When someone takes the plunge and starts their business, they are generally motivated by the desire to develop their own idea, or driven by their creativity or artistic talent. And that makes sense – because essentially that’s what they are marketing. And most of the time, the financial/reporting end of the business is delegated to an accountant or bookkeeper, and given the minimum attention by the business creator. But that’s where it stops making sense.
One of the biggest mistakes that small business owners make is that they look at the end of year or monthly reporting as something that their ‘financial person’ will take care of. They fail to view it as the opportunity that it really is – a critical business activity that can help them make active decisions regarding the running of their business.
The accounting data, including the end of year tax report is analogous to the blood running through a person’s body. And without having critical and timely information regarding how their business is operating, it simply can’t be run properly. It is crucial that business owners are constantly aware of all the financial aspects of their business.
As I mentioned last month, take advantage of the obligation that small businesses have to file year-end reports, and use that data to help you better manage your business. If your accountant needs to delay the year-end report for six to nine months after the end of the year (whereby your data will be long irrelevant), that doesn’t mean that you should accept the delay in receiving your critical business data. Make sure that your accountant has up-to-date information regarding all your business-related activities, even if he can’t file the end-of-year tax return for a while.
These last few paragraphs were directed primarily towards those who are already self-employed or set up as a business corporation. The next few paragraphs are intended to clarify things for those contemplating the step, and simultaneously to ensure that those already established in a business are operating within the correct framework.
Self-Employed Business Structuring Options
When operating an independent small business in Israel, whether you own a store or work independently like many professionals do (i.e., psychologists or tradesmen), there are different options available to structure your income in Israel. Structuring your income refers to the method in which your business is legally structured and through which type of business you choose to generate your income.
Self-Employed Workers (Atzma’im)
Many small businesses in Israel are operated by independent self-employed entrepreneurs. Self-employed individuals earn revenue and pay taxes directly to the Israel Tax Authority. They also pay social insurance and health taxes directly to Bituach Leumi (the National Insurance Agency). These taxes and payments are remitted monthly (or every two
months) based on either actual income earned or estimates of earned income. At year end, these self-employed workers file annual tax returns that include all income and expenses during the course of the year, correcting the estimates made when remitting taxes and Bituach Leumi payments during the year.
Self-employed workers are one of the few groups of workers who need to file their own tax returns in Israel. In addition to the annual tax return, self-employed individuals are required to file statements of net worth to the Israel Tax Authority (Mas Hachnasah), usually every four or five years.
Due to the nature of business activity in Israel and the large shadow economy, these workers face a high level of business scrutiny. This high level of scrutiny faced by the self-employed and the bureaucracy involved in running a business can be onerous and in many cases overwhelming.
Many self-employed workers thus use the services of local accounting firms to calculate and remit payments for them and to interact as necessary with the authorities. Because the accounting professionals have much more experience working with the government agencies,
they often know who to talk with and when. They know the ins and outs of the system and can save workers lots of time and money, even after their fees are deducted.
Being self-employed has many advantages. Self-employed workers have the flexibility to declare a wide range of business expenses and, if they work from home, can often include part of their home expenses as business expenses. They have maximum flexibility regarding the types of expenses and income earned. They also enjoy the ability to utilize many of the employee employment benefits described above (although somewhat reduced).
However, self-employed US citizens need to continue paying American Social Security payments on their earned income (as the foreign income exemption is for salaried income only). As a result, they will be faced with an additional approximately 15% tax on their income. This issue, together with the higher level of scrutiny for the self-employed mentioned above, has led many to consider other employment options.
Manpower or Outsourcing Organizations
In Israel, many manpower and outsourcing organizations operate (legally and openly) by “employing” self-employed individuals under their business framework. In this arrangement, a self-employed worker converts into a simple employee hired by the manpower company. His or her income and expenses are channelled through the company, and the company uses the revenue and expenses to pay the person a salary, contribute to various benefits and savings plans, and cover all employer costs.
The major advantage in this arrangement is the worker’s ability to avoid time-consuming and sometimes frustrating contact with government agencies by simply becoming a standard employee. It also eliminates the need for US citizens to pay social security on their earned income. Under this structure, all the costs of employing the worker (including employer pension contributions) are paid for out of the income generated by the employee. This arrangement allows the worker to save larger percentages of his salary (the employee’s and the employer’s contribution equal over 15% of one’s salary) as opposed to the smaller percentage that the self-employed can contribute to tax-deferred retirement savings plans.
However, manpower and outsourcing agencies charge monthly for their services (usually 5–7% of revenue up to a maximum monthly charge).
The employee also needs to pay all employer costs (up to a maximum of 22% of one’s salary). In most cases, the net impact of this arrangement is slightly higher costs, higher savings amounts — and much greater anonymity with the tax authorities.
The last structure commonly utilized by the self-employed is a corporate structure. By setting up a corporation, the worker turns into an employee, in addition to being the owner of the corporation. This structure gives the employee more flexibility to take part of his income as a salary and part as a dividend, which might allow him to save considerable taxes. Corporations have also been extensively used to avoid paying higher Bituach Leumi payments on wages as opposed to dividends, which are exempt from Bituach Leumi payments. Corporate structures generally entail higher fees, but can be very worthwhile for higher earning individuals.
The afore-mentioned are the most common options available for structuring your self-employed income, each with various advantages and disadvantages. Consult with your accountant to determine the best structure for you. But, regardless of the structure, remember that the success of your business depends on your involvement in all aspects of your business, including the financial analysis!