Okay, let’s talk about tax. I know this is not a hot topic and you would rather do anything else. But as long as you own a business, taxes are a part of your daily life, and trying to ignore it won’t make it go away. Rather, it will only make things worse for you and your business. So the best approach is to know as much as possible about taxes. Don’t worry, I will try to make this as easy to understand as possible and to do so, there are a few things I would like to discuss first before I dive into the main purpose of this article. 

Business Structures

When you are about to legalize your business, there are four main options you have to choose from. These are;

Sole proprietorship - This is an unincorporated business owned by an individual. It is the most common business structure. 

Partnership - This is a business that is owned by two or more people. Partnerships can be General Partnership, Limited Partnership (LP), or Limited Liability Partnership (LLP). 

Limited Liability Company (LLC) - A limited liability company is a business that is regarded as its own entity separate from its owners. So if the business fails or gets sued, the owners are not held liable to repay the company's debts. 

Corporation - This is a legal entity that accords the owners certain protection just like an LLC, The difference is that a Corporation is treated as an individual, so it possesses certain rights such as the ability to enter contrast, get loans, sue and get sued, etc. Corporations are of two types, C Corps and S Corps. 

These four classifications are referred to as Business Structures. Each structure is unique in its way, especially in the amount and type of tax the business would pay to the appropriate authority. For example, C Corps are subject to double taxation, meaning that they are taxed twice. 

The Corporation is taxed first since it is treated as an individual and then the shareholders are taxed when dividends are distributed. Now that you know the different business structures, here are some of the taxes that Startups pay. 

Types of Taxes that Startup Pays

There is a common question, do Startups pay taxes like other companies? The answer is Yes. I get why this question is often raised seeing that Startups are in many cases, money guzzlers. It is either they are running on investor funds or barely earning enough to break even. There are four main classes of tax;

• Income Tax
• Estimated Taxes
• Self-Employment Tax
• Employment Taxes
• Excise Tax

These can further be classified into three broader categories;

• Federal Tax
• State Tax
• Local Tax

Federal taxes are taxes imposed on businesses by the federal government. These include income taxes, payroll taxes, self-employment taxes, and in some cases, Federal excise taxes. 

Income tax - these are taxes levied on income earned by the business/individual. For companies, this is known as Corporate Tax, and for individuals (self-employed) it is known as income tax. The tax is imposed on the company’s taxable income, which is calculated by subtracting the expenses incurred from the revenue earned by the company. So basically, it is a tax on profits made. If a business is not making any profits, then it may not have to pay income tax. The Corporate Tax Rate in the US is a flat rate of 21%. 

Payroll Tax - these are imposed on businesses with employees. Employers are mandated to withhold a percentage of the wages paid to employees as tax to be remitted to the government on a quarterly basis. Payroll taxes are used to finance government programs like Social Security, Medicare, etc. Payroll taxes also include Federal Withholding and Federal Unemployment Tax (FUTA). 

Self-Employment Tax - as the name implies, these are taxes levied on business owners who identify as self-employed. It also goes into funding government programs like Social Security and Medicare. SE taxes are levied on any self-employed individual who has made up to $400 in earnings. The Self-employment tax rate is 15.3% of your earnings. 12.4% is for Social Security and 2.9% for Medicare.

Excise Tax - this is the tax imposed on certain goods and services. How this tax is collected differs but in most cases, it is imposed on businesses, who then collect it from their customers by including it in the pricing of goods sold or services rendered. Common products that are subject to excise tax are fuel, alcohol, and tobacco. This is not all, there is a whole page dedicated to Excise TAx here. 

Similar to taxes remitted to the federal government, businesses also pay taxes to states and local governments. One tax that is collected by both Federal and State governments is the Corporate Tax. The Corporate tax charged at the state level depends on the state where the business is located. 

Some states charge a flat rate while others use a progressive tax rate. The percentage collected and what is being taxed will differ from state to state. Excise and sales tax are two other types of tax that are to be remitted at the State level. 

Apart from knowing what taxes to pay at the federal, state, and local government level, it is also important to know how your business structure affects the tax you pay. 

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How To Pay Less Taxes (Legally)

There are a number of ways you can use to save money on taxes but before I go into that, it is important to emphasize that this is not the same as tax evasion. There are two words you would hear frequently when talking about taxes, one of them could land you in prison. 

Tax avoidance is steps taken to lessen tax liability and maximize after-tax income while Tax evasion is steps taken to hide tax or avoid paying tax or pay less than what you are supposed to pay. Tax evasion is illegal but Tax avoidance is not. In this section, I will be talking about how startups can legally lessen your tax burden. 

#1. Choose the right business structure

At this point, it should be clear why this is the first step to take. After all, before you even talk about paying taxes, you must have a business structure. Now you know the interrelations between business structures and taxes, you can decide which one is suitable for you. Is it a sole proprietorship, partnership, or an LLC? 

#2. Choose the right location

Like they say, it’s all about location, location, location. When planning your business, you need to put a great deal of effort into ensuring you take all the advantages you can get and that means choosing the right location for your business. Some States/Countries are tax heaven while others can drastically reduce your Startup’s chances of survival. You don’t want to be in a place where you get to pay double or even triple in tax compared to the industry standard. You need to know how paying a flat rate versus a progressive rate will affect your business’s income. Here is a comprehensive review of the tax rates for 2023. 

#3. Hire Employees

Having employees has a few pros, one of which is that it saves you some percentages in tax. I can see how counterintuitive this may seem being that you will have to pay wages. But you can deduct this from your tax since it is basically a form of business expense. 

That is not all, you can also lower your tax by deducting employee health benefits, money spent on tools, and resources, tuition reimbursement, and office renovations to accommodate employees with disabilities. There are additional credits for hiring veterans and family members too. 

You don’t have to pay unemployment taxes if you hire family members. But make sure they are real employees of the company and that they make positive contributions to the company. 

#4. Tax Credits

There are a number of tax reliefs available to startups and businesses in general. Aside from tax deductions, startups can also benefit from tax credits. These are incentives provided by the government for businesses that meet certain criteria. Tax credits include investment credits, work opportunity credits, research credits, employer social security credits, new market tax credits, etc. You would have to know which ones apply to businesses in your industry. 

#5. Deductible Expenses

Startups are costly to run and before you pay your tax, you are required to deduct the cost of running your business from the revenue generated. There are many deductions that Startups can take advantage of to reduce the tax burden. These are categorized as expenses and they include rent, travel expenses, office supplies, insurance, salaries, professional fees, contributions made to charity, etc. The list is quite long and that’s a good thing for business owners. You can get a full list of all allowable business deductions here. 

#6. Tax-Advantaged Accounts

These are accounts that offer certain tax benefits to the account holder for saving money. The benefits could be tax deferment, or tax exemption depending on the type of account. Examples of tax-advantaged accounts are 401k, Health Saving Account (HSA), and education plan. 

Conclusion

There are many ways to lessen the tax burden, some of which have been covered in this article. However, it is advisable to consult a professional to get more insight on how to avoid paying more taxes to the government. If you do not take advantage of the available means, the government stands to gain, and though the amounts may seem quite insignificant in the beginning, it add up quickly when the profits start coming in. Yes, planning your taxes takes a lot of effort, but it is often worth it in the long run.

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