake really is, we turn to our friend Josh Bauerle of CPA on Fire.
“Imagine two different companies – let’s call them Company A and Company B – who both sell beer (writing about taxes all day induces thoughts of alcohol, it seemed appropriate). Company A and Company B both have exactly $150,000 in gross sales. They both have exactly $50,000 in expenses. And their net income is $100,000 for both. They are essentially the exact same company in every measurable way.
Both companies are owned by single men who are the exact same age and who have no dependents, no other income and no other expenses. Their only taxable activity comes from their business. Come tax time, both men go to the same CPA to have their taxes done. Knowing what we know so far, their tax bill should be exactly the same, right? Not quite.
Company A walked out of the CPA’s office with a total tax bill of $29,106, which included $12,282 in self-employment taxes.
Company B walked out of the same CPA’s office with a total tax bill of $23,885, including $6,141 in self-employment taxes.”
Josh goes on to explain how this is possible. “The difference between the two companies tax bill comes down to one very simple thing, their choice of business entity. Company A is structured as an LLC. Company B is also an LLC, but has elected to be taxed as an S-Corp.” The difference between the companies is what forced Company A to pay nearly 22% more in taxes than Company B. Can you afford to pay an extra $5,221 in taxes each year?
There are millions of potential mistakes you could make with your small business accounting each year, but few are as costly and overlooked as how your entity is formed. This mistake will cost you and your business money before you even start making it. To make sure you’re in the structure that bit fits you and your business, read The Five Best Tax Tips For Entrepreneurs Part I: Choosing the Right Business Entity by Josh Bauerle.
If looking for a company to partner with to make sure every tax season is as smooth as a baby’s bottom, check out Kahuna Accounting. We’ll max sure your bookkeeping doesn’t stink.