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As an independent contractor, or the owner of a contracting company, you are no stranger to tight margins, scope changes, price increases on materials, and many other daily challenges. In the midst of managing all these situations, it is imperative that you do not forget a vital component of your overall business strategy: taxes.
How Should I Structure My Business?
First off, consider your Corporate Structure. Having the correct structure will facilitate your growth plan, as well as determine the tax benefits your company will receive. This is not a “one-size-fits-all” solution by any means. For instance, if the priority is to protect your personal assets, an LLC (Limited Liability Company) is a good business entity to consider, though you will incur higher self-employment taxes on all net earnings from your business. Whereas if you opt for an S (Subchapter) Corporation classification, it allows you to pay only those taxes on the salary you draw from your business.
However, itemized deductions could make an LLC a more lucrative option than an S Corporation for purposes of tax filing. Despite the fact that standard
deductions can simplify tax preparation, many contractors wonder whether itemized deductions are worth it. It’s possible that itemizing on your return could serve you well, as long as you have the receipts to back it up. Changes in tax laws year after year can eliminate certain itemized deductions, so it’s always advisable to consult a tax professional who is knowledgeable about the current tax laws. Remember, good tax planning never leaves money on the table.
LLCs and S Corporations are often discussed in the same breath, but that can be misleading. It’s important to recognize that an LLC is a business entity and an S Corp is a tax classification. However, many people don’t realize that an LLC can also choose taxation as a corporation, and owners can save money by electing S Corp tax status. A third example is a C Corp, which provides the ability to raise capital by issuing stock, with an ownership represented by shareholders. This is not something typically recommended for contractors since it involves time-consuming corporate requirements, such as annual meetings—and more paperwork! An LLC is great for smaller businesses with its simple management structure and the flexibility it provides to the owners.
Ultimately, whatever decision you make regarding your company’s structure directly affects your tax obligations and benefits. For example, one of our clients who was a contractor had an LLC, but discovered after consulting with us that he would probably reap greater benefits for his business with a different structure. Ultimately we helped him understand the nuances and he decided to create a Corporation for his company, which has enabled his business to grow and thrive.
Think Before You Hire
One area that consistently concerns owners is the hiring of independent contractors or, in many industries, the practice of paying workers “off the books.” This can result in Financials that do not show an accurate picture of the health of the company when it comes to obtaining new or additional financing to grow the business or to fund a big project.
More importantly, not setting up the proper system (including the employee profile) can create an employment tax issue down the line, especially if there is an audit later on. It’s always best to consult with your accountant or tax professional to ensure you are compliant with all the current tax laws pertaining to employee taxes.
Keeping Proper Records
One very basic area that all contractors can easily address is their record- keeping methods. The way that you record and log daily business expenses can make a big difference to the amount of taxes you’ll pay each year on the local, state, and federal level. A good rule of thumb is to keep your records organized all year long in order to support the expenses you plan on reporting.
All too often, busy owners and contractors just don’t have the time to keep track of receipts and purchases, when they are immersed in daily troubleshooting, dealing with urgent situations that pop up during the course of a job. One popular way to handle business expenses is to establish accounts with frequently used suppliers, who will typically store the receipts for your purchases for several years.
Unless it’s an immediate need (an emergency purchase), make all purchases through these supplier accounts, and if possible, use a credit card, in which case you’ll have your statements at the end of each month as well as the store receipts. When you make cash purchases, scan those receipts to a USB drive
and have them available to provide upon request. This will ensure their legibility should you need to provide them, since the ink can easily fade on the originals as time passes. If receipts are not legible, they are useless to the IRS or the State Tax authorities, so the USB is the perfect method of proof if you ever find yourself in the middle of a tax audit. Accurate record-keeping means your accountant or tax preparer will be able to maximize your deductions and minimize your liabilities.
Consistently reporting business losses is another trap to avoid as it could be a red flag to the IRS, and might result in an inquiry or even an audit. While losses can minimize a business’s tax liability, it can be detrimental to the company’s ability to acquire capital. Speaking of acquiring capital, it should be noted that a company’s ability to repay a loan is one of the most important criteria of all in a lender’s decision on whether to approve a new loan. Keeping flawless financial records can also help greatly when applying for a loan.
Benefit From Tax Planning
As a contractor/small business owner, year-end tax planning is a solid routine that should be considered in order to fully prepare for the new year. It’s the perfect time to assess your business’s financial health. To avoid last-minute tax planning, it’s wise to set aside time each week in your schedule to assess
your business objectively. Ideally, you’ll want to recap the previous year, analyze the lessons learned, and determine whether your business is growing, holding steady, or declining.
Most importantly, sitting down with your tax professional or CPA at the end of the year tax-planning session will help you make realistic decisions about how to streamline your business in the coming months and years.
Working with an expert advisor, you’ll discover new ways to lower your tax rate or reduce the amount of taxable income that you file. With the right guidance, you can maximize the tax credits for your business while avoiding costly mistakes.
We invite you to learn more about tax planning services for contractors. If you are being audited, our IRS Enrolled Agents have many years of experience acting on behalf of contractors, representing businesses from multiple industries including plumbing and heating, electrical, repair and maintenance (both residential and commercial), as well as construction.
Founder and CEO of LEK Management Inc., Lynn Karam has two decades of experience in finance, operations, and strategic planning. Karam is an Enrolled Agent authorized by the United States Department of the Treasury to represent clients who are undergoing an audit and to negotiate with the IRS on her clients’ behalf. Her success rate in resolving even the most challenging of IRS scenarios has become the cornerstone of her success. As CEO, Karam uses her financial expertise to establish sustainable strategies that result in significant business growth for her clients.