Understanding the Basics of Business Taxes: What Every Startup Founder Needs to Know

Posted on October 4, 2024.

As a startup founder, your focus is likely on scaling your business, innovating new products, or securing funding. Taxes? They’re often at the bottom of the list—until tax season rolls around. Understanding business taxes, however, is crucial to running a successful company. A strong grasp of your tax obligations not only helps you avoid penalties, but it can also help you save money through deductions and credits.

This guide offers a straightforward explainer on the fundamentals of business taxes. Whether you're just starting out or looking to refine your tax knowledge, here’s what every startup founder needs to know.

Types of Business Taxes You Need to Know

Income Tax

The most familiar tax for most people is income tax, which applies to the net income (profits) of your business. Depending on your business structure (e.g., LLC, S-Corp, or C-Corp), the way income taxes are filed will vary:

• Sole Proprietors and Single-Member LLCs: Business income is reported on your personal income tax return.
• Partnerships and S-Corporations: Pass-through taxation means profits are "passed through" to the owners, who then report them on personal tax returns.
• C-Corporations: The corporation pays taxes on its income at the corporate level, and any dividends distributed to shareholders are also taxed (known as double taxation).

Self-Employment Tax

If you're self-employed (including freelancers or sole proprietors), you’ll need to pay self-employment tax, which covers Social Security and Medicare. This tax rate is 15.3% and applies to net earnings from your business.

Payroll Tax

If you have employees, you'll be responsible for paying payroll taxes, which include Social Security, Medicare, and unemployment taxes. Payroll tax withholding is required on wages paid to employees, and employers typically match the Social Security and Medicare contributions made by employees.

Sales Tax

If your business sells physical goods or certain types of services, you might need to collect sales tax. The sales tax rate and the items it applies to vary by state, so make sure to check local regulations.

Property Tax

If your startup owns property—whether it’s real estate, vehicles, or equipment—property taxes may apply. These taxes are based on the value of the property and are typically paid annually to the local government.

Excise Tax

Some industries, like manufacturing or transportation, may be subject to excise taxes. This tax is levied on specific goods or activities, such as fuel, alcohol, tobacco, and transportation services.

Tips: 

• Determine your business’s tax obligations based on your business structure, the products or services you provide, and your location. Consulting with a tax professional can ensure you're complying with all federal, state, and local tax laws.
• Choosing the Right Business Structure for Tax Purposes
• One of the most important decisions you'll make as a startup founder is choosing the right business structure. Each structure has its own tax implications:

Business Structures

Sole Proprietorship

• Easiest to set up.
• Business income and expenses are reported on your personal tax return.
• You’ll pay self-employment tax.

LLC (Limited Liability Company)

• Can be taxed as a sole proprietorship (single-member LLC), partnership (multi-member LLC), or corporation.
• Flexibility in choosing how you want to be taxed.
• Protects personal assets from business liabilities.

S-Corporation

• Business profits and losses are passed through to shareholders and taxed at the individual level.
• Avoids double taxation.
• Only salaries paid to owners are subject to self-employment taxes, not the full business profits.

C-Corporation

• Profits are taxed at the corporate level, and dividends distributed to shareholders are also taxed (double taxation).
• Corporate tax rates are lower than individual tax rates for high-income businesses.
• Offers the most comprehensive liability protection.

Tips:

• Review the pros and cons of each structure, especially how they impact your taxes. If you're unsure, speak to a tax advisor or business attorney to help you select the best option for your startup.
• Understanding Deductions and Tax Credits
• Tax deductions and credits can significantly reduce your tax liability, but they are often overlooked by startup founders. Here’s what you need to know:

Tax Deductions

Deductions lower your taxable income, which means you pay less in taxes. Some common business tax deductions include:

• Home Office Deduction: If you work from home, you can deduct a portion of your rent, utilities, and other related expenses.
• Business Equipment: Computers, software, and machinery can be deducted under Section 179 or depreciated over time.
• Startup Costs: The IRS allows you to deduct up to $5,000 in startup expenses in your first year of business.
• Employee Salaries and Benefits: Payments made to employees, including wages, health insurance premiums, and retirement contributions, are fully deductible.
• Advertising and Marketing: Costs associated with marketing and advertising, including digital ads, promotional materials, and branding efforts, are deductible.

Tax Credits

Tax credits directly reduce your tax bill and can be even more valuable than deductions. Some common credits for startups include:

• Research & Development (R&D) Credit: A valuable credit for startups involved in innovation, technology, or product development. Even small startups may qualify.
• Work Opportunity Tax Credit (WOTC): This credit is available for businesses that hire individuals from certain target groups, like veterans or long-term unemployed.
• Employee Retention Credit (ERC): If your startup kept employees on payroll during certain periods, you may be eligible for this refundable credit.

Tips:

• Maximize your savings by taking advantage of all available deductions and credits. Keep detailed records of business expenses and work with an accountant to ensure you're claiming everything you're entitled to.
• Estimated Taxes: Don’t Get Caught Off Guard
• Many startup founders are surprised to learn that they must pay estimated taxes throughout the year, not just during tax season. The IRS requires businesses to make quarterly estimated payments if they expect to owe at least $1,000 in taxes for the year.

How to Calculate Estimated Taxes

• Estimate your annual income and the amount of tax you’ll owe.
• Divide this number by four to determine your quarterly payment.
• Pay by the quarterly deadlines: April 15, June 15, September 15, and January 15.

Tips:

• Keep a calendar reminder for estimated tax due dates. Failing to pay on time can result in penalties and interest, adding unnecessary costs to your business.
• Record-Keeping: Your Best Defense Against an Audit
• Good record-keeping is not only essential for running a smooth business but also your best defense if you're ever audited by the IRS. Keep thorough and organized records of all financial transactions, including: Receipts for expenses, Bank statements, Payroll records, Mileage logs for business travel, Contracts and agreements
• Use accounting software like QuickBooks or FreshBooks to track expenses, income, and taxes in real-time. If you prefer manual methods, organize your documents by month and category, making them easier to retrieve during tax season.

Hiring Help: Should You Get a Tax Professional?

• While some founders may prefer handling their own taxes, hiring a tax professional can save time, reduce stress, and ensure compliance with complex tax laws. A good accountant or tax advisor can:
• Help you identify deductions and credits you may not be aware of.
• Ensure you’re filing the right forms and meeting deadlines.
• Advise on tax-efficient strategies for business growth and expansion.

If you’re a first-time founder or dealing with multiple tax obligations (like payroll or sales tax), it may be worthwhile to hire an accountant to handle your taxes. The peace of mind and potential savings often outweigh the cost of their services.

Filing Deadlines: What You Need to Know

One of the most common mistakes startup founders make is missing important tax deadlines. These are the key dates to keep in mind:

• March 15: Tax filing deadline for S-Corporations and partnerships.
• April 15: Tax filing deadline for sole proprietorships, single-member LLCs, and C-Corporations.
• Quarterly: Estimated tax payments are due in April, June, September, and January.

Missing deadlines can lead to penalties and interest charges, which eat into your profits and create unnecessary stress.

Tips:

• Set calendar reminders a few weeks before each deadline to give yourself enough time to gather documents, organize financial records, and prepare your tax returns.
• Understanding business taxes can feel overwhelming, but taking the time to learn the basics will set you up for success. From choosing the right business structure to leveraging deductions and credits, these foundational elements can save you money, reduce stress, and help your startup thrive.
• Taxes don’t have to be a headache. With good planning, proper record-keeping, and expert guidance, you can navigate the tax landscape and make the most of the benefits available to your startup.