Chapter 5
Taxes, Employees, and Professional Services
Taxes
The purpose of this section is to provide you with a basic understanding of the tax process as it pertains to sole proprietorships, so that you can be of some help to your accountant at tax time. Let me be clear – you will not be qualified to prepare your own taxes after reading this brief description. I have no doubt that many of you may be capable of handling your business and personal taxes if you choose to do so. However, I stand by my recommendation to enlist the aid of a professional when it comes to such specialized matters. The laws pertaining to business and taxes are complicated, vary by state, and are always changing. Not only can you get yourself into trouble, you are likely to miss out on the savings to be had by taking advantage of tax breaks you may not know about. The information contained in this book is meant to provide you with a basic understanding of bookkeeping, accounting, and taxes. Consult an accountant before undertaking any new business. They know the laws, and their counsel shall supercede anything written in this book.
Before you do anything else, get IRS Publication number 334 “Tax Guide for Small Business” which will do a good job of getting you started. Read it thoroughly. The first decision you need to make is whether you will be using the calendar year or some other fiscal period. Some industries start their financial year on a date other than January first for various reasons. If you are a sole proprietor, you need to use the same tax period for your business as you do for yourself, which is the calendar year.
As a sole proprietorship, your business pays no income tax. The profit from your business is reported on your personal income tax by filling out Schedule C of Form 1040 (your personal income tax form). These forms are due April 15 of each year. Since there is no employer to withhold taxes from a paycheck each week, the government requires you to make estimated quarterly tax payments if your year-end tax bill will be $1000 or more. This probably means you. File Form 1040-ES. These payments are due on the 15th of April, June, September, and January.
Business expenses are deductible and lower your taxable income. The basic rules that determine what constitutes a business expense are as follows: 1) Is it an “ordinary and necessary” expense, and 2) Is it “reasonable”. Such ordinary and reasonable expenses are entered in your expenditure ledger such as buns, postage, and the mileage allowance. The wage or draw that you pay yourself is not a deductible expense. Your accountant can tell you what constitutes a legal business expense.
In addition to federal income tax, you are required to pay Self-Employment Tax, which is a combination of Medicare and Social Security for self-employed people. File Form 1040 SE.
State Income Taxes. Most, but not all states calculate income tax as a percentage of your federal tax liability. Check with your accountant to be sure. Some states have a “Gross Receipts Tax” which is based on the total sales revenue generated by your business before expenses.
Ask your accountant about any local taxes that may be imposed by your city or county.
Employees
This purpose of this training system is to teach you how to start and run a successful hot dog cart business, by yourself or possibly with a partner. When you have employees, your paperwork increases tremendously, you have to manage people, and you lose the freedom to make your own hours or take a day off at the drop of a hat. On the other hand, this is a business that can provide you the opportunity to make an unlimited income. If you want to grow beyond a one-cart business, you will have to hire people. In this section we’ll take a very brief look at what is involved when you have employees. If this is your eventual goal, I recommend further reading on the subject. There are many excellent business books that cover this topic in greater detail, and a chat with your accountant is mandatory.
Before you start interviewing candidates, you will need to complete a few procedures to become a legal employer. Let’s begin with federal requirements. The first thing you need is an EIN (Employer Identification Number, discussed earlier). If you don’t already have one, you can get one by filing Form SS-4, Application for an Employer Identification Number. Also get a copy of Employer’s Tax Guide – Publication Number 15, Circular E. This guide tells you what you need to do to comply with federal requirements. It also includes federal withholding tables. You will be responsible for withholding income tax, Social Security tax, and Medicare tax from each employee’s paycheck.
In addition to the money the employee pays in, you yourself are required to match a portion of the employee’s Social Security and Medicare. Yes, the government requires you to partially fund your employee’s retirement. You must file Federal Payroll Tax Returns four times a year. You must file a W-2 Wage and Tax Statement at year-end for each employee. A single Form W-3 Transmittal of Income and Tax Statements is sent to the IRS along with copies of all W-2s you gave to employees.
You may also be required to pay Federal Unemployment Tax if you paid wages of $1500 or more in any one quarter or had at least one employee who worked some portion of at least one day during each of twenty different calendar weeks…got that one? The INS (Immigration and Naturalization Service) requires you to fill out Form I-9 Employment Eligibility Verification Form for each employee (hiring illegal aliens is a crime). Get about 10 copies of Form W-4, Employee’s Withholding Allowance Certificate.
If you’ve ever worked for someone else, you are familiar with the W-4 because you were required to fill one out. The W-4 allows the employee to declare their marital status and choose the number of exemptions they want to claim, which determines how much tax is withheld from each paycheck. You will keep the W-4 in your files. The only time you need to send a W-4 to the IRS is if the employee claims more than 10 exemptions, or if the employee claims to be exempt from withholding but will make more than $200 a week.
As an employer, you will need to comply with several laws that exist to protect the worker from unfair or dangerous working conditions. The Fair Labor Standards Act covers such things as minimum wage, overtime pay, and child labor. This act primarily applies to hourly workers, not salaried people. You are exempt from this act if your business is not incorporated and hires only family members. You must comply with the Americans with Disabilities Act. OSHA (Occupational Safety and Health Act) requires you to meet certain basic safety conditions and requires that you keep official job safety records once you employ 11 or more people.
Now let’s look at some state requirements. You may be required to obtain a state Employer’s Identification Number as well as the federal version. In most states, you must have Worker’s Compensation Insurance. You must pay state Unemployment Insurance at a rate determined by the state based on occupation. You may be subject to payroll taxes for employers and employees, employment training, and disability. If your state has an income tax, you must withhold it.
As you can see, there is a lot to be aware of when starting down this path and the government won’t forgive you if you fail to meet its requirements. You could be liable for hefty fines and penalties. This is why I strongly urge you to get an accountant to help you. With a professional to handle the federal and state requirements, you will have the peace of mind to concentrate on hiring people and growing your business.
Professional Services
Perhaps you already know a good accountant, bookkeeper, and attorney. If so, you can skip this section. If you don’t, I’ll give you some suggestions on what to look for in a professional services provider. After reading this book, you should be able to do your own bookkeeping, but you will probably need to see an accountant at tax time. One exception to what I just said about bookkeeping – if you are horrible at math, or if you can’t stand math, or if you have trouble with details…hire a bookkeeper. Don’t ask your accountant to perform simple bookkeeping duties when a bookkeeper can do it for a lot less. Some accountants offer bookkeeping services at a rate lower than their usual accounting fees.
Here are some tips when shopping for an accountant. Ask other small business owners in your town for recommendations. You don’t want to go with an H&R Block type because they are used to dealing with people who are employees with regular paychecks. They don’t have experience with small business issues such as payroll and sales tax. You don’t necessarily need a CPA (Certified Public Accountant) or EA (Enrolled Agents – experts at dealing with the IRS), although they might be excellent if they deal with small businesses regularly. Try to get recommendations from local business owners with whom you do not directly compete. Your banker or insurance agent can also provide referrals.
Once you have a few names, give them a call and tell them that you are a starting a small business. See if you like the way they interact with you on the phone. Are they personable and understandable, or do they talk over your head, throwing around financial or tax terms that you can’t understand? The next step is to meet with those accountants who passed the phone interview. You are about to embark on a long-term business relationship so make sure you are personally compatible. How much time will he or she spend with you to set up a tax strategy? Avoid the guy who does nothing more than a year end “plug and chug” – plugging your numbers into a computer that chugs out a tax return. Planning for tax savings begins January first. A good accountant will take the time to get to know you and your business, and will find ways to save money through tax strategies, the timing of purchases, etc.
Having an attorney isn’t mandatory unless you get sued or need to initiate legal action against someone else, or when you decide to incorporate or form an LLC. Your accountant will probably know most of the local attorneys, and will have working relationships with a few. Ask for their recommendation if the need arises.
Note: This would be a good time for you to take a peek at the “101 Hot Dog Cart Business Deductions” report included with our Cash Tracker Software.
A warning from my accountant – maybe “California Only”, but I suspect it applies in a lot of states:
If you are selling “sales tax included” (as Steve recommends and I certainly am doing), make sure you state that clearly on your menu. If not, the local State tax board may look at your menu prices as the starting point, and impose taxes based on the menu price plus sales tax – thus driving your tax rate higher than necessary. Three words is all that is needed to protect yourself from this.
Thanks Matt! I have never run into this before but three words on your menu is cheap insurance indeed. Do this everyone.