Your First Business Tax Return

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A checklist for first time filers of business tax returns

It’s your first year in business, and tax time has arrived. How does the new business owner prepare for getting those returns filed accurately, timely and achieving the most favorable results for the business?

Review the form completely

First, take a look at a copy of the business tax return you will file to see what line items on the return the government expects you to fill in with amounts. Also, if there are questions asked on the return, make sure you have the answers to those questions. These could include the nature of the business, is it your first year in business, and your business location. Make sure your chart of accounts has the correct categories of income and expenses for you to both manage your business and properly file your returns. While all businesses must keep complete and accurate records, many do not reach that mandate without an effort to insure they are in compliance with the law.

Accounting basis

One decision the owner must make is whether to prepare the tax returns on the cash or accrual basis.

Under the cash basis, income is recognized when collected and expenses are recognized when paid. Under the accrual basis, income is recognized when earned and expenses are recognized when incurred. While lenders will generally prefer to see accrual basis financial statements, tax returns can still be prepared on the cash basis even if the financial statements are prepared on the accrual basis.

A new business might have more unpaid expenses than uncollected income at year-end, and therefore might consider taking those additional net expenses as a deduction. This would be done by selecting the accrual basis. However, in later years when the business is profitable, receivables should be greater than payables, and so the business would be recording additional net income and paying more taxes if it had selected the accrual basis instead of the cash basis. Once you make the decision on which basis to use you will stay with it throughout the life of your business, although changes are permitted. Certain businesses, including those with larger revenues or inventories, must choose the accrual basis.

Depreciation method

The next decision to consider is which depreciation method to use. The Internal Revenue Service permits a first year deduction of up to $100,000 for most furniture and equipment, instead of writing off the cost over five or seven years. So most business owners would generally elect to take the first year write off. However, businesses without profits can’t deduct the first year depreciation deduction, although they can carry it forward to profitable years. A business in its early stages might consider taking the slower depreciation route so that most of the deductions will be available when the business has income and is a higher tax bracket than in the startup phase.

Home office deduction

Sole proprietors in home-based business locations should consider the ability to deduct a portion of their residence as a business deduction. To be successful in this widely contested area, the business area used in the home must be used exclusively for business. The business owner would measure both the square footage of the home used for business and the total square footage of the home. The resulting percentage of business use would be applied to home office expenses to determine the amount to be deducted. If the business has a loss, then a home-based business deduction is not allowed, but can be carried forward.

In order to properly account for the business use of the home, the business owner would first deduct the percentage of the real estate taxes and mortgage interest that would otherwise be taken as an itemized deduction. If there are still profits remaining, then other home expenses such as landscaping, and general home repairs would be allocated to the business and personal portion, and a deduction would be allowed for the business portion. Finally, if there is still a profit, then depreciation on the home is allowed on the business portion. To calculate depreciation, the cost of the home must be allocated between the cost of the land (which is not deductible) and the building. The building must then be allocated between the business and personal portions by the percentage calculated earlier. The resulting depreciation deduction is then written off over almost a forty year period, and the actual annual home depreciation expense would usually not be more than a few hundred dollars.

Non-employee compensation

Another piece to year-end tax returns is the review of independent contractors you paid to see if the government must be notified of their non-employee compensation. Your employees receive a W-2 form to identify their income and withholding tax. Similarly, your contractors who make $600 (as of 2004 tax year) or more would receive form 1099-MISC from you, and the federal and state governments would also receive a copy. Contractors who are corporations are exempt from receiving this form, but partnerships and limited liability companies with more than one member must receive them. If you wait until year-end to obtain the contractor’s social security number or employer identification number you might not be successful in obtaining that required information.

Have your contactors fill out form W-9 to give you the needed information.

Automobile expenses

Automobile expense can be a major expense for a new or existing business. The business owner should maintain an auto log to keep track of where and when he or she traveled to, who was seen, and if there was a business purpose to the trip. While some individuals only track business use, I recommend keeping the log for all auto expenses, since those who itemize their deductions can also deduct transportation as a medical expense, and as a charitable contribution deduction if active in a charity. The business tax returns will want to know when you placed the vehicle in service, and the amount of the business, commuting and personal miles for each vehicle for the year.

Self-employment tax

Profitable sole proprietors are sometimes surprised to find that self-employment tax ( social security and medicare tax for self-employed individuals) can be overlooked and may be a significant part of their total tax bill. Be sure to calculate these taxes as part of your total estimated taxes when paying quarterly estimates. Also be prepared for the April 15 surprise. Not only is the balance due for last year’s taxes, but also due is the first quarter installment of the next year’s taxes. Cash flow must be monitored to have these funds available.

This list covers only a few of the many items a new business owner should consider in preparing for the initial business tax return. Those who work with business tax preparers should also consult with them to determine in what format the business data should be transmitted to them for preparation of your returns.
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Joseph L. Rosenberg is a Certified Public Accountant in Florham Park, NJ, specializing in working with entrepreneurs and small business owners. He can be reached at (973) 443-4332 or josephlrosenbergcpa@consultant.com.

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Not that long ago, Cindy Goble could barely send an e-mail. Today, she spends a good part of her day peddling perfume and beauty products on the Internet, as the owner of web-based retailer Beautymark Corp.

Goble's online career started in early 2004. She'd spent the past 10 years as a stay-at-home mom in London, Ont., and she'd been itching to get into business. "I was yearning for some kind of presence in the business world," she says. But she was determined to still spend as she could with her two kids.

Then a friend told her about a skin-care product that was only available in the United States. "I thought, why not try to sell this cream—which was remarkable for stretch marks and also on wrinkles—in Canada?" After speaking with the manufacturer, Goble decided that the best way to land a Canadian distribution deal was by going online. "I didn't know the first thing about the web," says the 43-year-old, "so I was very uncomfortable at first."

She holed up at the family cottage with a stack of books on how to operate an online business. "I read and highlighted and took notes," she says. Then she hired a web designer to create a site and teach her to run it. "It's very easy to operate, so I can add and delete products myself," says Goble. "That put me at ease." The designer also set her up to accept payments through PayPal, so she didn't need to be able to handle secure credit card transactions on her site (though she does take credit card payment by phone). To keep shipping simple, Goble restricted sales to within Canada and U.S., using Canada Post for domestic shipments and UPS for those headed south of the border.

Beautymark Corp. launched in November, 2004. But a few months later, having only served a handful of customers, Goble knew two things had to happen for her business to work: she needed to find a way to stand out online, and she had to expand her product offering beyond skin care. "I would go for weeks without any sales," she says. "I began to realize that my site was nowhere to be found in the millions of Web sites out there."

In the spring of 2005, Goble (with her husband's help) began to submit her site to online directories like Yahoo and Best of the Web. The more directories that listed Goble's site, the more likely it was that Beautymark would appear in an online search. Then, to boost her product offering, she bought the inventory from a perfume retailer who specialized in hard-to-find scents and was looking to shut down her shop. Goble updated the Beautymark site just a few weeks before Christmas and held an open house for the perfume store's existing customers in her living room. "It was a big hit," she says.

Now, when Goble sumbitted her site to all those online directories, she could add much broader keywords like "perfume," "fragrance" and "hard-to-find scents."

It worked. Goble went from fewer than 20 customers in September, 2005, to 100-plus that December. A year later, her business continues to grow. She now has more than 200 perfumes (more than 500 bottles at any given time) and stacks of coordinating boxes, tissue and bags stored in her basement. "The longer you have your Web site and the more directories you submit to, the more your business will grow. It's a snowball effect."

Goble's new products are doing so well (she has added a line of bath and beauty products to her inventory), she dropped the skin scream that started it all—it wasn't doing much to boost her sales. Now she's planning to move to a bigger home, so she can set up a permanent showroom and hold open houses. "I don't pay rent, I had no construction costs, and it's a one-employee business," she says. "My costs are very low, which made starting my own business more attainable." Plus, she's home every day when her kids get home from school.

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