The goal when filing business tax returns is to pay as little as possible. This is a worthy goal, and tax write-offs help serve this purpose. However, it’s important to remember that lenders will ask for financials. If business financial statements are not available, they will look at business tax returns. If it looks like your business is not profitable, you will not be able to get funding, or you may get less funding.
Taxes, Tax Write-Offs, and Fundability™
To understand how tax write-offs can affect your ability to get business funding, you need to understand the relationship between taxes and Fundability.
There are many factors that affect the overall Fundability of a business. Credit Suite identifies 23 core principles of Fundability. We break these down further into 125 Fundability factors, and one of these is “Business Financials.” Business tax returns, in turn, are one of the factors included in this principle.
Business Tax Returns
According to the IRS, except for partnerships, all businesses have to file an income tax return. There are different forms, and the one you need to use depends on the business structure you choose. This could be a sole proprietorship, corporation, S-corp, or LLC.
Business Tax Returns 101
Business taxes are not exactly the same as personal income tax. Here are the major differences you need to know.
Federal business income tax is pay-as-you-go. You have to pay the tax as you earn or receive income. Usually, this is done on a quarterly basis. Sole proprietors and S-corps that expect to owe tax of $1,000 or more when they file their business tax return, will generally need to make estimated payments. Corporations that expect to owe $500 or more will need to pay estimated taxes as well.
There are also differences in the required documentation. For example, you have to track expenses, asset purchases, income, and more. As a result, it’s best to hire a bookkeeper or bookkeeping agency. At least choose a great accounting software option. Then you can print reports at the end of each tax period and just hand them over to your tax preparer.
Don’t try to do this on your own. Splurge on a tax professional. The cost will be well worth the time and money you save, and you’ll reduce the chances of a mistake. They will have more in-depth knowledge of the tax write-offs you can take legally and how they will help you. They can also help if you end up in an audit.
Your tax preparer should not be the same person as your bookkeeper or accountant. With smaller businesses the same firm is ok, but it is not wise for the same person to do both. This helps deter and detect fraud. Even if you have an in-house bookkeeper or accountant, they can get ready everything the tax preparer needs. However, they should not complete the tax forms themselves.
Cash vs. Accrual
You will need to choose your method of accounting. You can choose either cash or accrual basis accounting. The cash basis includes income as revenue when it is collected. Expenses are deducted from revenue when they are paid.
With accrual basis accounting, you record income when you earn it. Consequently, you count expenses when you incur them.
Using cash basis accounting, you don’t necessarily count revenue as soon as an item sells. You count it when you get the cash for it. Unless the buyer pays cash on the spot, you do not record revenue until the customer pays the invoice. As a result, there are no receivables carried on the books.
With accrual basis accounting, you record revenue at the time of sale. Then, a receivable for the invoice goes on the books. New businesses may have more unpaid expenses and more uncollected income at the end of the year. Taking those outstanding expenses as a deduction can reduce tax liability. This accounts for many of the most common tax write-offs.
Later, when your business is profitable, your outstanding receivables will likely be higher than your outstanding expenses or payables. If you are using the accrual method, you will be recording more net income, and paying more in taxes versus the cash method. Be sure you consider this when making your decision.
The decision of which method to use is for the life of the business. However, there are some exceptions that allow for changes to be made. In contrast, businesses with larger revenues or that carry inventory don’t even have a choice. They must use the accrual method of accounting.
Depreciation is one of the most common tax write-offs, but there are some decisions to be made. Discuss them thoroughly with your tax preparer to ensure you are doing what is best for your business.
The first choice will be first-year depreciation. Typically, depreciation on assets is written off over the course of five to seven years. But the IRS allows a first-year deduction of up to $100,000 for equipment and most furniture instead. This is an election most business owners take. If you do not make a profit, you cannot take the $100,000 deduction. Yet, you can carry it forward to a year that you do make a profit.
In the beginning, a slower depreciation method may work better. You can save the deductions for later when there will likely be more income and you will probably be in a higher tax bracket. Again, a tax professional can help you make that decision.
Tax Write Offs and Fundability
Now to the real question. How does all of this affect your ability to get business financing? For a business to be Fundable, it needs to be fully recognizable as an entity separate from its owner. There is a lot of crossover between Fundability and business taxes. Entity choice is one example.
You can choose whichever entity you want for your taxes, but you do have to choose one. That choice will depend on your budget and needs for liability protection. Your tax advisor will be able to help you decide. However, it’s important to note that the decision you make affects Fundability as well.
For Fundability purposes, operating as a sole proprietorship or a partnership doesn’t work. Your business needs to operate as a completely separate entity from you as the owner. To do that, you need to choose to operate as either an S-corp, LLC, or corporation.
Fundability, Business Tax Returns, and the EIN vs. SSN Saga
If you are operating as a sole proprietor, it is possible to use your SSN to file your business tax return. You should not file a business tax return using your Social Security Number for maximum Fundability. You need to use an EIN, and you can get one for free at IRS.gov.
How Tax Write Offs Can Affect Fundability
Business lenders will not always request business tax returns, but what if they do? It’s not likely that they will if you have complete, professionally prepared financial statements. Still, if tax returns are the only financials you have for your business, that is what they will use. This poses a difficult dilemma
This is a problem because you want to make it look like you made as little money as possible on a tax return to avoid paying any more than necessary in taxes.
Typically, even if tax returns are on a cash basis, financial statements are prepared on an accrual basis. If all the lender sees is your cash basic business tax return, and it looks like you didn’t make a profit, they are going to be less likely to approve funding. And you can imagine why they will be likely to approve less funding.
Personal Taxes Can Impact Your Ability to Get Business Funding As Well
Even if they do not look at business tax returns, most if not all traditional lenders will usually look at personal financials separately. This is because almost all of them require a personal guarantee.
When they do, they will note how you get money from the business. Do you pay yourself a salary? Do you just take funds as needed? This may, again, lead to questions that require them to look at your business tax returns.
Tax Write Offs Can Impact Your Ability to Get Financing
Tax write-offs are a great way to save on taxes. They are totally legal and it would be ridiculous not to take advantage of them. However, be certain you have someone preparing professional financial statements at the same time. These documents serve two different purposes. Tax returns are to show the IRS how much taxable income you have. Financial statements are meant to show a profit, and that is what lenders want to see.
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