Read the post about taxes below, and browse the associated links. This exercise will hopefully assist you in thinking about simple processes that you can institute from the beginning of your business that will help you file taxes properly later.
Key takeaway: Do not let the idea of taxes prevent you from starting your business. A few simple business practices and a basic knowledge will guide you along until you may require additional accounting advice (remember, we are not accountants!).
Tax, whether relating to an individual or a company, is a broad topic and obviously not one that can be covered in a single day or by non-experts (us). I (Kyle) will be the first to admit that it's a weak area for me at the moment!
We won’t be able to address all of your tax issues today. Instead, we want to talk a bit about how best to get systems up and running now that will save you a lot of hassle down the line regardless of what taxes you and your company end up paying.
Realize that, while tax is a complicated and bewildering issue, it's also not something that should get in the way of you getting started. Too many people never get past the starting line because they get hung up about company structure, highly polished business plans, taxes, and other barriers that make them think starting a venture is harder than it is.
Here's the truth: If your business isn't a success, you won't make any profits. If you don't make any profits, then you won't have to pay taxes on these profits. If you spend a lot of time upfront working out the perfect tax structure, it will be all for nothing if the business never takes off!
I've started and collapsed multiple "companies" without official registration or ever having to deal with tax. The companies did not work – the product or service didn't fit the market, or maybe there was never a market in the first place! Instead, it is better to focus your energy on making sure you have a good product/service for the market. After that, if you start to make a profit, you can sort out the intricacies of tax.
Many of the details we address below are specific to the UK because that’s where we’ve set up our businesses, but at the bottom of today’s prompt we also try do address some specifics applicable to the US. And hopefully, if you’re setting up a business in a country other than the UK and the US, this chapter still helps you get started thinking about how your tax and business structure will work!
Self-employed or a company?
You will most likely either be filing taxes as a self-employed person or as a company, and this is a decision you should make early on, but can change later if necessary.
If you will be a one-man-band for the foreseeable future, then all you need to do is register with HMRC as self-employed and subsequently file Self Assessments every year.
As a PAYE ("pay-as-you-earn" – i.e., salaried employee), your taxes are (mostly) paid by your employer straight from your salary. Self-assessment requires you to keep track of your earnings and report them to HMRC once per year. It's a short and relatively painless process as long as you've kept decent records.
As always, the Government site for the process is actually quite self-explanatory and worth a read: https://www.gov.uk/self-assessment-tax-returns/overview
You can also have a look at the Self-Assessment form here:
The main difficulty is knowing how much you've actually made over the year. We’ll show you an invoicing system later that makes this a lot easier.
Another important point: You can be a PAYE taxpayer (i.e., an employee with a job) and still file self-assessments as a self-employed person. It's not one or the other – you are certainly allowed to have a side gig alongside your "normal" job.
For those of you who want to set up a company that will presently or in the near future include more people, then you'll need to register your company with Companies House and then file tax returns as a business. The process is more complicated that the self-employed Self-Assessment. This is actually one of the main reasons why you might want to stick with being a sole-trader rather than incorporating a company with Companies House.
On the flipside, as a company, you'll have access to lower tax rates (corporate tax is 20% for companies with a turnover of less than £1.5m with a plan to decrease to 17% by 2020) as well as more opportunities to expense costs.
If you are incorporating a company and planning on filing tax returns, I would certainly recommend talking to a business accountant, at least for an exploratory chat. Many accountants, especially those focused on small business, will happily have informal chats with people and give advice. This helps them get paying clients later.
There are actually accountancy companies set up around this sort of free-advice first, paying clients later. http://www.theaccountancy.co.uk/ask-an-accountant-a-question-for-free is a great example of this. On that page, you can submit an accountancy question, and an accountant will get back to you with advice and help walk you through the process.
There are also many, many (too many!) great resources on tax available online. One of our favorites is here: http://www.bytestart.co.uk/section/tax/tax-guides. It's worth bookmarking and using as a reference if you run into an issue.
We know it’s a lot – but remember: don't let any of this get in the way of starting your business and seeing if it works! All of this only becomes important once you start actually making money.
Some systems to set up now
There are a few things you can be doing right now to get everything in order for when you do need to worry about taxes. Doing these things ASAP (or as soon as you have your first customer) will make life a lot easier later.
First, separate your personal finances and your business finances immediately, and keep a very strict line between the two. This is the case for self-employment too. The biggest thing you can do is set up a business bank account and get a business debit/credit card linked to that account. This will divide your money up into individual/business streams and help keep them separated.
This is important for legal tax reasons but also for keeping track of your business incomings and expenses. Having everything separated out makes this so much clearer. One complication is that some banks won't let you open a business account unless you have a registered business. As a self-employed business, your options become more limited. What you can do is open a separate personal checking account at the same bank (or a different one) and unofficially designate it as your business account. Equally, you could use a PayPal account. As self-employed, you don't technically need to have an official business account, so this is a good solution – it still allows you to separate out the income and expenses of the business because they are all in a separate account.
If you have a registered company (with Companies House), then go ahead and set up a business bank account. There are fees attached to most accounts, but they are usually low for the first couple of years as your business is expected to be small. Sometimes, these accounts also come with access to small-business financing and even tax and legal advice, so the cost can be worth it. Also, these bank fees are, of course, a business expense, which can be deducted from tax.
Second, make your life easier with an online invoicing system. PayPal has a built-in invoicing system, which works well. Upgrade your personal PayPal account to a Business account to unlock these features.
I (Kyle) use Wave Apps for my invoicing (https://my.waveapps.com/). It's similar to PayPal but attached to a wider range of accounting/expense/bookkeeping tools, so it is versatile. You can also accept credit cards directly from your invoice if you connect it to Stripe (a payment process like PayPal). Wave Apps is also free.
Third: expensing. Your tax is worked out on your profits, which is equal to your revenue (the total amount of money your company is bringing in) minus your expenses (your costs). There are, of course, complications to this (otherwise, we wouldn't need accountants!), but this is the basic equation.
You can reduce your profitability (in your self-assessment or your company's tax return) by either decreasing your revenue or increasing your expenses. You probably don't want to decrease revenue, because it's nice to have money coming in! But you can increase your expenses in order to reduce that eventual tax bill.
What you can and cannot expense is a complicated topic, and it's worth reading up a bit about it. Here's a good starting guide that gives you an idea of the range of applicable expenses: http://www.danbro.co.uk/business/resources/expenses-guide-limited-companies/
A main point to remember is that you should never buy anything for yourself (or indeed anyone else) using the business's money that isn't directly for the business. A plane ticket to a business-related conference: fine. A plane ticket for a personal beach holiday in Tahiti: nope.
It's vital to keep the receipts of your business expenses. You can (and should) file these away at home/your office somehow, but we also recommend digital capture as a useful tool. Again, Wave has a tool for this: an app called Wave Receipts, which allows you to snap a photo of business receipts to capture the date, amount, and further details of the expense. All the information is sent to your Wave account, and, when it's time to pay taxes, you can easily export all the details. Beautifully simple.
These three basic systems are a great start to getting your business financials in order before it becomes a problem. Separate bank accounts, invoicing, and expensing systems will save you a lot of headaches later on, so it's worth setting up as soon as possible.
Tax is obviously a massive issue that can't be covered in one day. You only need to start worrying about tax once you've got money coming in! Before that, though, you now know the systems (bank accounts, invoicing and expensing) that can be set up with limited effort to save large headaches further down the line.
Subsection for our US readers
For our readers in the US, many of the details in today’s post were obviously geared towards our UK readers, but hopefully many of our points were helpful in general. For details about US tax structure, we recommend you visit the Small Business Association’s page about tax structure (and seek the advice of a small business tax attorney). We’ve read through several resources and broken down a few of the key points below for you to keep in mind:
Acquire an Employer Identification Number (EIN)
When registering your business as an LLC (NOT as a sole proprietor), you will be required by the Internal Revenue Service (IRS) to obtain an EIN. This nine-digit number unique to your business will be used to open your business bank account, apply for the relevant licenses, and file your tax returns.
You can apply for an EIN online via the IRS’s EIN page --https://sa.www4.irs.gov/modiein/individual/index.jsp.
Federal and state tax obligations
You will file taxes with the IRS based on what type of business you are – a sole proprietor, an LLC, or the other business types that we did not touch upon (partnership, corporation, or S corporation) because they are not especially relevant to our discussion.
You can find the right tax form for your type of business at the Small Business Associations site – https://www.sba.gov/starting-business/filing-paying-taxes/determine-your-federal-tax-obligations. On this page, you’ll also find a link to a state and local tax guide, where you can determine whether you’ll also be required to file taxes with your state. You will likely, at least initially, be paying Self-Employment Tax by filing Schedule SE (Form 1040), which self-employed individuals are required to pay if their net earnings are $400 or more per year. You may also be subject to Excise Tax, which is required if you’re selling certain types of products, using various types of equipment, or receiving payment for specific services. As we’ve mentioned, we are not tax lawyers, so it will be necessary for you to explore all of the form options and see which tax forms are required for your specific business.
Beyond federal regulations, the state tax obligations are specific for each state. As with business registration, it would not be efficient for our purposes to address each state’s regulations, so we suggest finding your state here: https://www.sba.gov/starting-business/filing-paying-taxes/determine-your-state-tax-obligations and reading through the regulations pertaining to your business.
When does your tax year start?
The tax year is defined as the accounting period for which you are required to report your business expenses and your taxable income. You may choose to report your taxes based on a fiscal tax year, starting in a certain month and extending for a twelve-month period. You’ll likely want to operate on a calendar tax year because it will be simpler to keep track of your records.