Are You Thinking of Quitting Your Job to Start a Business?

Are you one of the many Americans who are tired of the daily grind of working for an unappreciative boss who leaves you feeling overworked and underpaid and is quit your joblooking to start your own business?  If so, there are a number of things you should consider before you make the plunge of becoming self-employed.

 

Know the Rules for Rolling over Retirement Plan Funds

Upon leaving your job, you will generally be entitled to immediately receive vested amounts in your qualified retirement plan accounts.  You are probably aware that most distributions from qualified retirement programs can be rolled over tax-free into an IRA account.  However, you must arrange for a “direct rollover’ or the plan administrator is required to withhold 20% of your distribution for federal income tax.  Direct rollovers involve having the funds transferred directly from your former employer’s retirement plan into your designated IRA account.  (the distribution check cannot be made out to you)  Talk to your former employer’s benefits representative and to the financial institution or brokerage house where you will establish your IRA.  Tell them you want to make a direct rollover to avoid the withholding, and ask for the required forms and paperwork.  Failure to arrange a direct rollover means you will have to replace the 20% withheld to accomplish a totally tax-free rollover.

 

Expend Your Flexible Spending Accounts before You Quit

If you have a flexible spending account (or cafeteria plan reimbursement account) for uninsured medical expenses and/or childcare expenses, make sure you incur sufficient qualifying expenses to use up the funds in your account before you leave your job.  For example, go get new glasses or contacts if that’s what it takes to use up your account balance – otherwise, you will lose it when you quit.

 

Open a Separate Business Bank Account

Segregate your business and personal financial matters by keeping separate bank accounts.  Deposit all business income into the business account and pay all business expenses (including your own draws) out of that account.  If you pay business expenses in cash or out of your personal account, reimburse yourself with checks drawn on your business account and document this with receipts.  This will make your year-end recordkeeping easier.  Keeping separate accounts shows you are serious about running things in a businesslike manner, and IRS examiners like to see that.  You do not want to have to explain that the $10,000 deposited into your one and only checking account was actually a gift rather than business income.

 

Start Keeping Tax Records – But Do Not Overdo It

In addition to maintaining a separate business bank account, you need to start keeping documentation of your business income and expenses.  At the beginning this generally does not need to be anything fancy (however, if your business involves inventory, employees, or a corporation you are going to need to be much more detailed).  For example, in most cases, you can simply use file folders or envelopes to keep your business expense receipts until tax return time.  You may not really need a bookkeeping software program, a tax preparation program, or more sophisticated recordkeeping techniques until later.  Also keep a list of billings or sales and the dates you get paid.

 

Keep Good Auto Records

Expenses of using your personal auto for business uses are deductible, but only if you keep good records documenting the date, the number of miles, the business purpose of each business use of the car.  Mileage not properly substantiated is considered personal use and related expenses are not deductible.  You should also record the car’s mileage at the beginning of the year or when you first start your business.  Unless the standard mileage rate is used, receipts or invoices and cancelled checks should be retained documenting the car’s purchase price, fuel costs, repairs, taxes, insurance and other out-of-pocket costs.  Auto logbooks for recording mileage and expenses are available at local discount and office product stores.

 

Consider Setting up Your Own Retirement Plan

If you work for yourself, you are on your own when it comes to planning for your retirement.  A retirement plan set up for your benefit accomplishes two goals – it is a way to save money for your later years, and in most cases it saves taxes now.  Using a defined contribution Keogh plan, you can contribute and deduct up to 25% of your net self-employment income (maybe more if you set up a defined benefit Keogh plan), but remember Keogh plans must be in existence before the end of the year for you to take a deduction.  If this Keogh plan is also a 401(k) plan, you may also make elective deferrals.  A simplified employee pension (SEP) plan can be set up in the following year – as late as the extended due date of your return – and still get the current year tax return deduction.  SEP’s are simpler and cheaper to administer and you can contribute and deduct up to approximately 20% of your net self-employment income.  SIMPLE retirement plans are another option available to self-employed persons.  The biggest disadvantage of qualified retirement plans is that you may have to make contributions for any employees that you have.

 

Do Not Underestimate the Benefits of Tax Planning

Even after the above, tax planning can yield bigger benefits now that you are in business for yourself.  You may be able to employ your children part-time and save income taxes and SE tax.  If your spouse is an employee of your business, you may be able to set up a fully deductible accident and health plan that covers you and the family without the use of a corporation.  Certain expenses that your former employer did not reimburse (such as professional association fees and supplies for a home office) may now be deductible.  Year-end tax planning is critical – particularly if you can use the cash method for income and expenses.  As stated earlier, retirement plans other than SEP’s must be set up before year-end to get a current year tax deduction.

 

Do Not Automatically Incorporate

An often-repeated comment is that corporations are wonderful because they limit the shareholders’ business liability, which is true, but depending on the industry you are in this may not be an immediate concern for you.  You should know that using a corporation requires addition recordkeeping, tax preparation fees, legal expenses and state and local filing fees.  Significant effort must be expended to keep the affairs of the corporation and the owner separate.  Based on the above, depending on the size of your small business, incorporating may not be one of the first things on your list.

 

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