Dealing with taxes is one of the many challenges new business owners face. The first part of this article discussed taxes imposed directly on your business entity or its owners at the state and federal level. However, new businesses also have to consider that they are responsible for collecting some other types of taxes, such as payroll tax and sales tax. The rules for these taxes are often just as complicated as income-tax rules are, and the consequences of making mistakes can be equally devastating to your business.
Payroll and self-employment tax
If you hire employees, your responsibilities don't end once you hand them their paychecks. You have to make sure you withhold the proper amounts from their paychecks for the various taxes that your employees must pay, and your business will have to pay employment-related taxes of its own. You don't even have to have employees to incur employment-related taxes. Even a sole proprietor who works completely independently without any employees must pay a self-employment tax.
As an employer, you have an obligation to withhold certain taxes from the paychecks of your employees. These taxes include Social Security and Medicare withholding, federal income-tax withholding, and any additional withholding your state imposes, including state income tax, unemployment, and disability-insurance withholding. For 2006, the Medicare withholding amount is 1.45% on all wages, and the Social Security withholding amount is 6.2% on up to $94,200 of wages.
Determining the proper amount to withhold for federal and state income tax requires that you consult withholding-tax tables. To use the tables, you will need to know the number of withholding allowances your employees wish to claim; your employees will make this election on federal tax form W-4, which you should provide to them when you hire them. Depending on the amount of your total payroll, you must turn over these withheld taxes to the IRS on a regular basis, either twice a week or monthly. IRS Publication 15contains additional information for employers about their obligations. Similar provisions apply to any taxes that your state requires you to withhold from employee pay.
In addition to withholding employment-related taxes from your employees' pay, your business itself incurs taxes that result from hiring employees. The employer is required to match the amount withheld from employee pay for Social Security and Medicare. In addition, the employer must pay federal unemployment tax of 6.2% on the first $7,000 in wages you pay for each employee. This amount may be reduced if your state requires your business to make payments into a state unemployment fund.
Often, new businesses have cash-flow problems. However, making payments of withheld payroll taxes is the single most important thing for you to do as a business owner. The IRS takes it very seriously when an employer diverts money withheld from employees' wages. Congress has given the IRS substantial power to deal with situations involving a failure to pay withheld taxes. In addition to large penalties, the IRS can collect not only from the business itself, but also directly from the personal assets of the business owners, officers, and directors responsible for making financial decisions for the business. You may be tempted, but you don't want to go down this road.
For unincorporated businesses without employees, owners generally must pay self-employment tax on their profits. The self-employment tax rate incorporates both the employee and employer contributions to Social Security and Medicare, and so you must pay 12.4% on the first $94,200 of wages for Social Security, plus 2.9% on all wages for Medicare.
Many states and some cities and counties charge a sales tax on purchases. Some states limit the application of sales tax to physical goods, while others also impose sales tax on services. In most cases, it is the responsibility of the business to collect the tax from customers and to remit collected funds to the state government.
Although many commentators have suggested that replacing the federal income tax with a national sales tax would simplify the tax system dramatically, there are still many things to keep in mind in dealing with sales tax. For instance, most states provide for exemptions from sales tax for certain items, such as food or clothing. Other states charge different rates for different categories of purchase. In addition, you may not need to collect sales tax if the purchaser intends to resell the item as part of the purchaser's business.
For example, if you own an auto-parts store and sell a part to a consumer, then you probably need to collect sales tax. However, if you sell a part to a repair-shop owner who will then resell the part to a customer, then you may not need to collect sales tax because the repair shop-owner will get the tax from the final customer. Most states require such purchasers to present a sales-tax exemption certificate.
Other tax issues
As a new business owner, you have the ability to start your business on the right foot when it comes to taxes. It's best to take tax matters very seriously; many potential problems can be solved very quickly if you address them early. Conversely, if you try to bury problems rather than deal with them, you will quickly find yourself in big trouble that will likely be far more difficult or even impossible to resolve in a timely manner.
Keeping track of all of the taxes your business must pay can be a daunting task, but remember that you have many resources available to assist you in complying with all of the applicable laws. Although there are many responsibilities in being a business owner, the rewards are worth it.
- Taxes and Your New Business: Part 1
- Be the Boss
- Forming Your New Business
- Profit From Your Children
- Staying Ahead of the Tax Curve
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Fool contributor Dan Caplinger prefers taxes to death but tries to stay away from both. He doesn't hold shares of any of the companies mentioned in this article. The Fool's disclosure policy is always working for you.