Tax Considerations for Web Businesses
Despite their seeming complexity, taxes are fairly straightforward, at least on the Federal level. But one thing that every small business owner should absolutely understand is that the government and not so silent partner of every online business, will foot a part of the bill (in the form of tax deductions) to operate a business.
Surprisingly, the best time to take advantage of the government’s contribution to your business is right now, during the course of the year. After the end of the tax year it is usually too late to structure transactions or label expenditures to produce the maximum amount of tax savings.
Now is a good time to discuss the operating form of your activities with a tax professional. In fact, it is always a good idea to discuss all tax-related strategies, deductions and transactions with the professionals your operation will rely on.
The ordinary and necessary expenses of operating an online business are usually deductible — that is, subtracted from income on the annual tax return. Unfortunately, tax deductions cannot be taken until there is an actual business in operation. Expenditures before an actual business are capitalized — deducted or written-off over a 60-month period beginning in the month when the business begins. However, a loophole in the rules allows startup costs of up to $5,000 to be written-off on the tax return for the operation’s first year.
Among other deductions many Netpreneurs are allowed:
Website Development Costs: The IRS has yet to issue formal guidance on tax treatment of website development costs. However, informal guidance provided by the IRS suggests that one appropriate approach is to treat those costs like an item of software and depreciate them over a three-year span.
It is clear that Internet entrepreneurs who pay large amounts to develop sophisticated sites have been allocating their costs to items such as software development (currently deductible like Research and Development costs) and deductible advertising costs. Which is best for your online operation? Again, now is the time to decide.
The Office: If, like many Internet businesses you regularly work from home, you may be entitled to a tax deduction for home office expenses. This deduction may also be available if you have an outside office and do the bulk of your work at home. But, keep in mind that deductions claimed for a home office may need to be repaid, or tax benefits lost when the residence housing the home office is eventually sold.
In addition, the cost of traveling from the home office to meet with clients or for other business purposes is, unlike commuting to a job, a legitimate deduction. Now is the time to maintain records necessary to support that tax deduction.
Who Runs Whom? Withholding of payroll taxes is another year round issue. While business entities withhold payroll taxes and remit them to the government, the sole-proprietor, shareholder or partner in many online businesses is liable for paying their own tax liabilities. What’s more, the government wants it now — usually via quarterly installments during the tax year.
Deciding whether an Internet entrepreneur is an employee of his or her business is best done before the end of the tax year. On several occasions the courts have ruled that a shareholder who provides substantial services to his or her incorporated business, even an S corporation, is an employee insofar as withholding is required of the operation.
Education: Uncle Sam wants you to get better at your job, as well as enjoy the fruits of your labor — after taxes of course. An Internet professional can deduct expenditures to maintain or improve existing skills, so long as they are related to the Internet business.
Health Care and Retirement: As business owners, Internet professionals have an advantage that most others do not have with health care costs — they can deduct many of their health insurance costs. When it comes to saving for retirement, online entrepreneurs and other small business owners are also better off than regular employees. This is because the government allows small businesses to set up retirement accounts specifically designed for small business owners.
Taxes and the related hazards and benefits are usually on everyone’s mind only during the so-called “tax season.” But what better time than now to guarantee that all deductions are claimed while simultaneously incorporating tax strategies into the 2007 budget for your website or online enterprise?
About the Author:
Mark E. Battersby is a freelance writer based in the suburban Philadelphia community of Ardmore, PA. For over 25 years, Battersby’s tax and financial features, columns and reports have appeared in leading trade magazines, journals and on the Internet. He is also the author of four books.