the rise of Small business ownership has exploded in recent years. Of all these business structure options, none is as popular as a Limited Liability Company (LLC). However, despite the popularity, some business owners are still unsure whether an LLC is the right business structure for them.
You can always consult a tax professional and get their opinion, but as a business owner, it is always good to have a basic understanding of what you are dealing with. This is especially important when it comes to your LLC tax preparation Because tax season is where many business owners tend to make tax planning mistakes as they hesitate about what to do.
Top 4 Mistakes to Avoid Before Forming an LLC and Filing Your Taxes
Now, let’s take a look at some of the common tax planning mistakes to avoid so that you are better prepared to run your business:
1. Understand the type of forms you need to use
As a new business owner, the tax forms that apply to you are something worth examining. Invest the time and energy to educate yourself on the type of tax forms that apply to your business because you will be glad you did in the future.
Understanding the business forms you need is one aspect, the second aspect is working with a tax accountant or a company that specializes in your type of industry. If you do this, then your accountant will take the time to sit down and explain in more detail what forms are and what you should know about them because this is what they do. They specialize in handling taxes for small business owners in their specific industry.
Many new business owners find out the hard way after being in business for a year what kind of forms they need and you could easily avoid becoming one of these businesses. For example, if you are a single-member LLC, then one of the forms that would apply to you is Schedule C. This is one of the easiest forms a taxpayer can use to fill in their income and expenses. If you have a multi-member LLC, then the form you would need is Form 1065.
You would also have to file a K-1 form. LLC owners would also have a Form SS-4. This is the form that will allow you to request your EIN number. Your EIN number is your employer identification number. Think of your EIN number as a social security number for your business. Form SS-4 must be applied and completed accordingly for any new business that is established as an LLC.
Yes, there are many forms that you should become familiar with and luckily you have a whole year before tax season to familiarize yourself with these forms and learn as much as you can before submitting your application.
2. You need to know your income type
Before you start setting up your LLC, you need to know the type of income you are making. There are three types of income categories that a business owner could fall into.
The level of income you are in will determine whether you need an LLC or some other type of business structure like a C Corporation or an S Corporation. The first type of income category is called ordinary income. This is the daily W-2 income you work hard for. Your 1099 compensation would also fall into this category. The second type of income category is called passive income.
Technically, any income you earn that you don’t have to work for is classified as passive income. Some examples of this type of income include investment property or interest you earn. The third category of income is called Portfolio Income. You get this type of income from capital gains or from the sale of capital assets.
These three categories of income will help you decide whether to register your small business under the LLC structure.
3. Use your EIN number for income and expenses
When you set up an LLC, this number should be used for your income and expenses. Use this nine-digit number to your advantage as it will help you through tax season. Open a business bank account with your EIN number.
In this way, you can avoid the use of your personal credit and separate your personal expenses from business expenses. When tax time comes, it will be much easier for you and your accountant to sit down and review all your business income and expenses, as long as you document all expenses through your business account and your EIN number.
Some new LLC owners in the past made the mistake of establishing an LLC but never used an EIN number. Come tax time, they realize there are a lot of things they end up not qualifying for because they never used their EIN number for their income and expenses.
If you already have a registered LLC and an EIN number that you haven’t used, set up a business account today and start tracking all your business income and expenses through that account.
4. You need to know how to get reimbursed
If you own an LLC, it is important that you know how to repay yourself. This is one of the mistakes that many new business owners are guilty of. They don’t know how much they should reimburse themselves for their business expenses.
This is an example of why it is important to have a separate business account for all of your business expenses. Without a separate dedicated business account, you could find yourself paying for many business items out of your own pocket when they really should be classified as business expenses.
Hopefully, these tips will help you avoid some of the many mistakes new small business owners make. Becoming a smart entrepreneur is much easier than it sounds. All it takes is the willingness to spend time studying and learning about the different aspects of owning and operating your LLC.