Running a small business involves navigating three distinct phases, each with its own tax implications: Formation, Operations, and Exit Strategy.
Phase 1: Formation
Choosing the right legal entity is crucial. Your choice affects your liability, taxation, and administrative burden. Common options include:
- Sole Proprietorship: Easiest to form but offers no liability protection.
- Partnership: Simple for multiple owners but partners share liability.
- Corporation (C or S): Offers liability protection but involves more formalities.
- Limited Liability Company (LLC): A popular hybrid offering protection and flexibility.
Phase 2: Operations
Once up and running, maintaining accurate records is vital, especially for "red flag" areas that attract IRS scrutiny:
- Travel and Entertainment: Strictly document the business purpose of all expenses.
- Automobile Expenses: Keep a detailed log of business vs. personal mileage.
- Home Office Deduction: ensure you meet the exclusive and regular use tests.
Phase 3: Exit Strategy
Planning for the end is just as important as the beginning. Strategies include selling the business, passing it to family, or liquidating assets. Each has significant tax consequences regarding capital gains and estate taxes.