Looking at Taxable Income as a Business Owner or an Employee
Y. Michelle Coard- 3/27/2021 RD 692021
Spending is essential in business, and it is important to how we start, keep, grow, and sustain our business or businesses. Using the IRS (Internal Revenue Service) guidelines for eligible business expenses to direct spending will help to better manage taxes. Taxable income is money from sales after all spending. More importantly, planned spending is how the business grows over time. Spending can come with challenges as sadly many business owners take advantage of spending and attempt to deduct personal expenses to reduce taxable income for business income, but we cannot treat business income like employee (EE) pay.
No doubt Employee thinking because the employer carries the responsibility of the cash flow meaning revenue and spending, therefore, the employee will only see their pay but there are other business expenses and cost for the business owner. The employer withholds money for taxes, benefits, retirement, and other things that may be tax-deductible for the employee. The employees file taxes, hoping to get money back, using personal deductions and credits to reduce their taxable income. But, this is not the same taxable deductions and credits when looking at business transactions.
Going into business many people enter treating their business as a job within a business. Many make personal purchases through the business. We also have people using personal stuff for the business so in their minds they can keep money in the bank. When you do not have eligible deductions and credits your taxable income are your gross sales. The spending offsets your taxes so you can buy what you need business-related only and you would only pay taxes on net profit. Why is this information important?
Eligible and essential business spending includes buying inventory, managing inventory, selling inventory for sales, buying inventory for use within your business such as supplies needed to provide the service or internal use for daily operations. But if you only spend on things, you cannot use so you can try to lower taxes you limit or cut off the ability to buy what you need for operations or could use for growth. Because managed and planned spending is essential to increasing profit. Yes, the profit is taxable income but depending on your business structure there are other options. Learn more about taxable income in the Business Formation Course because your business structure is important.
Did you know your tax preparer can not just write off a total number of expenses? When we prepare taxes, we must break out spending into eligible categories. The majority of the business spending falls into preapproved categories and accounting software and Financial Statements help us with pulling the information together. Financial statements also allow us the ability to manage internal processes.
The financial statements are the ending reporting product but how we get to the production of correct financial statements will begin with your daily accounting processes. Yes, daily because managing money is daily even if we just check our balances but remember there are other steps so do not just stop with checking the bank balances.
Often, we have a tough time visualizing how to run a business in the ownership position once we leave the employee position. Alternatively, some people start out as business owners and do not understand employee positions and their responsibility with taxes. When running a business, the employee and the requirement associated with the employee fall under eligible business expenses.
When considering taxes there are two points of view business owners (contractors are business owners) or employees, therefore a business owner cannot manage sales and spending as if they receive a check as an employee.
A business can also work as an employee in their business but depending on business structure determines if the business owner will receive owner’s draw or payroll. However, a business owner that receives a draw can put themselves on payroll processing but when tax time comes, they would still report as a flow-through entity. Learn more about business structure and taxes in my business formation course.
As an accountant that works with various types of business, I do not work for the government or the IRS, but I understand how the processes work to help, us, the people. I do not enjoy paying taxes either, but it is part of society. I have found that it is better to understand how to honestly minimize your tax burden by starting during the year rather than waiting for tax season to understand your tax responsibility. I found that people that pay less for taxes can use the funding without worry about how to manage and grow the business.