Business Responsibilities

Business taxes: Taxes for your employees

• Employee income taxes
  As an employer, you are obligated to withhold federal income taxes from employee wages and pay these to the IRS. How much you withhold depends on your payroll frequency, size of the wage payments, number of exemptions claimed by each employee and their marital status. You must issue each employee a W-4 form for determining withholding exemptions.
  
• Social Security, Medicare
  These taxes must be withheld from employee pay. The current rates are 6.2 percent for Social Security and 1.45 percent for Medicare. As an employer, you pay a matching amount -- for totals of 12.4 percent and 2.9 percent.
  
• Unemployment tax
  Most employers pay both federal and state unemployment tax under the Federal Unemployment Tax Act. The tax is due on the last day of the first month after each quarter ends, and can be paid by the electronic transfer of money or in an authorized financial institution using Form 8109, Federal Tax Deposit Coupon.

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Forwarding the taxes
Withholding taxes are paid monthly or semiweekly, depending on the individual circumstances of the business. Large businesses are generally required to pay their tax within a day of each payroll. Details on your tax liabilities can be found in the IRS Tax Guide for Small Business and in The Employer's Tax Guide.

State taxes
You also may be required to withhold and forward state income taxes and other local taxes charged to employees, employers and businesses. Additional taxes and fees may be levied against firms in specific industries.

Business taxes: Excise taxes
Depending on what they manufacture and sell, how they operate or the equipment they use, some businesses must pay excise taxes. An excise tax is paid to the federal government for a privilege, or on the consumption, sale or manufacture of a commodity. For example, you would use Form 720 to report on the following taxes:

• Environmental taxes.
• Communications taxes.
• Fuel taxes.
• Tax on the first retail sale of heavy trucks and trailers.
• Luxury tax on passenger cars.
• Manufacturers' taxes on the sale or use of a variety of different products.

Use Form 2290 to report federal excise tax on trucks, truck tractors and buses with a gross weight of 55,000 pounds that use public highways.

Excise taxes must be reported quarterly, but may have to be paid before the quarter. For more information on excise taxes, see Publication 510.

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Business taxes: Filing requirements for sole proprietors
If you are a self-employed sole proprietor and earn at least $400 in a calendar year, you have to file an income tax return, using Form 1040.

To figure out your net profit and loss from business, use Schedule C and attach it to Form 1040.

Federal income tax returns must be postmarked by April 15 if you operate on a calendar year. If you use a fiscal year, your return is due on the 15th day of the fourth month after the end of your year. Late filing may result in stiff penalties and interest. Use Form 4868 to request an automatic four-month extension if you think you will miss the deadline. It excuses you temporarily from filing the form, but the tax is still due.

Your return may be due only once a year, but the IRS calls income tax a "pay-as-you-go" tax, a nice way to say it wants a percentage as soon as you get paid.

Most employers withhold a portion of workers' pay to submit to the government periodically. Self-employed people pay an estimated tax.

You pay only if you expect to owe tax on income of $1,000 or more. You have to make quarterly payments on April 15, June 15, Sept. 15 and Jan. 15. You pay tax only when you receive income. For example, if you received no income until May 10, you would pay estimated tax in June.

There are three ways to make an estimated tax payment:

• Mail in a payment voucher from Form 1040-ES
  
• Pay electronically using the Electronic Federal Tax Payment System
  
• Credit an overpayment on your return for the next year's estimated tax

Use Form 1040-ES to figure and pay the tax. For more information on estimated tax, see Publication 505, Tax Withholding and Estimated Tax.

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Business taxes: Income tax for partnerships
Partnerships that have gross income must file a return on Form 1065 showing income, deductions and other required information. Partnership returns should also include the name and address of each partner and their share of taxable income. See the form's instructions for more information about who must file it.

Form 1065 must be filed by April 15 if the partnership's accounting period is the calendar year. A fiscal year return is due by the 15th day four months after the close of the business's fiscal year. If the partnership thinks it will miss the date, it should file Form 8736 in April for an automatic three-month extension.

A partnership computes its income and files its return in the same manner as an individual. Partners must pay estimated tax if they expect to owe tax on income of $1,000 or more. Payments are due quarterly, on April 15, June 15, Sept. 15 and Jan. 15. Tax is only paid once income has been received. For example, if no income was received until May 10, the estimated tax would be paid in June.

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Business taxes: Income tax for corporations
All domestic corporations, even those in bankruptcy, must file an income tax return regardless of whether they have taxable income. Use Form 1120 to report your tax liability.

The exception to this is if gross receipts, total income and total assets are each less than $500,000. In this case, you can file Form 1120-A. For more information, see the instructions for Forms 1120 and 1120-A.

A corporation has to file a return by the 15th day of the third month after the close of its tax year. To request a six-month extension, file Form 7004. The extension is for filing a return only; you still have to pay the tax.

In keeping with the "pay-as-you-go" policy of the IRS, a corporation should make estimated tax payments as it receives income. Use Form 1120-W to figure each required installment.

Payments of estimated tax are due April 15, June 15, Sept. 15 and Dec. 15 if using a calendar year; and on the 15th day of the fourth, sixth, ninth and 12th months of the corporation's tax year.

You may also have to pay state income tax. The Federation of Tax Administrators maintains a listing of state corporate income tax rates.

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Business taxes: Income tax for S corporations
If you elected to be an S corporation, you report income, deductions, gains and other required information on Form 1120S.

An S corporation has to file a return by the 15th day of the third month after the close of its tax year. If you don't think you will make the deadline, file Form 7004 to request a six-month extension. The extension excuses you temporarily from filing a return only -- you still have to pay the tax due.

An S corporation should make estimated tax payments as it receives income. Use Form 1120-W to figure each required installment of estimated tax. Payments are due on April 15, June 15, Sept. 15 and Dec. 15 if using a calendar year; and on the 15th day of the fourth, sixth, ninth and 12th months of the corporation's tax year.

How to file
In addition to the traditional snail mail, here are a few filing options available for personal and business use:

• IRS e-file or electronic filing either through an authorized e-file tax professional or through your own personal computer.
• TeleFile with your home telephone.

1040PC computerized return, prepared at home and sent in by mail

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Cash flow: Understanding cash flow
If you're opening your own shop, no doubt you plan to make a profit. But how will cash flow toward your till? In a steady stream, or in floods followed by trickles?

Knowing how to do a cash flow analysis is an essential skill for every business owner; it can be the difference between being able to open a business and being able to stay in business.

Cash flow analysis provides a means for you to conduct a periodic check on your company's financial health. A projected cash flow statement estimates what the stream of money will be in coming months or years, based on a history of sales and expenses. A monthly cash flow statement reveals the current state of affairs.

A cash flow budget is your core tool for maintaining control of company finances. For example, you can show profits in a company, but still be short on cash if a customer is late on payments. While you can usually cut costs, you can't always generate income or sales. You need to know where the money is, where it's going and how to get more when you need it.

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Cash flow: Calculating your cash flow
To get a handle on the financial outlook for your company, start with your budget, which projects profits or losses by looking expected income and expenses. (If you need a hand with budgeting, check out our stories on the basics of financial planning for business owners.)

For our purposes, the most important use of the budget is that its numbers can be used to help anticipate cash flow needs, which is essential to keeping a business operating smoothly.

The basic elements of cash flow are:

• Starting cash -- This is your starting balance -- what you have on hand at the beginning of each month.
  
• Cash in -- This is all cash received during the month, including sales, paid receivables, interest or cash from sales of assets or stock.
  
• Cash out -- Includes all fixed and variable expenses.
  
• Ending cash -- This is your ending balance. Add starting cash to cash in for total cash, then subtract cash out.

Here is an example of how you measure cash flow by subtracting your monthly ending balance from your starting balance.

Let's say you started the month with $3,500. You brought in $2,500 in sales and $500 in paid receivables. You paid out $1,500 in rent, $250 in supplies, and $1,750 for wages and owner's draw -- for a total of $3,500 in expenses. Your ending balance is $3,000.

While you did show some sales, your monthly cash flow would be -$500. To survive, you want positive cash flow, which means taking in more than you are spending. Positive cash flow gives you forward motion to build and grow.

Even a small lag in sales or an outstanding bill can make a dramatic impact on cash flow, but you won't know that without your cash flow budget. At the end of every month, compare actual business sales with estimated cash flow and hold them up against your master budget.

If they are out of sync, consider the cause. Maybe you didn't factor in the need to hire summer vacation replacement help or the jump in paper prices for your printing business. Cut back on cash out where you can, and adjust monthly cash flow projections to more realistically meet your needs.

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Cash flow: Management practices
Good cash flow management means you can anticipate when your cash flow needs will occur. Your cash flow budget will help you predict what's coming, but you have to be diligent in daily record keeping and reporting of cash in and cash out.

The following steps can help you monitor cash flow:

• Use prenumbered cash receipts and account for all receipts
• Deposit checks daily
• Send customer invoices within two days
• Collect receivables within 60 days
• Take advantage of cash discounts
• Use prenumbered checks for all disbursements

A good cash flow manager should be ready to meet challenges. For example, if your company has a history of slow summer sales, you may have trouble meeting payroll in those months. If you have periodically reviewed your cash flow budget and projections, you will be prepared for the crunch with additional sources of cash, and will have established good relationships with creditors and banks should a short-term loan be necessary.

Here are some ways to project and meet cash flow needs:

• Anticipate payroll
• Anticipate outstanding debt payments
• Set money aside for expansion, emergencies and opportunity purchases
• Use short-term financing when necessary
• Establish a line of credit with a bank to avoid making bad decisions in a cash panic

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Cash flow: Offer customers credit, but be careful
You may find yourself in a situation where offering credit is necessary for doing business, or you may decide to accept credit as a way to generate more business. Of the two types of credit, trade and consumer, consumer is the easiest to offer and maintain.

• Consumer credit involves the acceptance of major credit and debit cards. To offer this service, you simply approach your bank and set up a program. The bank takes a small fee or percentage on each charge and in exchange, it accepts the credit risk.
  
• Trade credit is offered by the business itself. In some industries, such as manufacturing and wholesaling, customers expect trade credit. For example, when a wholesaler ships supplies to a retail company, the accompanying invoice indicates terms of payment. Most wholesalers give the retailer 30 days to pay the bill, which amounts to 30 days of credit.

Before you make trade credit a policy, make sure you understand the risk and take steps to reduce it. The best way to do this is to get training in credit procedures. This is offered by many credit bureaus. Also, become familiar with the Fair Credit Reporting Act, Equal Credit Opportunity Act, Fair Credit and Charge Card Disclosure Act and Fair Debt Collections Practices Act.

Good credit policies are essential to business survival, and will help you manage your cash flow. Remember that the same qualities a lender looks for in you are the ones you want in a borrower.

Carefully set up an overall company credit plan which will:

• Establish credit policies
• Create a credit application
• Set credit limits
• Oversee credit usage
• Formulate a collection policy

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Cash flow: How to deal with profit

What do I do with all this cash?
If you have managed your cash flow effectively, you should end up with extra cash. What you do with those profits should be directly related to your cash flow budget. Remember that you created this budget to predict cash flow needs. There may be some outstanding debts ballooning in the future or inventory that needs restocking. These anticipated needs determine where and how long you can reroute cash.

Some places to put excess cash include:

• Debt service -- Repaying debt should help improve cash flow even further, unless the loan's interest rate is so low you would get a better return for your money on outside investments.
  
• Investments -- Check out the pros and cons of investment opportunities such as certificates of deposit, money market funds, sweep accounts (combined checking and investment accounts) or interest-bearing checking accounts.
  
• Emergency savings -- Liquid cash accounts can help you over small hurdles and provide ready money for unexpected opportunities.
  
• Capital improvements -- Putting money back into the business may be a long-term goal in keeping with your business plan and capital budget.
  
• Increasing wages and dividends -- Salary increases can help you retain your best employees, and you may deserve a reward, too.
  
• Profit sharing -- A benefit and an incentive for employees

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Business planning: Financials
This section should be a little easier to start, since you've already thought through some startup and operating costs.

Key points to include are:

• The size and source for the initial investment
• The bookkeeping and accounting system you will use
• Balance sheets and projected income statements for two to three years
• The first-year operating budget and cash flow projections
  

If you're not sure how to pull together detailed financial reports, you may need to hire an accountant or financial planner. Just make sure you go over these final documents together. It's hard to impress a lender with the financials if you can't explain them.

Industry associations in your field of business can provide much of the information you'll need. The library reference area is an excellent source of industry data, and trade magazines and professional association newsletters often publish statistics. The federal government also provides business, economic and trade data.

Make sure to include copies of any supporting documents such as tax returns, personal financial statements and contracts such as franchisee agreements, purchase agreements or leases.

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Legalities: The importance of good record-keeping
With all the legal and tax obligations required of a small business, it's imperative to keep careful records. A good record-keeping system will help you achieve several objectives:

• Keep your company organized and growing
• Prepare important financial statements
• Make local, state and federal governments happy by keeping a clear account of income, expenses and employees for reporting taxes. Good records help you support any claims you make on your tax returns.

We'll divide this part in two -- the records to keep and how to keep them.

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Legalities: The records to keep
Your transactions and book entries need to be backed up by sales slips, invoices, receipts and canceled checks. If the IRS audits your business, you may have to show evidence of claims on your business tax return. Supporting documents should be organized and easy to find. For example, you may want to store them by year and catalog them as income or expenses.

General documents
Here are some of the documents the IRS expects you to have on file:

• Gross receipts -- Show the amount and sources of income with register tapes, bank deposit slips, invoices, receipt books, credit card slips
  
• Purchases -- To document items you buy and resell, including parts and raw materials, keep canceled checks, cash register tape receipts, credit card sales slips, invoices
  
• Expenses -- Track the cost of running the business through canceled checks, cash register tapes, account statements, credit card sales slips, invoices, petty cash slips for small cash payments.
  
• Assets -- Maintain records on property you buy, sell or improve that is used by the business by keeping purchase and sales invoices, canceled checks, real estate closing statements.

Get an EIN
Businesses larger than one person must establish an Employer Identification Number. EINs are used by the IRS to record the tax accounts. If you don't need an EIN, you must use your Social Security number.

You need an EIN if any of the following pertains to you:

• Have employees.
• Have a Keogh retirement plan.
• Operate as a corporation or partnership.
• File returns for employment taxes, excise taxes, or alcohol, tobacco or firearms taxes.

Include your taxpayer identification number -- your SSN or EIN -- on all returns and documents you send to the IRS or you may face penalties. You can obtain an EIN by filling out Form SS-4, Application for Employer Identification Number. Order the form from the IRS at 1-800-829-3676.

If you have employees, you must get a Social Security number from each one. When you make payments to an outside source, you must get the source's SSN or EIN.

Employee records
If you are an employer, you are also expected to keep records identifying each employee, as well as the hours worked and the wages earned. You will need:

• Employee's full name and Social Security number
• Address, with ZIP code
• Birth date, if under 19
• Sex and occupation
• Time and day of week when employee's work week begins
• Total daily and weekly hours
• Basis on which employee's wages are paid, e.g., hourly, by the job
• Regular hourly pay rate
• Total daily or weekly straight-time and overtime earnings All additions to or deductions from wages
• Total wages each pay period
• Date of payment and the pay period covered

How long to keep records
Most records should be kept at least until the IRS period of limitations has run out. For tax purposes, the IRS requires that all employee records should be held for at least four years. You may need to keep records longer for non-tax purposes, such as insurance or financing, so check with the appropriate institution.

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Legalities: How to keep the records

Bookkeeping basics
There is no special record-keeping system required or approved by the IRS. At a minimum, though, your records must clearly show your business income and summarize transactions through original and supporting documents.

To keep track of business transactions, you need to write them down, usually in specialized books called journals or ledgers. There are also several computer software programs that are easy to use.

Record-keeping is all about numbers. Once you've compiled the numbers required for tax purposes, they have to be submitted, along with the payments, to the IRS.

Hire a professional accountant
Hiring an accountant can take a lot of pressure off the small business owner who is concentrating on sales, marketing and operations. A good accountant can help set up a basic record-keeping system that works for your line of business.

While business owners can often handle the day-to-day bookkeeping themselves or with a bookkeeper, most are advised to let an accountant handle complicated tasks such as preparing tax returns and financial statements.

Once your bookkeeping/accounting team is in place, whether it's in-house or comprised of outside help, you need to make some important decisions on how you'll keep the records.

Pick a tax year
There are two types of annual accounting periods on which you can base the way you keep records and report income and expenses. You can choose either the calendar year or the fiscal year.

• The calendar tax year is a period of 12 consecutive months beginning Jan. 1 and ending Dec. 31.
  
• The fiscal tax year is a period of 12 consecutive months ending on the last day of any month other than December. Basically, it's a 52- or 53-week period ending on a specific day of the week that falls either in the last week of a specific month or nearest the last day of a month.

Select an accounting method
You must choose an accounting method to determine how you will report income and expenses in your books and on your tax returns. There are two basic types of accounting systems to choose from: accrual and cash basis. Check with your accountant, as there are instances when a company is required to use the accrual method.

• Cash basis -- Most small businesses use cash basis, or “real-time” accounting, whereby transactions are recorded when they happen. For example, when you are paid for a service, you record it as cash in, even if the service was performed a month ago.
• In accrual accounting, you record the income when it's earned, not received. It's the same with expenses: You record the utility bill when you get it, not when you pay it. Many businesses with inventories use the accrual method.

Cash, accrual or a combination of both methods are all acceptable by the IRS as long as records are clear and accurate and you use the same accounting method every year.

You must ask the IRS for approval if you want to change.

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Choose a bookkeeping system.

• Single-entry system -- The simplest bookkeeping system to maintain is the single entry system, which records the movement of income and expenses through a daily summary of cash receipts, and a monthly summary of cash receipts and disbursements.
  
• Double-entry system -- The field of accounting is based on the double-entry system, which records transactions into journals and ledgers. With this system, daily transactions, including sales, purchases, cash receipts, accounts receivable and accounts payable, are recorded in journals. Each account has a side for debits and a side for credits. You enter every transaction as a debit in one account and a credit in another. It's more time-consuming, but can be more accurate as it tends to be self-balancing.

The journal information is later summed up and transferred to a general ledger. From the ledger, you or your accountant can formulate the most important business financial statements, the balance sheet and income statement.

TIP: Many businesses have a business checking account, separate from personal checking, using the checkbook as the main record of daily expense transactions. By depositing all receipts into the checking account and writing checks for all business expenses, you can keep good daily transaction records. These records can be transferred to your books.

Preparing a financial statement
At the end of your accounting year, you will have to balance the books for tax purposes and to check on the financial health of the company. The financial statement that shows this information is called the balance sheet, and it's similar to the personal net worth statement.

Most of the numbers needed to enter into this spreadsheet can be compiled from the general ledger after all the journal entries have been posted.

A sample double-entry business balance sheet would look like this:

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