It's Not Fun, but It Has to be Done Benjamin Franklin wrote a 1789 letter that states, “But in this world nothing can be said to be certain, except death and taxes.” Even at the United States’ early beginnings, federal taxes were a necessary evil to fund various public projects and administrative costs. Today, federal taxes serve much of the same purpose. While virtually no one likes to prepare and file their taxes, it is a necessity if you want to avoid fines and further hassle. It is no secret that preparing and filing your taxes is notoriously complicated. Many people lament that it should not be so difficult to pay the government. However, some of the complications allow people to save money if they discover specific tax benefits. Knowing how to file your own taxes may be a good option if your tax situation is relatively straightforward, or if you are willing to learn the process. Why Do You Need to File Your Taxes Every Year? The short answer is that federal law requires that most individuals file taxes annually. Income taxes are assessed every year based on your income earned during that period. You then pay a percentage of that income to the government, less any deductions, adjustments, or credits that you qualify to receive. If you do not file (and pay) your taxes, then you may be assessed penalties and interest. The Internal Revenue Service (IRS) can even go as far as garnishing your wages and repossessing your property if you do not file and pay as required. The Benefits of Filing Your Own Taxes If you are one of the 43% of Americans that are doing your own taxes, you are certainly not alone. Roughly 53 million people prepared and filed their own taxes in 2018. There are many benefits to filing your own taxes, including: Saving money: Hiring a tax professional is expensive, and many people can prepare and file their returns on their own, completely free of charge. Control: Some people like knowing the exact information that is included in their return and being able to control the data, and for some, knowing precisely how the numbers work out, is comforting. Gain helpful information: When you prepare your taxes, you can see what items saved you money this year or which issues you should address so you can save money next year. While filing your own taxes is complicated, it can be beneficial under the right circumstances. There are several programs online that walk you through the process to help ensure you are taking advantage of all of your available deductions and credits. The Drawbacks of Filing Your Own Taxes In addition to the benefits, there are also some disadvantages to filing your own taxes. These include: Time and effort: Preparing and filing your taxes takes time and work You have to sift through financial information and deal with concepts that you may not understand well. The process can be frustrating and take a considerable amount of time. Error risk: If you do not completely understand how your taxes work, you run the risk of making a mistake because of misconceptions. If that happens, it could lead to underpayment and audits down the road. Questions: Even if you use a tax preparation software, you may still have questions that will remain unanswered unless you do significant research or reach out to a tax professional. For some people, the risk of having a substantial error that triggers the IRS’s attention is enough to scare them away from preparing their own taxes. Preparing for Filing Your Taxes When you begin work on your taxes, you should have information gathered throughout the year. Some of the most common items that you will need include: Social Security numbers for you, your spouse, and any dependents Information about wages, such as W2s or 1099s Investment income information Documents that represent any other source of income Information regarding adjustments to income, such as student loan interest paid, IRA contributions, and health savings account contributions, just to name a few Information regarding potential credits, including, for example, child care expenses, education expenses, or retirement savings contributions Data about any tax payments that you may have made throughout the year Keeping good records will help make tax preparation easier at the beginning of the year. [youmaylike] The Basics About What You Can Claim When Filing You must pay income taxes on all your income earned throughout the year. However, that income is reduced by a few things. The further you can reduce your taxable income, the less you tax you will pay. There are three general categories of tax reduction methods: Standard or Itemized Deductions Everyone can claim either the standard or itemized deductions. Standard deductions are a set amount that is based on your filing status. Itemized deductions are based on actual expenses that you incurred throughout the year. You can choose to use the higher deduction. The higher the deduction, the less tax you will have to pay on your income because your income decreases on paper. Itemized deductions include things like medical expenses, state and local tax payments, and home mortgage interest deductions. Itemized deductions will only decrease your income by a certain percentage, or up to a specific point. Adjustments Some adjustments to your income may also be available. These include things like paying student loan interest or alimony. Adjustments are more valuable compared to deductions because they decrease your income dollar for dollar. Credits A credit decreases your taxable income as well. Some credits are refundable while others are not. For example, you get a child tax credit simply for having children that qualify for that credit, but that credit will not be paid out to you if you do not have any tax obligations. On the other hand, the Earned Income Credit, which is available for low-income filers, will be refunded to you even if you do not owe any taxes. There are a wide variety of deductions and credits available. Take a look at the federal forms and related schedules to determine whether you might qualify for any of these. How to File Your Own Taxes If You Live Overseas If you earned income in the United States as a U.S. citizen or resident alien, you likely need to pay taxes on that income. This is true even if you live overseas. You can still choose to e-file or mail your tax return to the IRS once you have it prepared, just as if you physically lived in the United States. In some cases, you will be taxed on the income that you earned throughout the world. However, you may be able to deduct a portion or all of the revenue that was not made in the United States in some circumstances. Filing Online The IRS offers an online filing option that is free for individuals that have an adjusted gross income below a specific threshold. Generally, your income must be below $66,000 to qualify for this service. You can also file online by using a commercial tax preparation software. Examples of this type of software include: H&R Block TurboTax TaxCut TaxSlayer There are many programs available that will file your taxes for you, often for a fee. Knowing how to file your own taxes can be a great way to save money, but it can be tricky as well. If you want to file your taxes yourself, be sure to read the form instructions thoroughly and get familiar with various tax saving opportunities before you begin preparing your return.
Debt vs Equity Financing
An entrepreneur has a million things to worry about. Between pleasing customers, keeping staff happy, maintaining the books and being a public face for the company, an owner’s stress never ends; it just dissipates for a while as you solve problems.
One of the biggest things a business owner must worry about is growth. As the old expression goes, “if you’re not growing, you’re dying.” Expansion is no small feat either, since it usually comes with its own assortment of challenges. Production must be increased, new staff need to be hired, and any marketing spend must be done wisely.
And then there’s financing that growth. There are two main methods for financing growth, and these are debt and equity. Which one is right for your business? It’s a complicated question without a simple answer. Let’s take a closer look.
The Pros and Cons of Debt Financing
Let’s start with debt, which is usually an entrepreneur’s default financing method.
First, the advantages of using debt. The main one is as simple as it is powerful — you’re not giving up any equity if you manage to use debt to finance your business. The owner keeps all the upside while lenders get nothing more than the principal and interest owed to them.
Another advantage is any interest paid on debt is tax deductible. That’ll undoubtedly reduce your entire tax bill, especially if your company doesn’t make much profit anyway (like most start-ups).
Getting debt financing also means the lender doesn’t have much say in how you run your business. Compare that to equity financing, where a new partial owner will likely give you a lot of input. Many entrepreneurs don’t do well in such an environment.
Let’s pivot over to some of the disadvantages to using debt to grow your venture.
Debt is often very expensive, especially if your business isn’t very mature. Lenders are conservative in nature and will want to be compensated for the risks of lending to a risky operator. Expect to pay 10-20% annually in interest.
No, that’s not a typo. Business debt is expensive; especially for small companies.
One way to get the interest rate down is to borrow the money yourself, using something like your house as collateral. This adds risk to any entrepreneurial venture, but it also makes the reward that much sweeter. You’ll want to run that one by your spouse first.
You might not even be able to qualify for debt, depending on the nature of your business. Some of the best businesses are ones without many fixed assets. However, lenders hate them because they have nothing physical that can be seized if the loan isn’t paid. You could potentially get around this by personally guaranteeing a loan, but you’ll need good credit to do that.
Another disadvantage to using debt is it must be repaid, something that can really impact your cash flow. Many businesses have used debt to expand and then found themselves paralyzed by the repayment terms; any momentum is stopped dead in its tracks right when you’re getting started.
Essentially, debt financing comes down to this: it allows owners to keep all the equity in the business, which is massive. But to gain that advantage, an entrepreneur has to endure a lot of disadvantages, too.
The Pros and Cons of Equity Financing
Let’s start with the big knock against equity financing: you’ll lose part of your ownership stake if you agree to it. For many entrepreneurs — especially those who insist on going at it alone — this makes equity financing a non-starter.
But I’d encourage every business owner to at least consider it. Everyone has weaknesses, and a good partner can contribute more than just cash. A venture capital firm can even open possibilities by having mentors that can work with a business owner or create opportunities to work with other companies that are in the portfolio.
However, that doesn’t mean equity financing will be painless. Your new partner will expect to have a significant say in the business, something that could go quite well or very poorly, depending on the skill set they bring to the table. There’s no guarantee someone with cash will end up being a good operator.
Depending on the success of your business, equity could end up costing you a bundle. A 10% stake might not seem like much today, but it’ll really hurt giving up a chunk of the upside if you eventually sell for millions. It has the potential to be much more expensive than debt.
Equity financing also comes with tons of flexibility. You don’t have to worry about making interest payments, putting up collateral or making a lender happy. You just take your equity investment, put it to work, and then worry about execution.
Investors have a much better outlook than lenders as well. These folks know it often takes years for an equity investment to work out, so they’ll be much more patient. On the other hand, a lender wants their interest the minute it’s due.
Finally, equity financing can never offer one of the biggest advantages that debt financing offers; you can’t deduct any interest from your taxes.
Debt vs Equity Financing? Which Should You Choose?
There are several factors that influence your debt vs equity financing choices. Certain businesses will be more apt to choose one over the other.
Say your business is in something with a lot of fixed assets, like flipping real estate. Lenders will be more attracted to this business, which will make getting a loan much easier. Compare that to running a website or a software company, something that owns virtually zero fixed assets. In that situation, equity financing would be your best bet.
Also, keep in mind that equity financing is a little different than what you see on Shark Tank. You’ll be forced to pitch your company to numerous investors, and you’ll spend hours each time in meetings talking about mundane details. It’s also very possible that these investors will expose numerous flaws in a company’s business model, something no entrepreneur wants to hear.
Equity financing might be the right choice if you’re convinced your business doesn’t have as much potential. Giving away a percentage of something small doesn’t hurt as much as giving away a percentage of something much larger. Keep in mind, however, that many equity investors aren’t interested in a business without great potential.
Ultimately, there are pros and cons to each form of financing. In most situations, debt is ideal. It allows growth without giving up ownership. But it’s often not possible, which forces owners to pivot to equity financing. It might hurt to give up a chunk of something you think could be massive one day, but it’s still better to own part of something big rather than all of something much smaller.