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Business credit cards can be useful for managing daily expenses or covering larger purchases. If you’ve been relying on personal credit cards, loans, or savings to fund your venture, the time may be right to add a business credit card into the mix. 

Read on to learn everything you need to know about business credit cards.

What is a business credit card?

A business credit card is designed specifically for business use, rather than personal expenses. So, for instance, you might use a business credit card to pay for:

• Office supplies.
• Computer equipment.
• Business travel.
• Client dinners.
• Utilities, internet, and/or cell phone service for the business. 

Business credit cards can be helpful for businesses of all sizes. So whether you’re a sole proprietor, a freelancer, or the owner of a small business with dozens of employees, you could take advantage of a business credit card. 

There are two types of business credit cards available: revolving cards and charge cards. 

A revolving business credit card has a revolving credit limit you can use for purchases. As you make new purchases, your available credit shrinks. As you pay down the balance, that frees up the available credit. With a revolving card, you have the option to pay in full each month or carry a balance if needed. 

Charge cards are a little different. With a charge card, you may have a fixed spending limit or your card may have no preset spending limit. No preset spending limit on a business charge card means that your limit can change from month to month, based on your account activity, credit rating, and financials. 

With a charge card, you don’t have the option to carry a balance. You’re required to pay in full every month unless the card offers special extended payment terms. The upside of paying your balance in full, however, is that no interest accrues on the things you charge.

Business credit cards vs. personal credit cards

Aside from being designed for business spending, some other characteristics distinguish business credit cards from personal credit cards. 

1. Credit reporting

To apply for a business credit card, you’ll need to provide your Social Security number. Some card issuers may allow you to apply with your federal Employer Identification Number (EIN) instead, though it’s less common. 

Qualifying for a business credit card is based on your personal credit history, among other criteria. But once your account is open, your payment activity, credit limit, and other account details are reported as part of your business credit history.

Defaulting on a business credit card account can negatively affect your business credit history. Most card issuers require you to sign a personal guarantee for business credit cards. This guarantee makes you personally liable for any debt incurred. If you default, the card issuer could report your negative account history on your personal credit report. 

2. Card protections

Various federal protections cover personal credit cards, including those outlined in the 2009 CARD Act. For example, federal law limits consumers’ personal financial liability for fraudulent purchases made with their credit cards. 

Those same protections don’t automatically extend to business credit cards. If your business credit card is stolen, you could be held responsible for any charges resulting from the theft. The good news is that some business credit card issuers do limit fraud liability for cardholders. 

3. Rewards

Many business credit cards allow you to earn rewards on eligible purchases. That in itself isn’t much different from personal cards. Where the 2 diverge is in which purchases can earn rewards. 

For example, you may have a personal credit card that pays you cash back at grocery stores while business credit cards may pay cash back at office supply stores instead. Rewards programs cater to those expenses most often incurred by businesses, not individuals. 

4. Spending limits

Business credit cards can offer more purchasing power compared to a personal credit card. Where you might have a $10,000 limit on a personal card, your business card might bump that up to $50,000 or more, depending on your credit and business financials. The higher spending limits reflect the greater purchasing needs of businesses.

Pros of business credit cards

There are several good reasons to consider opening a business credit card if you’re not using one yet:

• It may be easier to get approved for a business credit card, compared to a business loan. 
• It’s possible to qualify for a card even if you haven’t started your business yet.
• Business credit cards offer flexibility since you can choose to carry a balance or pay in full.
• Earning miles, points, or cash back on purchases can save your business money. 
• It can be an easy way to keep track of business expenses.
• You can build a business credit score, which could help you qualify for loans or other lines of credit.
• No collateral is needed for unsecured business credit cards.
• Interest rates may be lower compared to other types of business financing, such as a merchant cash advance or invoice factoring. 
• Interest paid on your card balance may be tax-deductible. 
• You can use your card to meet a variety of spending needs.

Cons of business credit cards

On the other hand, there are potential drawbacks to consider:

• Some business credit cards charge an annual fee and/or foreign transaction fee.
• You’ll need good to excellent credit to qualify for the lowest APR. 
• Your credit limit may be less than what you’d qualify to borrow with a loan. 
• Signing a personal guarantee makes you personally responsible for business credit card debt.

How to choose the best card for your business.

If you think opening a business credit card account is the right move, the next step is choosing a card. When considering card options, there are a few important things to keep in mind.

1. Card use

First, think about what you primarily need a business credit card to do for you. For example, are you mainly looking for a way to earn rewards, or do you need a card to cover the occasional cash flow shortfall? Or are you looking for a card that can help you establish and build positive business credit history?

What you plan and need to use the card for can help you narrow down your choices as you shop around. 

2. Rewards

If rewards are on your list of credit card must-haves, consider which kind of rewards would be most valuable to you. 

Earning cash back could be good if you want to apply rewards as a statement credit. You may prefer to earn miles or travel points, however, if you take frequent business trips.

Aside from the type of rewards you might earn with a business credit card, factor in how different rewards programs are structured. 

Some cards, for instance, offer a flat number of miles, points, or cash back on everything you spend. Other cards offer tiered rewards in multiple categories. 

For example, you might earn 3 miles per dollar on travel purchases, 2 miles per dollar on dining and entertainment, and 1 mile per dollar on everything else. 

That type of rewards program could work in your favor if you spend more heavily on certain business expenses than others. One thing to watch out for with tiered rewards is a spending cap. Your card might limit you to earning a higher rewards rate up to a certain dollar amount each year. 

3. Cost

Keeping the bottom line healthy is always important, and while you may be earning money-saving rewards with a business credit card, you have to weigh their value against the card’s cost. 

As you compare cards, look at:

• Annual fees.
• Foreign transaction fees.
• Balance transfer fees if you’re planning on transferring a balance to the card. 
• Promotional APR.
• Regular purchase APR.
• Balance transfer APR.
• Penalty fees and APR. 

As a general rule of thumb, the better a card’s rewards program or the more generous the perks, the higher the annual fee tends to be.

4. Card extras

Rewards and cost matter, but don’t overlook any additional benefits a business credit card may offer. 

Say you’re interested in a travel card. One that offers perks such as free checked bags, travel insurance, complimentary business lounge access, and free WiFi might be even more valuable in your eyes if you take frequent business trips. 

On the other hand, benefits such as cell phone insurance or extended warranty protections may be more appropriate if you need a cash back card to cover everyday spending. Just like with rewards, measure the value of any added benefits against the card’s cost. 

5. Payment options

Last but not least, consider carefully whether you should apply for a business charge card or a revolving credit card that allows you to carry a balance. 

Avoiding interest charges is always good if you want to save your business money. The caveat is being certain that your business will be able to pay off what you’ve charged in full each month. 

If you’re still working to establish a newer business, your cash flow might not be consistent yet. In that scenario, you may be better off with a revolving limit card to start so that you have the option to pay over time if needed.

Best practices for using a credit card for your business.

Once you have a business credit card, be sure to use it wisely. Pay your bill on time each month and in full whenever possible to avoid interest charges. Redeem rewards strategically to get the most value and establish a business card policy before handing them out to employees. Lastly, maintain good records of what you spend with your card so you have a go-to reference for claiming those expenses as deductions at tax time.

Applying for a business credit card

Ready to explore options for a business credit card? Compare business credit card options here.

The average startup owner would probably prefer to focus on growing their business over maintaining their books, but you can’t afford to neglect your financial responsibilities.

Accurate, up-to-date records are necessary for many of your startup’s essential processes, including applying for financing and managing your tax obligations.

Here’s everything you should know about startup bookkeeping to optimize the function of your business.

Difference Between Accounting And Bookkeeping

Accounting and bookkeeping are intimately linked, but they’re not interchangeable. Understanding the difference between the two should help you clarify which financial responsibilities you can handle yourself and which you’ll need help with to complete.

In simple terms, bookkeeping involves maintaining records of your company’s day-to-day transactions. It’s less complex and more routine, requiring little more than fundamental financial skills in most cases.

Meanwhile, accounting refers to using bookkeeping records to refine or interpret financial statements for various purposes. For example, that would include filing a tax return, analyzing revenue trends, and investigating areas of overspending.

The primary difference between the two processes is that bookkeeping is an administrative task involving little critical thought. Meanwhile, accounting is more sophisticated and requires a higher level of expertise and analysis.

Many startup founders and small business owners do their own bookkeeping. It’s relatively simple, and software like the Lendio Bookkeeping Solution can automate a significant portion of the work.

However, accounting is usually too complex for you to do alone. You’ll typically need expert help to avoid making costly mistakes, in which case you can either outsource your accounting to a service provider or hire an accountant full-time.

How To Do Bookkeeping For A Startup

Startup bookkeeping is similar to bookkeeping for any small business. Here’s a step-by-step guide to establishing a bookkeeping system that you can follow to get off the ground.

Separate Your Business And Personal Accounts

One of the ways that startup founders most frequently create bookkeeping and accounting messes is by failing to open dedicated accounts for their business when they get started.

Eventually, someone in the organization realizes that no one knows which transactions are personal and which ones belong to the business.

As a result, the founder, accountant, or bookkeeper usually has to go back and review each financial transaction since operations began to isolate the business activity.

Fortunately, all of that trouble is easily avoidable. Before you do anything else, take the time to establish separate accounts for your business. Most startups opt for one dedicated bank account and one business credit card to start.

Connect Your Accounts To Bookkeeping Software

Some business owners still keep track of their transactions by hand, but there’s little reason to do so these days. It takes significantly more time and effort than bookkeeping software and exposes you to human error.

In addition, you don’t have to pay to get access to the software you need. Lendio offers free accounting software for small businesses that can automatically track your transactions.

Once you have a bank account and credit card dedicated to your business, you can connect them to the software. It’ll pull the activity directly from your accounts and use it to populate your transactions, even generating your income statement. 

Choose An Accounting Method

Contrary to popular belief, there are multiple ways you can choose to maintain your financial records. Startups typically use the cash or accrual accounting method to record their transactions.

The difference between the two methods comes down to timing. The cash basis recognizes revenues and expenses when money enters or leaves your account. It’s the easiest to follow, and your bookkeeping software should be able to handle it.

Meanwhile, the accrual method recognizes revenues when you earn them and expenses when you incur them. It requires that you track accounts receivable and accounts payable, which often means you have to do more bookkeeping work by hand.

While the cash basis is generally easier to employ, the accrual method is more accurate, especially for startups with high inventories.

Be aware that the Internal Revenue Service (IRS) may require that you use the accrual method once you average $25 million in gross receipts for three years.

Keep Digital Documentation

Fortunately, you don’t have to hold onto physical documents anymore. In fact, an accountant will probably be pretty annoyed with you if you bring them a shoebox full of crumpled paper receipts every year for tax purposes.

It’s perfectly acceptable and much more efficient to keep a digital copy of each receipt, invoice, or statement. You don’t have to worry about damaging or losing your documents, and you can transfer them to a bookkeeper or accountant more easily.

Fortunately, when you sign up for Lendio’s accounting software, our free small business accounting app lets you take pictures of physical documents and upload them automatically for future reference.

However, you typically don’t have to worry about keeping a copy of every receipt. In many cases, your bank account and credit card statements should provide sufficient supporting details for the average business expense.

Perform Regular Check-Ins

The best accounting software can automatically track your transactions and even categorize your startup expenses, but it’s not always perfect. It’s a good idea to check in with it regularly to ensure that your records are accurate.

Otherwise, you may open your books after six months of activity, find that your software has been miscategorizing certain transactions, and have to spend hours going back through it all to find the errors and fix them.

That doesn’t mean you need to monitor it constantly, but it’s a good idea to have a monthly and quarterly routine. Do enough each month to ensure no significant issues develop, then have a high-level check-in each quarter.

For example, it might be best to perform a bank account and credit card reconciliation and enter all cash transactions each month. Once a quarter, you could then review your financial statements and make adjusting journal entries as necessary.

Things A Startup Should Track On A Monthly Basis

Maintaining clean financial records is a lot like keeping a clean house. You’re better off doing a little bit of work consistently than putting it off for months and trying to get everything done at once.

Like housekeeping messes, bookkeeping issues tend to compound the more you procrastinate on them. That’s how mistakes get repeated for months, causing you to go back further to fix the damage.

Waiting too long also increases the chances you’ll forget the details of your activities. It can be a struggle to go back and record something accurately when it’s been weeks or months since you last thought about a transaction.

To prevent those issues, try to develop and stick to a monthly bookkeeping checklist. Here’s a list of some things you should do on a monthly basis:

• Enter any income and expenses that you’re not using software to track
• Reconcile to your bank and credit card statements
• Write down supporting detail to any unusual transactions you or your accountant may question in the future

Your monthly bookkeeping processes should prevent you from falling too far behind on anything. You want to avoid leaving any messes that will be overwhelming to you or your accountant in the future.

Which Financial Statements Should You Maintain?

As the founder of a startup, the three financial statements you should prioritize are the balance sheet, income statement, and statement of cash flows. Here’s what those are and how they work:

• Balance sheet: This documents your startup’s assets, liabilities, and equity on a fixed date, such as the end of the calendar year. It gives readers insight into the strength of your business’s financial position.
• Income statement: This documents your revenues and expenses over a period of time, such as the first quarter of the year. It gives readers insight into your business’s profitability.
• Statement of cash flows: This documents your net cash flows from your operations and your investing and financing activities. It helps readers understand where your dollars come from and where they go.

Your balance sheet and income statement capture your business’s fundamental financial information. They’re the two most important financial statements, and you’ll need them in every scenario where someone wants insight into your startup's finances.

For example, prospective lenders and investors will always want to see your balance sheet and income statement before deciding to work with you. Your accountant will also need them to help you with tax planning.

In addition, these two financial statements can help company management make better decisions. Analyzing them can reveal your startup’s strengths, weaknesses, and growth opportunities.

Third parties may or may not require your cash flow statement, but it’s essential for informing management decisions. Running out of capital is one of the most significant dangers for startups, and a cash flow statement helps you see that coming.

Do Startups Need In-House Accountants?

One of the most common reasons startups fail is that they run out of capital and can’t secure more funding. As a result, company founders need to be highly strategic with their resource allocation, especially in their earliest days.

One significant decision startups face is whether to hire in-house accountants or outsource the function to an independent accounting firm.

While the best option depends on your circumstances, outsourced accounting is often superior for the following reasons:

• Cost savings: The primary reason to outsource your bookkeeping and accounting processes is to keep your costs low. Hiring full-time accountants and bringing the function in-house is often more expensive than it’s worth.
• Service flexibility: When you outsource your accounting, you choose what professional services you need. You can expand and reduce your accounting service as your cash flow or business needs change.
• Expert, niche advice: If you bring an accountant in-house, they'll likely be lower-level. Hiring a full-time accounting expert for a startup costs more than most can afford. However, if you outsource, you can work directly with top talent.

Ultimately, it’s simply not necessary to pay extra for in-house accounting services for most startups. Outsourcing is cheaper and usually more than sufficient for your needs.

Typically, it only makes sense to hire an in-house accountant after your startup has expanded significantly. At that point, you’re likely to have more complex accounting needs each month and the cash flow necessary to afford full-time help.

How Lendio’s Bookkeeping Solution Can Help

Accounting software has made manual bookkeeping obsolete, but some small business owners record transactions by hand to save money. Most accounting software has a monthly subscription cost that may not seem worth it to a bootstrapped startup.

However, not every software forces you to open your wallet. Lendio offers free small business accounting software that can make bookkeeping a breeze for your startup. In addition to tracking your income and expenses, it can also:

• Sort your activities into appropriate categories
• Generate a professional-looking invoice in minutes
• Integrate with Gusto to calculate your payroll
• Create custom financial reports
• Analyze your cash flows trends
• Forecast your estimated tax burden

With Lendio, you get all the bookkeeping services you need for $0 per month, and you can chat with our bookkeeping experts to get help with any issues you may face. Give it a try today!

*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.

A Certified Public Accountant (CPA) is one of the most beneficial service providers you can hire as a small business owner. In addition to helping you complete and file your annual tax return, they can provide valuable tax and business planning during the year.

Average Cost Of A CPA

The average cost of hiring a CPA for a small business.

Though CPA fees vary by location and expertise, their tax services cost $174 per hour on average in 2020 and 2021. The cost of hiring a CPA for your small business usually depends on their hourly rate and the amount of work you need. Your actual accountant fees depend significantly on the help you need from them.

Fortunately, small businesses usually don’t need to hire a CPA full-time. Most can get by paying for CPA services intermittently throughout the year, such as calendar year-end, tax season, and before significant decisions.

Here are the average hourly costs for some popular CPA services.

Average hourly costs of different CPA services.

CPAs also often bill their clients fixed fees for specific services, such as preparing individual tax forms. For example, the average CPA charges $192 for a Schedule C, $323 for an itemized Form 1040, and $913 for a corporation’s Form 1120.

Costs for additional services.

Remember, the hourly cost of hiring a CPA depends significantly on the type of work you need them to do. As you might expect, the more complex and involved the work, the higher the hourly rate is likely to be.

As a simple example, it costs more for a CPA to complete your IRS Form 1040 if you itemize than it would if you were to take the standard deduction. In 2020, the average hourly rate was $161.34 for an itemized return and $153.74 for a non-itemized return.

Here’s what you can expect to pay per hour for the services above:

• Tax planning: $174
• Financial planning: $170
• Compilations, reviews, and audits: $164

Fortunately, there are some services that a public accounting firm won’t charge clients for if they’re paying for something else. For example, 58% of CPAs don’t charge a fee to file a tax return extension.

Because accounting fees vary significantly between providers, you should shop around before committing. Ask each CPA how they bill for services and try to get a quote for your expected needs.

Benefits Of A CPA

What does a CPA do for you?

CPAs are most well-known for business and individual tax preparation, but they provide many accounting services. Here are some other types of assistance you may want from a CPA.

Tax planning

There’s only so much a CPA can do to lower your tax bill once the year has already ended. As a result, if you only visit one when you need to file your tax return, you’ll probably pay more to the Internal Revenue Service (IRS) than necessary.

However, if you consult a CPA at the beginning of the year and stay in contact with them, they can help you develop and execute a plan to reduce your tax burden significantly.

For example, they might have you file an election so the IRS treats your limited liability company (LLC) as an S Corp, which could lower your self-employment taxes.

Business advisory

The Thomson Reuters Institute shared that 95% of accountants have clients asking for broader business advisory services. As a result, CPAs are increasingly taking on a more general consulting role.

These services may include:

• Cash flow forecasting and analysis
• Mergers and acquisitions assistance
• Outsourced chief financial officer services
• Key performance indicator (KPI) analytics

CPAs are well-equipped to provide this kind of advice due to their in-depth understanding of financial statements, taxes, and individual industries since so many CPAs specialize.

Assurance services

Finally, CPAs provide assurance services for your financial statements. That means verifying the accuracy of documents like your balance sheet and income statement.

There are 3 types of assurance engagements:

1. Compilations: These involve a CPA using data that you provide to create financial statements. Your statements don’t have to follow generally accepted accounting principles (GAAP), and the CPA won’t verify your financial data.

2. Reviews: These provide limited assurance that your financial statements are accurate and conform with GAAP. The CPA will follow procedures designed to reveal unusual items in your documents and investigate them.

3. Audits: These provide reasonable assurance that your statements are free of material misstatement and conform with GAAP. That’s the highest level of assurance possible and involves an in-depth review of your internal controls and financial data.

There are many different scenarios in which you may require assurance services. For example, you may need audited financial statements to qualify for funding from an investor.

When Is It Worth It To Hire A CPA?

Is hiring a CPA worth it? 

Whether or not it makes sense to hire a CPA for your business depends primarily on the complexity of your financial situation. Here are some times when hiring one makes sense.

1. Your tax returns are complex.

The more complicated your tax situation becomes, the more likely you'll benefit from hiring a CPA. For example, if you’re a sole proprietor with one income stream and no investments, you could probably get by with accounting software.

However, if you have 3 business entities and four rental properties in separate states, you’ll likely need to hire a tax preparer.

2. You’re considering significant financial decisions.

If you’re about to make a change that might significantly impact your tax and financial situation, it’s best to talk to a CPA first. They can explain the potential repercussions and walk you through the process.

For example, if you’re considering moving to another state, changing your legal relationship status, or bringing a partner into your business, ask a CPA for guidance.

3. You’re in trouble with the IRS.

Dealing with the IRS is a major headache, but having a good CPA makes it a lot easier. Not only can they guide you through the interactions, but they can serve as a middleman to take most of the work off your plate.

For example, if you have multiple delinquent returns or are undergoing an IRS audit, it’s a good idea to hire a CPA.

4. You need assurance services.

If you need to verify that your financial statements are accurate so a third party can use them, you’ll need to hire a CPA. They’re the only ones authorized to issue an opinion on financial statements.

For example, if you want to take your company public, you’ll need to hire a CPA firm to audit your statements.

The return on investment of a good CPA.

Whether or not paying a CPA is worthwhile for your business depends on how much their services cost and how much money they can generate for you. They might reduce your taxes, save you time, or help you qualify for financing.

For example, say you’re considering hiring a CPA to perform the following services in 2022, which will cost you the following amounts:

• Tax return preparation: $180 per hour for 3 hours
• Quarterly tax planning: $174 per hour for 4 hours
• Financial statement review: $164 per hour for 3 hours

Your CPA expects that they’ll be able to save you $6,000 in taxes by finding additional deductions and optimizing the way you pay yourself from your business. 

In addition, you’ll need your balance sheet and income statement reviewed to qualify for a $100,000 loan.

In this case, you’d be paying your provider $1,728 for the year, but they’d generate $106,000 of additional capital. In this situation, the return on your CPA would be well worth the investment.

It’s always best to avoid getting in trouble with the Internal Revenue Service (IRS) in the first place, but sometimes mistakes happen. If you’ve failed to file one or more of your federal tax returns, the IRS may penalize you and require that you fix the issue. 

Here’s what you should know about how far back the IRS can go for unfiled taxes, the consequences you’re likely to face when you fail to file returns, and the best way to rectify the situation.

How Does the IRS Audit Tax Returns?

One of the primary ways the IRS ensures that taxpayers fulfill their tax obligations is by conducting audits. That involves verifying the accuracy of the information you report to them to ensure you’ve paid the proper taxes.

Of course, that doesn’t mean the IRS is limited to auditing filed returns they think contain mistakes. Failing to file your tax return altogether by the standard or extended due date will also typically put you on the IRS radar and cause them to take action.

However, they probably won’t immediately audit you for failing to file your tax return unless it’s a recurring issue. Instead, the IRS will usually take the following steps first:

• Impose failure to file penalties and begin charging interest on your balance
• File a substitute return using information reported from third-party sources
• Assess a tax liability based on the substitute tax return and send you the bill
• Start the IRS collection process, levy your wages and accounts, or file a tax lien

You should get regular letters in the mail at each stage of the IRS collections process. Each IRS notice will include the steps you need to take to rectify the problems with your unfiled income tax return and the best number to call if you have any questions.

What is the Statute of Limitations?

If you fail to file a federal return, there’s no statute of limitations on your tax debt for that year. The IRS can always go back, impose penalties and interest on your outstanding balance, and attempt to collect your assessed tax liability.

However, while the IRS can go back to any unfiled tax return, they generally don’t try to enforce filing requirements for returns older than six years. The only exceptions might be if they:

• Find signs of fraudulent or illegal behavior
• Need the information to inform returns for later tax years
• Suspect you have significant tax liabilities in those years

However, failing to file your return typically leads to consequences well before you reach the six-year mark. They usually take action on tax issues within three years of the return’s due date.

For example, if you fail to file your 2020 tax return by April 15, 2021, the IRS will probably come after you and force you to fix the matter by April 15, 2024.

Note that once you file a delinquent return, a statute of limitations clock will begin. The IRS generally has three years to initiate a tax audit for the return. However, they may have six years if you meet an exception like underreporting your gross income by 25%.

In addition, the IRS will have ten years from the date you filed to complete their investigation and collect the balance they’ve assessed. Again, they could do so by levying your wages or bank accounts or imposing a tax lien on your property.

Consequences of Not Filing Tax Returns

Failing to file a return by the due date is a fairly common mistake, but it can be costly, especially if you don’t fix the issue quickly. Here are all the consequences you may encounter:

• Penalties and interest: If you fail to file a tax return for a year that you owe money, the IRS will penalize you 5% of your unpaid taxes for each month you’re late up to 25% of the balance. You’ll also accrue interest on your original amount plus penalties at the federal interest rate plus 3%, compounding daily.
• Increased tax liability: If your tax return is more than a year or two late, the IRS will eventually file a substitute tax return on your behalf. They often ignore a tax credit or deduction you’d take otherwise, artificially increasing your tax liability.
• Loss of refunds: If you fail to file a return for which you deserve a tax refund, you only have three years to collect the amount. In other words, if you file more than three years late, the IRS gets to keep your refund.
• Loss of Social Security benefits: If you’re self-employed and fail to file a tax return, the Social Security Administration won’t credit you for your earnings that year. As a result, your eventual benefits may diminish.

Failing to file tax returns gets worse the longer you wait to fix the issue. If the IRS decides you’re evading taxes or committing tax fraud, they can even pursue criminal penalties. Always act as soon as possible to avoid that and minimize the consequences. 

How To File Missing Income Tax Returns

Completing your return for an old tax year can be difficult if the necessary records aren't readily available. If you’re missing information that you need to complete your tax return, consider:

• Pulling bank account and investment statements for the tax years in question
• Contacting old employers or payers of income for documents like W-2s
• Request a transcript from the IRS for wage info or prior-year tax return details

Also, keep in mind that tax rules change from year to year. As a result, the instructions for completing a current year IRS form may mislead you when completing previous years. Check the IRS resource for prior year products to get more accurate guidance. 

Once you’ve completed them, filing delinquent income tax returns with the IRS isn’t much more complicated than filing a current one. Remember, they want you to fix the issue so they can collect any money you owe them.

However, you may not be able to e-file your old returns unless you’re working with a tax professional who can do it for you. If you find that e-file isn’t an option, print out a paper copy and mail it.

Tips for Filing Past Returns With the IRS

Catching up on your tax compliance responsibilities and getting back in the good graces of the IRS can seem like an overwhelming ordeal, especially if you have multiple unfiled tax returns. However, it doesn’t have to be as difficult as you might fear.

Here are some tips to help you get through the process as painlessly as possible.

Take Action Today

One of the primary reasons people get in trouble with delinquent returns is that IRS tax problems tend to compound. Failing to file your tax return one year makes it more likely you’ll do so again in future years, and the longer you wait, the worse it gets.

While that's partially because it can be harder to complete a tax return if you don’t have your prior-year numbers, it's also human nature. The longer you wait, the bigger the tax problem becomes and the more intimidating it is to try to fix it.

Unfortunately, ignoring your unfiled returns is the worst thing you can do. Not only will your penalties and interest continue to accrue, but the IRS will be less likely to treat you favorably as time passes.

Even if you don’t know all the steps you have to take to fix everything, start doing what you can as soon as possible. Being proactive will minimize the impact on your finances and earn you some goodwill with the IRS.

Get Help From an Expert

Accurately preparing a tax return is an involved process in the best of times. However, trying to prepare several at once for previous years while missing tax documents, factoring in penalties, and accounting for changing tax law can be a nightmare.

As a result, it’s often worth working with a Certified Public Accountant (CPA) or tax attorney for tax help and legal advice. They can help with the details of filing your returns and minimize the anxiety you may feel by answering your questions.

If you don’t think you can afford professional help, check if you qualify for free tax preparation services. It’s typically available to people who generally make $58,000 or less per year.

Request Tax Relief When Applicable

If you fail to file because of circumstances outside your control, you may qualify for tax penalty abatement. The IRS grants this kind of relief for reasonable cause, such as:

• Inability to obtain necessary records
• Natural disasters or other significant disturbances
• Death, serious illness, or incapacitation of the taxpayer or a family member

For example, if you didn’t file your tax return because you were in and out of the hospital for months due to cancer, the IRS may waive your penalties. However, you’d need to provide proof of the illness and each stay in the hospital.

Take Advantage of Payment Plans or Negotiate

Failing to file your tax returns can lead to a pretty hefty tax bill. If you owe back taxes for multiple years with significant penalties and interests, you may not be able to pay it all at once.

Fortunately, the IRS lets taxpayers who can’t pay their balances request a free payment plan that grants an extra 60 to 120 days. If you still need more time, you can ask for a long-term installment agreement, though you may incur set-up fees.

Finally, if you feel there’s no way to pay your balance without financial hardship, try to negotiate a tax resolution with the IRS. They may grant you an offer in compromise that lets you settle your debt for less than it’s worth.

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Will I Go to Jail for Unfiled Tax Returns?

Failing to file your tax returns is a serious matter, but you typically won’t go to jail for the offense. Most people who fail to file their returns just made a mistake, missed the deadline, or were preoccupied with some other significant life matter.

In these cases, failure to file results in penalties and interest. However, it is possible to go to jail for unfiled returns, especially if the IRS believes you’ve committed tax evasion or tax fraud.

What Happens if You Haven’t Filed Taxes in 5 Years?

Failing to file your returns for five years represents a significant tax issue, and there will be consequences from the IRS. At the very least, you’ll incur stiff penalties and interest if you owe money for the income on those returns.

In addition, the IRS may file substitute tax returns, levy your wages or bank accounts, or file a tax lien on property like your personal residence. In rare cases, they could also attempt to prosecute you, which could cause additional fines or jail time.

Do Back Taxes Fall Off After 10 Years?

Theoretically, back taxes fall off after 10 years. Once you file a tax return, the IRS only has a decade to collect your tax liability by levying your wages and bank account or filing a lien on your property.

Unfortunately, the clock for that limitation doesn’t start until you file your tax return. As a result, it doesn’t apply to back taxes you owe on unfiled tax returns.

Regardless, waiting out the clock isn't a viable tax solution since the IRS rarely lets liabilities go unaddressed long enough to reach the statute of limitations.

People often conflate payroll and income taxes because employers withhold both of them from their employees’ paychecks. However, there are notable differences between the two payroll deductions that you should understand for tax planning purposes.

In simple terms, the payroll tax is a flat tax on employee wages that both employers and employees have to pay. 

Meanwhile, the income tax is a progressive tax on all earnings, and only the earner is responsible for paying it.

Let's take a closer look at how these taxes work, the differences between them, and their impact on employers and employees.

What is Payroll Tax?

The payroll tax includes the Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), and State Unemployment Tax Act (SUTA) taxes. Surprisingly, it’s more burdensome for most Americans than the individual income tax.

The payroll tax applies to gross pay from employment, including salaries, bonuses, and tips. It’s a flat tax, which means the rate is the same at all applicable income ranges. There are caveats to that, but we’ll discuss them in the next section.

The FICA tax includes Social Security and Medicare taxes. While it applies to employee earnings, employers are responsible for paying half of the burden.

Note that FICA taxes are essentially the same as the self-employment tax. However, self-employed people are both employers and employees, which means they have to pay both roles’ liabilities.

FUTA and SUTA taxes apply to employee wages also, but are primarily an employer payroll tax. Employees typically aren't responsible for paying them, as they help fund unemployment insurance for employees.

How is Payroll Tax Calculated?

The FICA tax equals 15.3% of wages, bonuses, and tips. 12.4% goes to the Social Security Administration, and 2.9% is for Medicare. Employers and employees split FICA equally, so each pays 6.2% to Social Security and 1.45% to Medicare, or 7.65% in total.

The FUTA tax is 6% of the first $7,000 of compensation for each employee. However, employers get a 5.4% tax credit as long as they pay their requisite SUTA taxes, which effectively lowers the rate to 0.6%.

SUTA tax rates vary between states and individual businesses, so check your state government’s website if you need to find yours.

Payroll taxes are flat, but there are exceptions at higher earnings levels. For one, the Social Security portion of the tax only applies to the first $147,000 of compensation for single filers in 2022, though that number updates annually for inflation.

The Medicare portion of the tax applies to all earnings levels, but employees pay an additional 0.9% Medicare tax on income past a certain level. In 2022, that threshold is $200,000 for single filers.

You should use payroll software to calculate your liabilities, but here's an example to demonstrate the rules. Consider a single employee with a $225,000 wage in 2022. They’d have to pay 6.2% Social Security tax on the first $147,000, which equals $9,114.

They’d also have to pay 1.45% Medicare tax on all $225,000, which equals $3,263. In addition to withholding tax for the employee portion of these tax liabilities, their employer would have to match them. As a result, both parties owe $12,377 so far.

Assuming the employer pays their SUTA taxes and qualifies for the FUTA tax credit, they’d also have to pay 0.6% on the employee’s first $7,000 of taxable wages, which equals $42. The total employer payroll taxes without SUTA are therefore $12,419.

Finally, the employee would owe an additional Medicare tax of 0.9% on the $25,000 they earned beyond the $200,000 threshold. As a result, they’d owe another $225 for a total liability of $12,602.

Accurately tracking your cash flow is essential for proper tax planning. Use our free small business accounting app to organize your financial records automatically!

What is Income Tax?

While the payroll tax only applies to income from an employer, you owe income taxes on just about everything you earn during the tax year. For example, in addition to employment income, that could include:

• Earnings from a side hustle
• Interest on a savings account balance
• Ordinary dividends on taxable investments

Again, unlike the flat payroll tax, federal income taxes are progressive. That means you pay a different tax rate for each earnings range. For instance, the first $10,275 a single person earns is taxable at 10%, but the next $31,500 is taxable at 12% in 2022.

There’s a common misconception that earning more can bump you into a higher income tax bracket, causing all of your income to be taxed more, but that’s not the case. Entering a new tax bracket just means your next dollar is taxable at a higher rate.

While everyone in the United States is subject to federal income taxes, you may also have to pay state income tax or even a local income tax, depending on where you live. State and local taxes can be progressive or flat.

Unlike payroll taxes, the federal government doesn't use your individual income tax dollars for specific programs. They may go toward supporting healthcare, military, education, transportation, or a wide range of other government expenses.

How is Income Tax Calculated?

Once again, the federal income tax is a progressive tax, which means that higher income ranges have higher tax rates. These are the 2022 federal tax brackets.

2022 Federal Tax Brackets

Source: IRS

Unlike the payroll tax, there are ways to reduce the amount of income taxes you’ll owe in a year besides earning less. That’s because you pay income taxes on your net taxable income rather than your gross wages.

In fact, you can lower your net taxable income in two ways:

• Above-the-line deductions, like contributing to traditional retirement accounts
• Either itemized deductions or the standard deduction

For example, say a single filer earns $75,000 in gross income, contributes $6,000 to a traditional Individual Retirement Account (IRA), and takes the standard tax deduction, which is $12,950 in 2022. Their net taxable income would be $56,050.

They’d pay 10% federal income tax on the first $10,275, 12% on the next $31,500, and 20% on the remaining $14,275. Their total liability would be $7,948. If they didn’t reach that via income tax withholding, they'd pay the difference when they file their tax return.

Whether you’re an employer or an employee, you need to pay the proper payroll and income taxes to stay on the good side of the Internal Revenue Service (IRS). 

As a result, it’s best to get help from a Certified Public Accountant (CPA) if you have a complex tax situation.

Software can help you organize your financial records and make tax time much less stressful. Fortunately, Lendio offers free accounting software for small business. Give it a try today!

*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.

Accepting different forms of payment is critical to the success of a small business. The good news is that there are more ways than ever to accept payments from your customers. Each payment option comes with a set of risks and benefits. And you can choose more than one. 

Some might carry hefty fees for using them while others are more susceptible to fraud or theft. Choosing the right payment method for your business is tricky but you can balance the pros and cons based on your business’s needs and customers’ preferences.  

Credit Cards and Debit Cards

The study found that about 42% of consumers prefer to pay for purchases using their debit cards. Another 29% of consumers preferred to use their credit cards to make payments. Cash came in last place at 23%. 

To avoid alienating customers, many small businesses offer credit and debit card payments. It comes with pretty significant benefits: 

• Customers find it convenient, quick, and easy to manage
• Payments show up quickly, which improves business cash flow
• Extra payment options help to expand your customer base
• Debit card transaction fees are low. (These can vary based on the merchant) 
• Improves security by reducing the risk of carrying large amounts of cash
• Helps facilitate larger purchases

• It could be expensive. Card issuers like Visa, Mastercard, Discover, and American Express charge a fee for each transaction processed. According to Reuters analysts, credit card processing fees cost small business owners 1.5% to 3.5% on average.
• You’ll need to pay for costly equipment or software. This might include card readers, virtual terminals, Point of Sale (POS) machines, and merchant services. 
• Customers may process disputes with their bank that result in chargebacks on the business. Chargebacks can hit your account unexpectedly. 

Mobile Payments

Such as food trucks, construction, or landscaping. 

All of these require a way to process payments without being tied to one location. All it takes is a smartphone and a mobile card reader. 

Mobile payment options allow the use of several payment methods to receive money from a small business customer. 

• Money transfer applications (Zelle, Cash App, or Venmo)
• Digital wallet payments facilitated by NFC technology
• Mobile card reader payments
• Mobile POS systems

Online Payments

• eChecks
• Credit card and debit card payments
• Digital wallets like Apple Pay, Android Pay, and Google Pay
• Money transfer apps (Venmo and Zelle)
• Money transfer services like PayPal, Square, and Stripe

This isn’t exclusive to businesses that only exist online. Physical storefronts can accept payments online too. Here are some of the reasons why small business owners are quick to adopt an online payment system: 

• Payments hit your bank account fast. This helps the business improve cash flow. 
• Your customers have more ways to pay. They’re more likely to buy from you again when there are plenty of payment options. 
• Top-notch security. Online payment gateways offer features that keep your clients’ information secure, like two-factor authentication and encryption. This gives you theft and fraud protection. 
• Online payment gateways take tasks off your plate. There are fewer bank visits to deposit cash. You can manage transactions and money transfers in one place. And most times, the system will automatically send a receipt to the client. 

Lendio

• Integrated payment processing with Stripe, PayPal, and Square
• Accept debit and credit card payments from Visa, Mastercard, Discover, and AmEx 
• Accept bank transfers as payment
• Manage income and expenses
• Create and send invoices

Accepting digital payments can be costly with other services, but it doesn’t have to be with Lendio's software. 

Drop the expensive per-transaction fees. With a reasonable monthly fee for their Plus version, you get a 1% discount on each transaction fee for card payments and bank transfers.

Businesses that need mobile solutions can use their free small business accounting app to manage invoices from wherever your business takes you. With Lendio's software, you can:

• Easily check on the status of invoice payments 
• Track expenses and income with minimal effort
• Take receipt images with your phone and directly upload them into your account

ACH Payments

When the customer goes to check out with their purchase, they supply their bank account information, which may include their account number, routing number, and the name on the account. Then they authorize the business to withdraw the total purchase amount. 

ACH payments are often used to satisfy recurring billing obligations. Customers can choose to set recurring payments as well. Common examples of businesses that accept ACH include: 

• Childcare providers
• Property management
• Health and wellness businesses

If you don’t have a bank account that’s suitable for receiving multiple ACH payments, it could result in high bank fees or holds on your account. 

Cash

As mentioned in the earlier study, cash was the least preferred payment method for customers. That doesn’t mean it’s obsolete though. 23% of people still prefer it when the option is there. Cash transactions come with two big pluses. 

• Immediate payment means no waiting around for transfers.
• There are no fees for accepting cash.

• More susceptible to theft. Cash requires extra security measures and protocols to stay safe until you can make it to the bank.
• Extra equipment is needed to store it. Registers and locking safes are essential for cash businesses. 
• Your merchant account could have deposit limits that restrict the amount of cash you can deposit daily or monthly. Going past the limit could be costly. 
• Only accepting cash may drive away customers who only carry cards. 
• Cash-heavy businesses are a big target for tax audits. Excellent accounting records are needed to stay in the clear. 

Checks

• Date
• Payment amount
• Who the check is payable to
• Customer signature
• What the check is for

Accepting checks as a form of payment requires a business account and a predetermined policy for how checks are handled. For protection, the SBA recommends: 

• Only accepting in-state checks from familiar banks
• Requiring checks to be written for the exact amount
• Using a third-party to check verification

Cryptocurrency

Some benefits include: 

• Accessing a different type of clientele that values transparent transactions.
• Increased purchase amounts. A Deloitte study found that customers who use crypto make 2X larger purchases compared to credit card users.
• Real-time money transfers that are secure and verifiable. 

Its value is considered more volatile and there’s a lot more that goes into hosting these payments. 

• Conversion pricing and tax considerations make accounting challenging
• The value of the currency fluctuates wildly
• You’ll need to hire a third-party payment processor
• Accepting these payments might be more expensive than others

What Are The Best Payment Methods For Small Businesses?

B2B companies, like commercial vendors or property management, might go for checks or ACH payments. Meanwhile, construction companies, salons, and landscapers need to have mobile and online payment options. 

Still, you’ll need to consider the cost of offering each option. Processing fees, penalties for rejected payments, and the price of equipment will impact your bottom line. 

With that being said, determining the best payment method requires you to analyze three factors: 

1. Customer preferences
2. Business requirements
3. Cost compared to profits

It’s possible to offer more than one option to help expand your customer base and increase sales. It may take trial and error to see which ones are the best. Checking around with entrepreneur peers in your industry can help as well.

*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.

The income statement and balance sheet are the two most important financial statements. Together, they create a comprehensive picture of your business’s finances that managers, investors, and creditors can use to facilitate various processes.

Despite being integrally connected, income statements and balance sheets have some significant differences. Let’s explore those differences to help you better understand how each report works.

What Is a Balance Sheet?

A balance sheet is a financial statement that presents a snapshot of your company’s assets, liabilities, and equity on a specific date. As a result, it’s also known as the statement of financial position.

Balance sheets are structured around the accounting equation that states:

Assets = Liabilities + Equity 

You can always use that formula to make sure your balance sheet is accurate. If your equation doesn’t balance, something’s wrong.

Because of its subject matter, analyzing your business’s balance sheet is the best way to assess your liquidity and solvency. Those terms refer to your company’s ability to convert assets into cash and to pay its debts, respectively.

For example, a prospective lender might use your balance sheet to calculate financial ratios like your debt-to-equity ratio, which equals debt divided by equity. If it’s too high, the lender might decide you’re over-levered and can’t afford more debt.

Notably, because your balance sheet can only document a single day at a time, users of financial statements often compare one balance sheet to another for greater insight.

For example, you could compare your balance sheet on 12/31/2020 to your balance sheet on 12/31/2021 to determine how much your cash reserves grew during the calendar year.

What is Included in a Balance Sheet?

Your balance sheet should document your company’s assets, liabilities, and equity. Here’s what each one of those terms means and what kind of accounts they include.

Basic balance sheet components:

• Assets
• Liabilities
• Equity

First, your assets are the resources your business owns that you expect to provide some future economic benefit. Typically, that means you’ll be able to generate cash by selling or using them in your business.

Depending on how long you expect to hold an asset before realizing its economic value, it can be current or long-term. If you can turn it into cash within a year, it’s a current asset. If it’ll take longer, you have a long-term or noncurrent asset.

Current assets include accounts like cash and cash equivalents, inventory, and accounts receivable. Long-term assets include fixed assets like property and equipment.

Second, your liabilities are the debts you owe to third parties like lenders and suppliers. They represent fixed obligations that you have to fulfill. You can use them to get financing without giving up ownership of your business, though too much is dangerous.

Liabilities can also be current or long-term, but you often have to split accounts between the two. For example, the mortgage payments on your rental property due next year would be a current liability, but the rest of your loan is a long-term liability.

Finally, your equity is whatever you have left after subtracting your total liabilities from your assets. Also known as your net assets or net worth, it’s what the owners or shareholders of the business would receive if they were to liquidate the company.

Equity accounts include things like owner contributions, shares of company stock, and retained earnings.

What Is an Income Statement?

Your income statement measures your company’s revenues and expenses over a given period. In simple terms, that means it tracks what you earn and spend to calculate your financial performance. As a result, it’s also referred to as the profit and loss statement.

Income statements are structured around the equation that states:

(Revenue + Gains) - (Expenses + Losses) = Net Income 

In simple terms, it documents how much money you earned during a period, how much you spent, and how much is left over.

Because of this, an analysis of your income statement is typically the best way to gain insight into your company’s profitability. Beyond the obvious calculation of your net income, you can also use it to review things like your gross profit and net profit margin.

Unlike balance sheets, income statements capture information over time, so even one of them can help you analyze your company’s trends. However, it’s still a good practice to compare them across multiple periods.

For example, you might compare your year-to-date income statement to your income statement from the same months last year. You’d be able to determine whether you’re on pace to beat your previous numbers.

What’s Included in an Income Statement?

Your income statement should include your business’s revenues, expenses, gains, and losses. Let’s explore each of those in turn.

First, your revenue accounts sit at the top of your income statement. They include everything your company earned from its day-to-day operations during the given period.

If you’re on the cash basis of accounting, that only includes money you’ve collected. However, if you’re on the accrual basis, it may also include money you’ve earned but not yet received.

Next are your expenses, which can fall into two categories: direct and indirect.

Direct expenses are involved in creating your product or providing your service. They’re also known as your cost of goods or services sold. Subtract them from your revenues to get your gross profit.

For example, say you sell custom wooden chairs. Your direct expenses would include the price of each chair’s raw materials and the labor costs you pay your craftspeople.

Your indirect expenses or operating expenses come next. They contribute to your business, but they aren’t directly involved in your product or service.

For example, advertising and administrative expenses are both indirect costs. Subtract them from your gross profit to get your operating income.

Finally, gains and losses go toward the bottom of the income statement. When you sell something, they equal the difference between your proceeds and your cost basis. Your cost basis usually equals your purchase price minus any accumulated depreciation.

For example, say you buy a building for $200,000. After three years of depreciation, its cost basis is $175,000. If you sell it for $225,000, you’d show a $50,000 gain on your income statement. If you sell it for $150,000, you’d have a $25,000 loss.

What is the Difference Between an Income Statement and a Balance Sheet?

Your income statement tracks your revenues, expenses, gains, and losses over time to arrive at your net income. Meanwhile, a balance sheet displays your total assets, liabilities, and equity on a specific date.

Now that we’ve covered how these two financial statements fit into your general financial reporting, let’s highlight their most notable differences and review them in greater detail.

Accounts

One of the fundamental differences between the two financial statements is that they hold different accounts. Income statements measure your revenues, expenses, gains, and losses, while your balance sheet documents your assets, liabilities, and equity.

They’re also structured around separate accounting equations, which are:

• Income statement: (Revenue + Gains) - (Expenses + Losses) = Net Income
• Balance sheet: Assets = Liabilities + Equity

Knowing why these accounts go together and how they relate to one another is critical to understanding how money flows through your business.

Timing

Another fundamental difference between income statements and balance sheets is that they measure different lengths of time. Namely, income statements cover extended periods, while a balance sheet can only ever document your position on a single date.

That seems like a superficial point, but it impacts their utility significantly. In fact, it’s one of the main reasons you need to use both statements in conjunction to draw meaningful conclusions.

In simple terms, your balance sheet tells you where your business is on a given day. Your income statement tells you exactly what you did to get there. One without the other tells an incomplete story.

Uses

The most practical difference between income statements and balance sheets is that they fulfill different functions for users of financial statements.

Generally, income statements are better for analyzing your business’s profitability. You can back into your net income for a period by comparing your balance sheet before and after, but you need your income statement to dig into the details.

For example, you can use one to facilitate your cash flow forecasting or review a variance between a budgeted and actual operating expense.

Conversely, balance sheets are better for analyzing your business’s liquidity and solvency. For example, say your business is currently making interest-only payments on a long-term loan that ends in a balloon payment.

A potential investor could see from your income statement that you have enough total revenue to cover your current monthly obligations. However, that would be dangerously misleading if they didn’t also look at your balance sheet.

They'd likely also want to review your long-term loan amounts and compare them to your cash reserves to have an accurate picture of your company’s ability to pay its debts.

In addition to tracking your business transactions, accounting software can automatically generate your financial statements! Fortunately, Lendio offers free accounting software for small businesses. Give it a try today!

FAQs

How Are Balance Sheet and Income Statement Related?

The primary connection between your balance sheet and income statement is that your net income flows from your income statement into the retained earnings account on your balance sheet.

However, that’s not the only link between the two statements. You’ll also find that transactions often affect both your balance sheet and income statement simultaneously.

For example, say you use some of your cash reserves to pay a debt. You’d have to decrease your cash and debt accounts on the balance sheet, but you’d also have to increase your interest expense on the income statement.

Which Is More Important, Income Statement or Balance Sheet?

Neither the income statement nor the balance sheet is more important than the other. Each one's significance is situational and depends on the user, what information they’re looking for, and why they need it. In many cases, they’re equally necessary.

For example, say you’re applying for a loan, and your lender reviews both of your financial statements to determine whether you’re likely to pay back the account.

Using your balance sheet, they might check your debt-to-equity ratio and compare your current assets to your current liabilities. However, they’d still want to review your income statement to see if you have enough cash flow to afford more monthly payments.

What Comes First, Income Statement or Balance Sheet?

In theory, the income statement comes before the balance sheet. Your net income, which is the final result of your income statement, flows into your retained earnings, a balance sheet account.

That said, it’s something of a chicken and egg situation in practice. These two financial statements work in tandem, and you’ll often need to adjust them simultaneously to track your activities.

For example, say you pay your office’s rent with cash. You’d need to reduce your cash account, then increase the rent expense account. Of course, cash is on the balance sheet, while rent expenses go on the income statement.

*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.

When it comes to taxation, a limited liability company (LLC) is the most flexible type of business entity. It lets you elect to be taxed in several ways, including the tax treatment that’s usually only for S corporations.

If you’re interested in the potential tax savings of making that election, here’s everything you should know before deciding, including the pros and cons involved, the eligibility requirements, and the specific impact on your taxes.

Benefits of an LLC Being Taxed as an S Corp

There’s only one legitimate benefit to treating your LLC as an S corp for tax purposes, but it’s significant. Making the election lets you reduce the portion of your business’s earnings that are subject to self-employment taxes.

In fact, besides earning less money, changing the tax classification of your business is the only way to pay less in self-employment taxes. Many of the deductions that reduce your income tax burden, like traditional retirement contributions, won’t help you here.

By default, filing as an LLC means that 92.35% of the net earnings from your business activities are subject to self-employment taxes, also known as FICA taxes. Your net earnings equal your gross revenues minus your tax-deductible business expenses.

The standard self-employment tax rate is 15.3%, of which 12.4% goes to fund the Social Security program, and 2.9% goes toward funding Medicare. As you can imagine, reducing your earnings subject to a 15.3% tax can generate some significant savings.

For example, say your LLC generated $100,000 in net earnings in 2021. Using the default LLC tax treatment, you’d owe $14,130 in self-employment taxes. (92.35% x $100,000 x 15.3%)

However, choosing to be taxed as an S corp might allow you to pay self-employment taxes on just 75% of those earnings, in which case you’d only owe $10,597 in taxes and save $3,532.

How Do LLCs Get Taxed?

When you file as an LLC, the default tax method doesn’t require you to pay any taxes at the entity level. Instead, all your company’s net earnings flow through to your personal return, where you’ll incur some income and self-employment taxes on the amount.

There are some slight variations depending on the number of owners your LLC has. Here’s how it works in each scenario.

Single-Member LLC Taxes

A single-member LLC has only one owner. By default, these are disregarded entities for tax purposes. As the owner, you pay taxes on the business’s net earnings the same way you would if you were a sole proprietor.

That means you generally don’t have to file a separate tax return for your company. Instead, you report your revenues, expenses, and net earnings on your Internal Revenue Service (IRS) Form 1040, Schedule C.

Like a sole proprietorship, you have to pay the 15.3% FICA tax on 92.35% of your net earnings from self-employment. You’ll also owe federal and state income taxes on your net earnings after a few additional deductions.

Multi-Member LLC Taxes

Multi-member LLCs have at least two owners. They’re also disregarded entities for federal income tax purposes, but the owners pay taxes on the business profits as if it were a partnership rather than a sole proprietorship.

That means the owners have to file an IRS Form 1065 for the business to report its partnership income, even though the LLC pays no taxes at the entity level.

In addition, the partnership must issue a Schedule K-1 for each LLC member, which reports that individual’s portion of the company’s profits or losses. Each owner’s percentage is fixed and should be in the LLC’s operating agreement.

Then, at the personal level, each owner has to pay self-employment taxes on 92.35% of the net earnings on their K-1. Finally, they’ll owe federal and state income taxes on their K-1 net earnings minus allowable deductions.

Pass-Through Entities

If you’ve read through guidance about legal entity structures, you’ve probably come across the phrase “pass-through entity.” In simple terms, that refers to companies that pay no taxes at the entity level. Instead, all income passes through to the owners.

Single-member and multi-member LLCs are both considered pass-through entities by the IRS, as are sole proprietorships, partnerships, and S corporations.

Pass-through entities contrast with C corporations, which must pay taxes at the entity and owner levels, leading to the infamous double-taxation problem. C corps have a flat tax of 21% on all net earnings in 2022.

For example, say you’re the sole shareholder of a C corporation that generates $100,000 in net earnings. You would have to file a separate return for your C corp using IRS Form 1120 and pay $21,000 in corporate taxes.

Subsequently, you could keep the remaining $79,000 in the C corp or distribute some or all of it. Your distributions typically count as dividends subject to long-term capital gain taxes but not self-employment taxes.

How Does an S Corp Get Taxed?

Like LLCs, S corporations are pass-through entities. That means they don’t owe any taxes at the corporate level. Instead, earnings from the business flow through to the shareholders according to the percentages in the operating agreement.

Each shareholder must then pay federal and state income taxes on the amount distributed to them after accounting for individual reductions, like contributions to traditional retirement accounts and the standard or itemized deductions.

However, they don’t have to pay self-employment taxes on the S corporation’s net earnings. Instead, S corps must treat their owners as employees and pay them a reasonable salary. Only those wages are subject to the FICA payroll tax.

In addition, the S corporation and the business owner split the 15.3% tax, with each picking up 7.65% on their returns. As a result, you avoid paying FICA taxes on the rest of the S corp’s net earnings distributed to you.

Naturally, this incentivizes you to pay yourself as low a salary as possible to minimize your self-employment taxes. However, that’ll get you in big trouble with the IRS. Your salary must be “reasonable,” and the IRS won’t hesitate to call you on this.

There’s some inherent subjectivity to this requirement, but an easy rule of thumb is to pay yourself a wage equivalent to the market rate for the services you provide your company.

For example, say you’re a freelance bookkeeper, and your S corp generates $90,000 in net earnings. In your city, a bookkeeper with your experience level typically earns $65,000, so you pay yourself an equivalent salary and take the rest as distributions.

For more guidance on what constitutes reasonable compensation for an S corp shareholder-employee, check out the IRS resource and consult with a Certified Public Accountant (CPA).

Using software to track your company’s cash flow makes calculating your taxes much easier. Fortunately, Lendio offers free accounting software for small businesses. Give it a try today!

How an LLC Being Taxed as an S Corp Works

If you elect to have your LLC taxed as an S corp, you’ll follow the same taxation rules outlined in the section above. You must pay yourself a reasonable salary subject to FICA and income taxes, then pay income taxes on distributions of the remaining profits.

To be taxed as an S corp, you must complete and file IRS Form 2553. To qualify for the tax treatment during a tax year, you generally must do so no later than two months and 15 days after the start of the year.

For example, if you’re using the standard calendar year, you must complete and file Form 2553 by March 15th. Alternatively, if you started your business partway through the year on June 1st, you’d have until August 15th.

If you make the election on time, your LLC will receive S corporation tax status for the entire tax year and all future tax years unless you file additional paperwork to revoke the election.

Note that if you elect to have your LLC taxed as an S corp, your legal business structure is still technically an LLC. Remember that when considering issues like personal liability protection and specific state requirements.

Requirements for an LLC To Be Taxed as an S Corp

For an LLC to be taxed as an S Corp, you must meet some fundamental IRS eligibility requirements in addition to filing the forms as discussed in the previous section. These include the following:

• Be a domestic entity
• Have only allowable owners

• May be individuals, certain trusts, and estates 
• May not be partnerships, corporations, or non-resident alien owners

• Have no more than 100 owners
• Have only one class of stock; for LLCs, all owners must receive equal rights for distribution and liquidation
• Not be an ineligible entity (i.e., certain financial institutions, insurance companies, and domestic international sales corporations)

For more detail on these requirements, you can look at the IRS instructions for Form 2553.

Disadvantages of an LLC Being Taxed as an S Corp

There are a few potential disadvantages to electing to have your LLC pay taxes as an S corp. Typically, the most significant ones to consider are the following:

• Retirement contributions: Filing as an S corp rather than an LLC may reduce the amount you can contribute to some of your tax-advantaged retirement accounts.
• Higher tax preparation fees: Because filing as an S corp requires an additional income tax return for your company, you’ll usually pay an accountant more to complete your taxes each year.
• Reasonable salary mistakes: The IRS can decide the salary you paid yourself wasn’t high enough and reclassify some of your distributions to wages after you file your return. That will increase your S corp tax liability and may cause you to owe back taxes, penalties, and interest.

Most disadvantages of having your LLC taxed as an S corp come from increased paperwork and complexity. There are more moving parts to consider, which may cost you additional time or money.

Should You Choose an S Corp Status for Your LLC?

Choosing to elect S corporation status for your LLC often comes down to a simple calculation at lower incomes. If you'll save more money from the tax benefits of the election than you’ll spend on the increased costs to maintain the entity, it’s often worth it.

However, the decision becomes increasingly complicated the higher your earnings are and the more income streams you have.

For example, if you have W-2 wages from a job with another employer, it may reduce your self-employment tax savings from electing S status.

Ultimately, making changes to your small business’s tax treatment is a significant decision and can have repercussions beyond the scope of this article. As a result, you should always consult with your CPA before filing the election.

Using software to generate your financial statements makes tax time much easier for you and your accountant. Fortunately, Lendio offers a free small business accounting app. Give it a try today!

*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.