If you own a business or are considering starting one, financial planning can help mitigate the financial risks. Here are some financial considerations for when you’re starting or already running a business, as well as tips to ensure your business stays financially healthy.
In this article:
Creating a financial plan for your business
The financial factors you need to consider when starting or running a business depend entirely on your situation. Costs may be lower for businesses that offer services rather than physical products. Regardless of your business model, you may still face expenses such as legal, marketing, and subcontracting fees.
Use this startup cost calculator to see how much money you might need to start your business.
Before tapping into your own assets or taking out a small business loan, consider researching alternative funding options such as angel investors or crowdfunding, both of which involve less personal risk in exchange for equity or partial ownership in a business. Depending on the type of business, economic development loans through your city or state chamber of commerce may be another way to raise capital.
If you choose this route, it’s critical to protect your other personal assets (e.g., your home) by choosing an appropriate legal structure for your business. The Small Business Administration offers more details and resources at sba.gov.
Tax considerations for business owners
There are several types of federal, state, and local business taxes that you should be aware of when creating a financial plan for your business: income taxes, self-employment taxes (SECA), employment taxes (FICA), excise taxes, sales and use taxes, and business property taxes.
The type of business you own will determine the taxes you must pay and how to pay them.
- C corporations: For C corporations, the organization is taxed separately from its owners. Dividends paid by the corporation to the owner are generally taxed again.
- S corporations: This type of business enjoys some of the benefits of incorporation but are taxed as a pass-through entity — or an organization where business income is treated as the owners’ personal income. As such, all income, gains and losses, deductions and credits are included on the personal income tax returns of the owners.
- LLC: For tax purposes, an LLC, or limited liability company, can be a partnership, a C corporation, an S corporation, or a disregarded entity (much like a sole proprietorship, see below).
- Sole Proprietorship: If an individual business owner doesn’t establish a separate legal entity for the business, the business is considered a sole proprietorship and the owner of that business reports all income, deduction, gains and losses, and credits from the business on his or her personal income tax return.
- Partnership: Partnerships are also pass-through entities, so all income, deduction, gains and losses, and credits from the partnership are allocated to the partners (on Schedules K-1) who report these items on their personal tax returns. If two or more people (other than spouses) operate a business but don’t form a separate legal entity, this arrangement is also treated as a partnership for income tax purposes.
Learn more on the IRS Business Taxes web page.
Tax deductions and credits for small businesses
When outlining the financial considerations of starting or running an existing business, take into account that you could potentially qualify for certain business tax deductions as a small business owner. To deduct a business expense, the expense must be both ordinary (common and accepted in your trade or business) and necessary (helpful and appropriate for your trade or business). Here are a few expenses that may be particularly relevant to new entrepreneurs:
|Legal and professional service fees
- Fees you pay to tax professionals, consultants or lawyers generally may be deducted as a business expense in the tax year incurred.
- Most insurance premiums you pay for your business may be deducted as a business expense. This includes health, fire, theft, credit, and liability.
- If your business owns its own vehicle, or you use your car for business, you may be able to deduct certain maintenance and fuel costs associated with the business use of the car, which you will need to track.
- Use either the standard mileage allowance or your actual business-related vehicle expenses to calculate your deduction.
- In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business.
- Business travel costs may be deducted as a business expense.
- If it’s your first time owning a business and you’d rather not hire a tax or legal professional, you may be able to deduct business books as an expense.
Many of these expenses have specific requirements, exceptions, and limitations for tax deductions. A tax professional can help assess these deductions.
Financial planning for retirement when you’re self-employed
Solo retirement plans are a common option for self-employed individuals to manage their tax burden and potentially reduce their taxable income. Popular retirement savings plans for entrepreneurs include the individual 401(k) and the Simplified Employee Pension (SEP IRA).
If you’re thinking about consolidating 401(k) plans from previous employers, we can help you weigh the pros and cons.
Establishing an employer-sponsored retirement plan
When creating a financial plan, it’s imperative to explore appropriate financial considerations for setting up your business, including the right type of retirement package for your employees. The right retirement plan may help you attract (and keep) high-quality employees and provide tax benefits.
If you establish an employer-sponsored retirement plan, your business may be eligible for an immediate federal income tax deduction for funding the plan — and you can generally contribute pretax dollars into a retirement account.
You may want to consider the following types of retirement plans for business owners:
- Keogh plan
- Simplified Employee Pension Individual Retirement Arrangement (SEP-IRA)
- SIMPLE IRA
- SIMPLE 401(k)
- Individual (or "solo") 401(k)
The type of retirement plan that your business establishes depends on your specific circumstances. We can work with you and your tax professional to explore your options and consider the details of each plan. Bear in mind that if your business has employees, you may have to provide coverage for them as well. (Note that you may qualify for a tax credit of up to $500 for the costs associated with establishing and administering such a plan.)
Insuring your business
When you’re taking into account all the financial considerations of starting a business, it’s important to be prepared for the unexpected. Properly insuring your business can help mitigate many common risks that could otherwise threaten your business.
Insurance for physical damage
Property and casualty insurance provides coverage for losses due to the physical damage or destruction of your business.
You can buy various types of insurance protection separately, or you can purchase a commercial package policy that covers many potential hazards. These generally include the following forms of coverage:
- Building and equipment insurance. This protects you if your facility or equipment is damaged or destroyed.
- Valuable papers insurance. This provides coverage if the documentation supporting your accounts receivable (or other valuable business records) is lost or destroyed.
- Crime insurance. This can protect your business in case of theft.
- Business interruption insurance. This offers protection by replacing some or all your operating cash flow if your business is unable to maintain its normal operations (for a limited amount of time) due to a covered event.
Life and disability income insurance
Another factor to consider when starting a business is your personal liability. If you're a sole proprietor, you are personally responsible for all the debts of your business. Protection is especially important for these types of business owners — if you're unable to pay your bills, creditors could come after your personal assets.
You can purchase life insurance and disability income insurance to cover you, with the business named as the beneficiary. Upon death or disability, the policy will pay your business a certain amount of money, which it can then use to cover its normal operating expenses like rent, utilities, employee salaries, advertising, and maintenance costs.
Your business can also purchase life insurance and disability income insurance on a key employee (i.e., an employee who brings in substantial accounts or has specialized knowledge or talent). In the event of a death or disability, your business would receive a sum of money to compensate for the lost income generated by the event, or for the cost of replacing the employee.
Note: These types of policies are different from workers' compensation insurance, which nearly all states require businesses to have. Workers' compensation insurance provides compensation to your employees if they become injured at work or get sick from job-related causes. Once an employee opts to receive benefits under such a policy, he or she is usually prohibited from suing your business for the same injuries.
Asset insurance in the event of a lawsuit or threat
Planning for potential lawsuits or threats is a key financial consideration to make when starting a business. With a liability insurance policy, the insurance company will pay (up to policy limits) third parties who claim they were injured on your property or damaged by your product or service. If a lawsuit is threatened or filed, the insurance company will hire and pay (up to policy limits) a lawyer to defend you.
You can purchase general business liability insurance separately or as part of a commercial package policy, which combines this coverage with other types, such as property and casualty insurance. If your business needs broader coverage or higher liability limits than these policies offer, you can purchase supplemental liability insurance with a commercial umbrella policy.
Read more about business insurance from the U.S. Small Business Administration.
Providing your employees with benefits is a crucial financial factor to consider when you’re starting a business or have been running one for a while. Here are some group plans that you may decide to offer as part of your employee benefits package:
- Health insurance
- Dental and vision insurance
- Life insurance
- Disability income insurance
- Long-term care insurance