Millions of Americans are self-employed and, with the economy tilting down, more will join them in coming months -- working from their homes, buying a franchise or starting a small consulting or manufacturing operation. Most of these businesses will fail within five years.
While starting up your own business sounds like a dream, it becomes a disaster more often than not. The reason frequently is not the entrepreneur's lack of experience in his or her field. Rather, it is lack of knowledge of financial management. Failure to understand cash flow. Or too many surprises from the tax collector.
"You must pay attention to your total financial commitments at the inception of the business," says Prof. Dennis Lassila, a contributing editor to Bender's Federal Tax Service. "Be aware of tax forms you must file and taxes you must pay. Many entrepreneurs fail to build the cost of these taxes into their overhead, or they forget to file forms. They pay the price later."
Lassila, who is associate professor of accounting at Texas A&M University, warns you to be aware of these fundamentals as you build your business plan:
* As a business owner, you must pay self-employment tax -- both the employee and the employer portions. In 1990, the amount of this tax is 14.1 percent of net income from the business, as per your tax return. (There is a special deduction mechanism used to arrive at this figure for 1990 -- the nominal rate is 15.3 percent.) You must pay self-employment tax on up to $51,300. If you have a company and still hold another job, your other wages will be included in the equation.
* When you start your own business, you should project what kind of wages you could have made elsewhere as an employee. You will not pay yourself a salary. Rather, you will "draw" on your net profit, which is subject to income tax and self-employment tax.
* You must make estimated quarterly tax payments. The government requires regular payments because it assumes that you might not have enough money for an annual lump payment. If you own a business and are employed by someone else at the same time, you can ask your employer to withhold more to compensate for money not being withheld in your business.
* When you have employees, you must withhold federal income taxes on their gross pay and Social Security taxes (FICA). Employers can deposit FICA and tax payments through a deposit system. You will make state tax deposits in a similar way.
Businesses can be threatened -- even closed up -- if they do not deposit these taxes. The IRS levies penalties for late or missed payments as well. All tax liabilities survive bankruptcy.
* You must pay state and federal unemployment taxes for all employees. The state unemployment rate varies from state to state. When you set up a payment schedule, set up a forms schedule as well. The IRS demands that you file certain information at certain times of the year.
* Remember, having employees is more than a power trip. It involves widespread responsibilities. Your employees and you may be subject to workman's compensation, federal wage and hour laws, civil rights provisions and Occupational Safety and Health Act provisions.
* As a self-employed owner, you cannot get ordinary fringe benefits available to employees in corporations. One exception is that you can deduct 25 percent of health insurance through the business. You also can provide yourself with a Keogh retirement plan.
* Your tax professional will tell you which of your expenses are deductible. Keep your personal and business expenses separate. Use separate checkbooks. Use separate credit cards. If you use your business account to pay for something personal, write it on the stub.
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