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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.

My spam folder is littered with emails from businesses I don’t currently patronize. Some of them—like my favorite nail salon in a town I no longer live in—have been replaced with new local spots, so any offer they send me goes ignored, no matter how attractive it is. (Unless it comes with a free plane ticket, of course.)

I’d gotten out of the habit of patronizing other businesses during the pandemic’s fluctuation, like my nearby yoga studio that’s now welcoming customers back with revamped safety protocols and class-package specials. And for other businesses still, a bad customer service experience—like repeated delivery errors from the local market that just can’t seem to get my order right—means I’m no longer interested in giving them a fourth, fifth, or sixth chance.

If you’re the owner of this salon, studio, or market, however, you might not know why I’ve filtered your emails to spam and stopped crossing your threshold or using your app—or whether my decision is just for now or forever.  

Why good customers go dormant.

A customer can go dormant for 3 main reasons:

1. they’ve forgotten about you, but still are interested in what you have to offer
2. their need for your offerings or products has shifted, either temporarily or permanently
3. they’ve had a bad experience and don’t wish to give you their business anymore

Are you facing a roster of inactive or under-active clients or customers? Read more to learn how to bring some of these customers back into the fold, how to find out which customers probably aren't worth pursuing, and when to say goodbye to others for good.

Why rekindle an old relationship?

There are new customers out there—so why bother trying to win back your dormant ones? Put simply: they’re more valuable than new customers. 

A study conducted by Marketing Metrics and analyzed by American Express found that small businesses have “a 60–70% chance of successfully selling again to a current customer, a 20–40% chance of winning back an ex-customer, and a 5–20% chance of turning a prospect into a customer.” 

The best marketing strategy takes into account all 3 of these customer categories, of course, but the data shows that ex-customers are 2–4 times more likely to shop with you than a newbie. Make sure you’re not overlooking this key demographic with these 3 tips to entice them back to your doorstep or website.

Strategy 1: Reach out.

The inactive customers at the center of your recruitment strategy should be those who still need your offerings, but may have forgotten what you offer. 

To reach them, come up with a few different ways to put yourself back on a customer’s radar. These could include simple reach-outs via email (beware the spam folder, though!) or a social media campaign highlighting your latest and greatest promotions.

When my local yoga studio launched a targeted Instagram campaign advertising a BOGO class package for the summer, I jumped at the chance to return—and I’d never have known about it if they hadn’t proactively let me know what they were offering.

Strategy 2: Give a gift.

As a millennial woman, I grew up on Clinique skincare. Anyone my age who did the same knows all about their free-gift-with-purchase phenomenon, where a certain spend means a new makeup case and travel-size favorites to fill it with. It’s a promotion that exists across the beauty-product spectrum (I now take ample advantage of it at Sephora), and a strategy that you can leverage to recruit ex-customers back.

Send your dormant customers valuable content or a free product you can assume they’ll need because you haven’t seen them—like a treatment mask to clear their pores before they come in for a facial or a bonus box of printer paper for your B2B office client. For content, how about some free recipes that include your business’s homemade pasta or an exclusive how-to tutorial on repotting houseplants that would look beautiful in your home-goods store’s new planters?

Strategy 3: Create an exclusive opportunity.

Consumers love an insider opportunity—and especially if they’re free or low-cost for your business to offer, so should you. Let your inactive customers know that you have a special offering just for them, and you just might draw them back into your cohort of shoppers.

For example, if you’re a boutique vintage clothing store, you could offer your 6-month-dormant clients an exclusive spring trunk show. A bike shop could schedule an in-person maintenance workshop for folks dusting off their wheels for the new season—and who haven’t shopped for gear since last summer. For e-commerce sites, a WELCOMEBACK discount email code solely for customers who haven’t shopped with you in 2022 could entice them back to—and through— your checkout. 

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What if they're just not that into you?

What about the other 2 groups of customers—those who either no longer need what you offer or who’ve had a bad experience with your business? The first step is figuring out which type of customer they are and proceeding accordingly.

Chris Cristoff at Forbes recommends utilizing a survey to get to the bottom of this issue. “You can easily find out why customers are leaving by sending an exit survey to email subscribers. When someone goes a specific period of time without completing an order, or cancels their membership, send a short survey with targeted questions. You could ask them what your company could do to get them to stay.”

This survey could include a few key questions, including:

• What was your last experience with [Business Name] like?
• On a scale of 1−10, how satisfied were you with this experience?
• On a scale of 1−10, how likely are you to shop with us again?
• If you’re no longer interested in shopping with us again, can you share your reason why? (This could include a drop-down to guide them into categories useful for your analysis, like No longer interested in product/service, Negative experience with company, No longer live in the area, and any other relevant categories specific to your business.)

Based on their response—or lack thereof—you can weed out the no-longer-interested (no reply) from the frustrated or satisfied, based on how they rate your services or products. For those who express interest in returning, it’s time to utilize the 3 strategies above.

For those customers who report a negative experience, it’s all about customer service. Thankfully, Lendio’s got a guide all about solving this tricky, nuanced problem. If it seems like a customer is still reachable, use every reasonable tool at your disposal to recruit them back to your business. 

If not—like my ongoing market-delivery-fail—it’s time to let them go, address the issue at hand if relevant, and put your money and energy to work helping other customers.

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.

Your small business is different than any of the other 32.5 million small businesses in the US, right? But do your customers know it?

Whether you’re looking to start a company find a way to set yours apart from the pack, however, you need more than just a good idea, funding, and elbow grease—you’ll need a differentiation strategy.

Why Is Differentiating Your New Business Important?

Your differentiation strategy is how you distinguish your business, your products, and your services from other businesses in your space. It may highlight a specific quality of your service or a price points or even a company mission or philosophy. Differentiation is an important way for your business to add value, increase brand recognition, and gain a competitive advantage. And the more competition in your market, the more important differentiation becomes. 

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Continuing with the gelato example, you may find that you can differentiate by offering flavors that no competitor in your market has. By stepping outside the scope of what your competitors offer, you can suddenly provide new unmatched value. These unique flavors give you an advantage over your competition and can help you acquire customers who may not have switched previously.

Unfortunately, differentiating your gelato business in a competitive market may take more than just adding additional flavors or unique toppings. You may need to dive into your competition to find the best opportunities to differentiate your small business from others on Main Street.

Start By Analyzing Your Competition

With this new perspective, you can now begin to identify your unique advantage(s)—differentiation—or what you aspire your unique advantage(s) to be.

For example, you may decide to open a clothing retail store. Selling apparel isn’t necessarily unique and the market may already be saturated with competition, so how do you plan to stand out?

Maybe you offer a clothing rental service, maybe you hire a fashion consultant to assist your customers, or maybe you focus only on businesswear. Before you can find a unique path forward, you need to see what already exists—and what opportunities are available.

A competitive analysis will offer more direction for you to build your differentiation strategy, and it should be an always-on exercise you conduct to make sure you are continuing to develop competitive advantages.

How Do You Differentiate Your New Small Business?

Below are 3 common differentiation strategies for small businesses to consider.

1. Provide An Unmatched Customer Experience

Differentiating your new business through quality customer service will benefit you in the short and long run because it can:

• Improve customer retention
• Increase the customer lifetime value (CLV)
• Build brand equity and awareness
• Lead to more referrals and word-of-mouth advertising

Providing a great customer experience goes beyond customer service; it extends to the entire customer-business interaction. Other ways to improve the customer experience can include:

• Set clear and honest customer expectations: Some businesses have the tendency to oversell and underdeliver, which can leave the customer feeling misled or dissatisfied. For example, many construction businesses will set unrealistic timelines on projects just to win the bid. As work gets underway, they may ask for extensions, miss deadlines, or cut corners just to hit those timelines—which can all have negative effects on the client experience. Instead, be honest with your customers and set expectations that you can hit or exceed. This will ultimately lead to more satisfied customers and can improve your brand’s reputation within your market.
• Be mindful of your customers’ time: Time is money, right? Well, it can certainly feel that way to your customers—especially when you leave them waiting. A study from TimeTrade found that 75% of retail businesses surveyed lost customers due to time-related issues. These issues can include wait time, travel distance, service time, or transaction delays. These time-related issues can negatively affect the customer experience, but they can also be opportunities for you to prioritize and differentiate yourself from the competition.
• Make the shopping experience memorable: If you want to differentiate yourself from the competition, create a memorable shopping experience. This can include a fun and vibrant atmosphere, friendly staff, a streamlined store layout, or customer-centric features like buy-online-pickup-in-store (BOPIS). A recent study from SOTI found that 73% of people surveyed thought self-service checkout options improved the in-store shopping experience—which may be an opportunity for you to differentiate your business and improve customer satisfaction.

2. Find And Own A Niche

Take Under Armour, for example, which recently surpassed Adidas as the #2 sports brand in the US with a 14% market share behind only Nike (46%). When Under Armour started in 1996, nobody could have imagined this moisture-wicking athletic T-shirt company would grow to become Nike’s biggest rival. Before expanding to jerseys, shorts, or shoes, it spent its early years focused solely on athletic shirts and working to dominate that niche.

Finding and owning a niche within a larger market is a great strategy for new businesses because it’s based on differentiating yourself to a specific audience that’s being underserved. By narrowing your focus, you can devote yourself to satisfying a unique need or problem—differentiating yourself as the go-to business for that audience.

The main benefits of using the niche strategy to enter a competitive market are that you can:

• Remove some of the competition: By isolating a subset of a market, you can phase out some of the indirect competitors. Yes, other businesses may sell workout equipment or bicycles, but if you sell racing bikes and equipment for marathon cyclists, you can eliminate the less-targeted competitors.

• Charge more for your product or services: Customers are usually more willing to pay for specialty products or services that are uniquely targeted to their needs. While you may have fewer potential customers, you can often earn more per transaction.

• Simplify your marketing efforts: Targeting a niche within a larger market allows you to focus your marketing on that single audience. By narrowing your marketing to focus on what differentiates your business, you can develop a more loyal community and grow your identity to align with your differentiation strategy.

3. Add More Value To Your Community

Instead of focusing on internal changes to add value to your customers, consider going outward and adding value through community involvement. While not directly related to your business, it can increase your brand image and loyalty—which can be especially helpful for differentiating a new business in a saturated market.

For example, if you’re starting a dog grooming business, you could become a volunteer at the local humane society or offer your services at some of their adoption events. Not only is a great way to build trust and good will in your community, but it can provide a great platform for networking with potential customers.

Some ways you can get involved in your community and add more value include:

• Attend or host industry-related events: Networking at events or hosting meetups can get your new business in front of other people in your community and help to position yourself as an influential member of the community and subject matter expert. For example, if you’re opening a tax business, consider organizing tax planning meetups for local companies every quarter. Not only can you use it to acquire new clients and market your specialty, but you can build your name within the community and establish goodwill.
• Volunteer, donate, or sponsor locally: 85% of customers view businesses that contribute to charities in a more positive light. As a new small business, consider finding local causes that align with your mission and contribute time or money. You can also sponsor other local events to attach your business to causes or activities others in your community care about.
• Partner with established, complementary businesses: If you want to add more value than your competition, find complementary businesses to collaborate and partner with. For example, if you’re opening a lawn care business, consider partnering with an established pool cleaning business to offer a summer package of pool cleaning and yard services. Not only can you provide more value to customers through lower prices or more convenience, but you can use that brand’s established name and client base to penetrate the market as a new business. 

FAQs

How do you communicate your differentiation strategy to customers?

Your differentiation strategy needs to be a cohesive part of your marketing mix and your customer experience. From your social channels and website to your store displays and advertising, there needs to be a clear and consistent message explaining your unique difference.

Remember, differentiation is more than just what you say, it’s what you do and how you do it. If you’re selling quality as your differentiation, your office, product, employees, website, and even logo needs to convey that message. You’re a new business, you need to build trust quickly and a cohesive strategy can help you do that.For example, if you are trying to penetrate the market as a low-cost provider, you should have signs and marketing collateral that compares your price to others in your area. You may also want to implement a store policy where you will beat any of your competitors’ prices. A lot of businesses claim to offer the best price, but if you will actually beat any price from your competitors, you are likely to build a reputation quickly as the brand with the lowest, best price.

What are the risks of a differentiation strategy?

The risks with differentiating your new business include factors like:

• There may not be enough demand: If you try differentiating through a niche focus, there may not be a large enough market to sustain your business.
• Consumer interests change: Buying habits, technology, environmental changes, and other unpredictable factors can affect your unique business.
• Resources may be limited: Differentiating can take effort and resources, which you may not have readily available or may be better used elsewhere in your business.

What is an example of differentiation in business?

Apple is a great example of differentiation because they have to build a brand that makes their products more “valuable” in the eyes of customers even if the technology is not much different from what else is available. Customers, in many ways, are buying Apple products (much like Starbucks) for the brand name or prestige they feel and not the tangible features.

Make Your Difference Matter

These subtle factors, in addition to the differentiation strategies outlined above, can have a huge influence on the success of your new small business. Even if you’re not able to implement major differentiation strategies at the onset, you can still prioritize small habits like excellent customer service and reliability, which can still help to differentiate you from the competition.

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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 views and opinions expressed in this blog are those of the author and do not necessarily reflect the official policy or position of Lendio. Any content provided by our bloggers or authors are of their opinion and are not intended to malign any religion, ethnic group, club, organization, company, individual or anyone or anything.

Your business is diving into social media, so what about Twitter and LinkedIn?

Twitter and LinkedIn are very different platforms—one’s a firehose of information and the other is a professional network—they’re similar from the business owner’s point of view because they’re both useful tools for brand-building. In LinkedIn’s case, you’d do it with long-form content where you can give customers more reasons to trust you by sharing opinions and solutions for issues that matter to them. Twitter, on the other hand, is the place to be seen by the press who will then amplify you to their audiences.   

But could LinkedIn and Twitter really help you grow your small business? 

There are several key variables to consider, but the primary one (as always) is audience: who is your primary customer base, and how are they connecting with other brands and businesses on social media? 

Once you’ve answered that question, let’s apply your findings below to LinkedIn and Twitter’s users and see if they're the right fit for your needs:

LinkedIn

While most social media channels serve multiple niches, LinkedIn’s a bit different: they’re known as the network for all things work-related. Their mission to “connect the world’s professionals to make them more productive and successful” has made them indispensable to American businesses of all sizes, as well as to their employees.

Here’s who else is using the network:

• Number of monthly active users: 810 million
• Largest age group: 25−34 (58.4%)
• Gender: 48% female, 52% male
• 63% of LinkedIn users access the network weekly, and 22% daily

While B2C companies have had some recent success on LinkedIn,  your B2B relationships are where LinkedIn will benefit you. According to Sprout Social, “a staggering 79% of marketers say that LinkedIn is a prime source of new leads” for B2B brands and businesses. 

Unlike Twitter, where short missives rule the day (more on that below!), driving growth to your LinkedIn page is all about thoughtful post-crafting and mutual engagement between your business and like-minded others. Since its primary audience is more professionally geared, think of your LinkedIn posts more like the content you’d share in the workplace, vs. the more personal or intimate content that might come from a solo Instagram or TikTok account.

LinkedIn also can serve as a vital hiring hub. Not only is the platform a great place to network with other businesses, it’s also a prime place to find new workers: “each week,” say the experts at Sprout, “40 million people use LinkedIn to search for employment opportunities.” If you’re not already looking here for new talent, it’s time to start.

Twitter

The end of April 2022 has been a banner time for Twitter headlines: Tesla and SpaceX CEO Elon Musk’s $44-billion bid to buy the platform was front-page news on April 25, and at the time of publishing this post, Twitter has accepted the offer, which was under review by federal regulators.

The New York Times reports that if it does go through, it will be the largest deal to take a company private in at least 2 decades. 

A lot is still uncertain—but for now, here’s what to expect from the primary users of this social media network, known for its short-form text focus and like/retweet engagement style.

• Number of daily active users: 211 million (up from 187 million)
• Largest age group: 18−29 (42%)
• Gender: 38.4% female, 61.6% male (no data on other genders)
• Time spent per day: 31 minutes

Building a Twitter following is all about voice. If your business had a personality, what would it be—and how would you communicate it? And importantly, how would you do it in a sentence or two, as the character count on the site maxes out at 280 characters per tweet?

One of America’s shining examples of a strong Twitter personality is the restaurant chain Denny’s, whose irreverent and meme-driven online persona gained the brand nearly half a million followers and a ton of industry press about the followers they get, which gets them more followers and more press and so on. They’re even selling their most famous tweet as an NFT for charity. 

Like LinkedIn, Twitter thrives on connection. It’s not just about creating and sharing media—you also have to interact, and often, to grow your imprint and understand why certain topics are trending (valuable information for you to reach potential customers). 

There are countless ways to build this engagement, but one that’s especially common—and helpful—is Twitter’s use as a customer-service arm for concerned or frustrated customers. According to Podia’s Rachel Burns, “Offering real-time customer support on Twitter has its pros and cons. On the one hand, customers expect it: 57% of customers who reach out to brands have a question, and 45% have an issue with the product or service.” 

Burns also points out, though, that providing this service on Twitter—however helpful—could lead to burnout for smaller businesses or solo entrepreneurs who may not have enough hours in the day. Before tackling this aspect of Twitter for your small business, ask yourself first: how quickly can I respond to customers? Perhaps bringing on a social media manager will help to build this branch of your social-media presence.

LinkedIn vs. Twitter: Which platform is best for my business?

Unlike the previous two posts in our series, which considered similar pairings of social networks (Facebook and Instagram are both Meta products, and YouTube and TikTok both thrive primarily in video formats), LinkedIn and Twitter serve 2 vastly different functions for a small business. 

You may find as a result that both platforms could aid in your growth, whether you’re looking for new employees and B2B clients (LinkedIn) or to learn more about what’s trending and why (Twitter). 

Read more about using social media for your small business.

Managing Social Media for Your Small Business: Getting Started

Managing Social Media: 3 Tactics to Connect With Customers

Do Facebook and Instagram Make Sense F=for Your Small Business?

YouTube vs. TikTok: Which is Better for Your Small Business?

Disclaimer: 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.

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.