Tax planning may not seem like the most exciting part of starting a new business, but down the road when it saves a lot of money, the payoff can be exhilarating.
"Starry-eyed entrepreneurs who skip planning could get caught in the taxman's net," said Daniel D. Morris, a partner at accounting firm Morris & D'Angelo in San Jose.
Some budding businesspeople don't realize they may have to file a tax return, even if they've not yet made a penny in revenue or even started formal operations.
For example, if a start-up registers as a limited liability company in California, a state income tax return will need to be filed along with an $800 payment.
New entrepreneurs, who might be working out of their homes, also have to be careful to document tax-deductible expenses, accountants said. If a budding businessperson is planning to write off car and cellphone expenses, for example, business versus personal uses of these items will need to be carefully tracked.
And many new business owners put off tackling tax issues because they are daunted by the topic and busy trying to get their products or services to market. About one-third of the start-ups Morris sees in his practice don't become clients until after the tax year ends, giving them fewer options to cut their tax bills, he said.
Jewelry designer Sara Wilson, who made her first sale in July of the sorority logo necklaces she designs and sells on her Greek Girl Shop website, said she has yet to meet with a CPA and is not sure whether she should be paying federal income taxes quarterly or waiting until April 15.
"I wasn't exactly business savvy when I started," she said.
In defense of new business owners, it's not easy to navigate the maze of federal, state, county and city tax rules when starting out, especially in situations that make it difficult to estimate how much income will be generated.
"It's very difficult to plan tax-wise for your first year because you don't know really where you are going," said Linda Freeman, who started House Calls, a contractor referral and home-services consulting business, out of her Sherman Oaks home in February. "I don't know what my tax liability will be."
Different tax rules apply to different kinds of start-ups. And to make matters more confusing, California tax law doesn't always follow the federal tax code.
Learning the ropes, including the exceptions, is important. For example, if an LLC or corporation is formed in California within 15 days of the end of the year and no revenue has come in, it won't have to file a state return or owe state tax for that year, said Lynn Freer, publisher of Spidell Publishing Inc.'s California Taxletter in Anaheim.
She encourages start-ups to sign up for the free workshops and "webinars" hosted by government agencies.
The Internal Revenue Service's website has a section for small businesses and self-employed people at http://www.irs.gov/businesses/small/index.html. And the agency's taxpayer advocate service has an online toolkit with information for new business owners at http://www.taxtoolkit.irs.gov/tax-topics/businesses.
California's Franchise Tax Board has information for all businesses online at http://www.ftb.ca.gov/businesses/index.shtml.
You can obtain outside help, but it's still a good idea to get at least somewhat familiar with how tax policy might apply to you.
Sheba Williams of Cerritos learned that lesson the hard way. She aims to restart a talent management company she closed a few years ago, but she still owes taxes for the firm because she didn't take the time to learn all the tax rules and relied on outside advisors. This time she wants to do things differently.
"Even with taxes and those things I am scared of, finances, there are people to help you," Williams said. "But it's good to learn it yourself."
Here's additional tax information for start-ups:
• Many start-up costs are tax deductible. This year, the IRS will allow $10,000 in start-up costs to be written off, twice as much as in 2009. Those costs can include market research, advertising, employee training, business travel and professional fees rung up before the business begins operations.
• Jobs credit. A new small business in California that will hire its first employees this year may also qualify for up to $3,000 in state tax credits for each full-time employee hired, Freer said.
• Keep records. "The biggest lost opportunity I see is simply failing to keep good files, good records, and failing to keep them up," said Gregg Wind, a partner in accounting firm Wind Bremer Hockenberg in Los Angeles.
Roughly one-quarter of Wind's new clients don't use accounting software to track deductible expenses.
• Income tax is pay as you go. New business owners often come from corporate jobs where income was withheld from paychecks. It can be a rude awakening to learn they probably will have to make quarterly estimated tax payments on their own.