5 Small-Business Tax Tips For Beginners

Vlad Rusz is a CPA at Centaur Digital Corp, helping busy business owners efficiently manage their accounting systems.

With the prevalence of side gigs and freelance work in today’s economy, many people are small-business owners without even realizing it. Working as a freelancer or independent contractor essentially makes you a business owner, and that means you must pay taxes like one.

Unlike the way it works for traditional W2 employees, there are no taxes withheld from money made by a business, a side gig or freelance work. Instead, small-business owners get the ability to deduct costs associated with that income on the tax return, as well as some preferential tax elections. Take full advantage of the tax code and set yourself up for success with these five small-business tax tips for beginners.

Tip 1: Set money aside for taxes.

A stark difference between business owners and W2 employees is that business owners must pay taxes independently, while a W2 employee has taxes withheld as they receive each paycheck. To avoid an unexpected tax bill, business owners need to set money aside for taxes. This amount will vary from business to business, but an accountant or tax professional can help. If you’ve been in business for more than a year, one shorthand way to estimate is to divide last year’s tax amount by your sales.

Tip 2: Track all money in and out of the business.

Unlike traditional employee income, business income does not always come with summary tax forms like the W2 at the end of the year. While some clients may issue a 1099 to a contractor, it’s not required in all situations, and some neglect to do so. It’s the responsibility of each taxpayer to report all income they’ve made, regardless of tax forms received. Thus, a business owner must track all the money going in and out of the business to accurately determine their taxable income.

Tip 3: Separate business and personal funds.

One of the biggest distinctions between a dedicated business owner and someone simply with some side freelance income is the separation of business and personal funds. While not strictly required for all businesses, separating business funds can alleviate many audit issues because it makes the business income and expenses distinctly identifiable. This separation doesn’t always make logical or economic sense, since you are essentially moving money from one pocket to another, but it’s a tremendous boon to record-keeping requirements.

Tip 4: Elect a favorable tax structure.

An overlooked benefit of having business income is that small-business owners may have options to elect a different tax structure. If you’ve registered your business as an LLC or corporation, this election option can drastically reduce your taxes if executed correctly. These options are not available to W2 employees, which is why working with a competent tax professional is essential if you have a substantial amount of business income.

Tip 5: Know what you can deduct.

The biggest benefit of business income is that you can deduct costs that are ordinary and necessary to generate that income. For example, while a W2 employee might use their personal car to pick up office supplies, there is no deduction for these expenses unless their company reimburses them for these travel costs. However, a business owner gets to deduct the use of their personal vehicle for business use. Depending on the type of business, there are myriad expenses that are deductible, from office supplies and equipment to furniture and real estate.

Transitioning from W2 employment to business income, whether full-time or as a side gig, can have many tax implications. After acknowledging that your freelance work makes you a small-business owner, use these five small-business tax tips for beginners as a foundation to help you better manage your taxes at the end of the year.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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