With success come taxes. Well, true success brings a lot of things, such as confidence, pride, more responsibility and, most definitely, more taxes. It’s one of the few unfortunate parts about becoming successful: You have to pay more to the government. It’s a part of the game you play as an entrepreneur. You’re fortunate enough to be a steward of your own future and of the future of those who believe in you, and because of that, you have a bigger price to pay than those who choose the safety and security of working for someone else.
The first years as a successful entrepreneur can come with lots of shocks. Business owners are all ignorant when they start out, and it’s the process of trial and error that allows them to become educated and aware of the things they don’t know. I want to walk you through three things you should know about taxes as a starting entrepreneur and help you avoid the trial-and-error phase.
1. Your initial investment into your business can be taken out tax-free.
I’ve seen several accounts come in that are overpaying on taxes just from this one thing. Many people don’t know that your initial investment into your business is called your basis. In any investment, the initial amount is called your basis.
What many entrepreneurs don’t know is that because that initial investment is already taxed money, the government has no right to tax that investment into your company. So for the first year(s) in business, most entrepreneurs and business structures are able to take that amount as tax-free income.MORE FROMFORBES ADVISOR
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So why is this important? Because after you start profiting in your business more than you’ve invested, you’ll have to start paying more in taxes — even if you don’t pay yourself. You have to pay taxes on your profit, unless you’re a C corporation, which has its own set of advantages and disadvantages.
2. You’re going to have to pay taxes on profit for any pass-through corporation.
All too often, I see clients draining their business account into their personal account solely because they want to see tangible rewards for their efforts after a successful year in business. As I said earlier, when you have success, you have to pay more taxes.
One thing most beginning entrepreneurs get shocked by is the fact that they have to pay taxes on their business profit even if they keep it within their business bank account. Once your business has some level of success, it would be ignorant to believe you’re not going to fall on hard times. Every business has times of feast and famine, and being ready for those times of famine is what has kept my business and my clients’ businesses afloat during times of famine.
The good thing about paying taxes on your business profits is you’re able to count that as part of your basis, and if you take money out of the business on a particularly good year, you’re able to take anything that tax has already been paid on out without being taxed again.
Quickly, let’s define what a passthrough entity is; a sole proprietor, single-person LLC, multi-person LLC and S corporation are all pass-through business entities, which means the tax liability is passed on to the owner or owners of the company, whereas a C-corp takes on the tax liability on its own. The downside to a C-corp is you’re also taxed on any salary you pay yourself, so the money is essentially taxed twice. As a disclaimer, different entities work well for different business structures and partnerships. Always consult a financial and tax professional before making any decisions about your business structure or tax strategy.
3. There are benefits to being a spender and a saver, and making an informed decision can help.
There are benefits to spending a lot of money within your business. There are a number of write-offs that can be paid for in part or in full that are tax-deductible. The standard Instagram-worthy life can be yours if your business is making a decent amount of money and you don’t want to pay a lot in taxes. While that lifestyle is not only culturally admissible but lusted after, it can come at a price because of tax avoidance.
When you pay for most of those luxuries through your business, you’re able to avoid taking larger paychecks into your personal account and avoid paying taxes on those paychecks or the potential profits in your business because the profit and loss statement shows a large number of expenses. It sounds great in theory but can come at a price. When you’re not saving money, whether it’s in your personal or business account, and you’re not investing in income-producing assets, you’re committing yourself to liabilities, and sometimes, those are long-term commitments.
If and when you fall on hard times, you need to be prepared to pay for those liabilities. When you’re saving money in business, or personally, you’re going to have to pay more in taxes and live a less glamorous life, but you’ll be prepared for hard times and be able to withstand large setbacks, like for instance the effects of lockdowns and the pandemic.
In the end, with success come taxes, but when you’re prepared, you can be proud of your ability to provide for yourself and others. You can be proud to pay those taxes, and you can rest well knowing you’re building a better future for yourself and those you love.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.