self employment and taxes - what do you do?

Posted on: 26 July 2019

As you move forward with your plans to start your small business, you know one thing for sure — you want to be paid. However, how you structure your payments and accounting practices is also important, so you have to choose between an accrual or cash system. Learn how each of these accounting structures is different so that you can determine which option is the best for your business.

Accrual

The accrual method may be the least-used method for accounting structuring, but it is helpful in certain scenarios. The most important thing to remember about this process is that it does not necessarily track sales at the time they were paid. 

For example, if you follow this practice and you perform the service on January 1st, you bill the client on February 15th, and the client doesn't pay until March 1st, you would still record the earning in the month of January. As a result, when you file your taxes, you could be taxed on income that you have not actually received just yet. 

Keep in mind that if you project that your business will eventually earn millions of dollars in revenue a year, it's might be wise to follow this method from the beginning. Companies that earn over a certain threshold are required by law to follow this tracking practice.

Cash

A cash-based accounting system is the most straightforward option to understand. With this method, you tally income when you actually receive it. 

So, using the previous example, you would not record the payment from the services until the month of March, since this is the time when you were actually paid. A cash structure also doesn't record an expense until you have paid it, so if a vendor bills you in October but you don't pay until January, you won't record the expense until January. 

The tax implication with this option is that even though the funds you used to make the payment might have come from your earnings in October because you did not make the payment until January, you have to wait until the following tax year to claim the expense. 

Deciding between the two options can be a tedious process as the valuation of your business, your tax payments, and other matters are all dependent on the method you use. For further assistance with selecting an option and maintaining the records for your selected calculating choice, a small business CPA can help.