Filing small business taxes for the first time can seem daunting, but it doesn't have to ruin your month. The IRS provides in-depth resources on taxes for small business owners, and most federal tax requirements can be completed online.
If you're just getting started with your small business and you're preparing to file taxes for the first time, this article can get you started in the right direction. However, each business is unique and we recommend working with a professional accountant to make sure you meet all of your tax requirements.
Understanding your tax obligations
As a small business owner, you are responsible for paying federal income taxes according to the rules for businesses set by the IRS. The amount and frequency of your business taxes will vary based on the type of business structure you choose, whether you have employees and the amount of the profit generated by your business.
Business structures and taxes
When you first form your small business, you will need to decide on a legal business structure. There are several options in the United States, but the most common include:
- Sole proprietorship
- Limited Liability Corporation (LLC), Corporation
Each structure has advantages, drawbacks and tax implications that you should consider before making a selection. Here's what you should know:
To qualify for this legal structure, you must own an unincorporated business by yourself. This business structure is the easiest and typically cheapest to register.
As a sole proprietor, you should be prepared for higher taxes. You are typically taxed as a self-employed individual, and the IRS will expect you to pay both the employer and the employee share of Social Security and Medicare taxes when you file.
Sole proprietors file small business taxes on their personal tax returns using Schedule C to outline the profit or loss from the business.
Limited Liability Company (LLC)
The IRS governs taxation for LLCs, but individual states control who can form an LLC and how the business must be structured. LLCs are typically more complex and costly to start than a sole proprietorship, but they provide more flexibility and certain legal protections not offered to sole proprietors.
For federal tax purposes, your LLC would be treated as a sole proprietorship if you have only one legal owner, and a partnership if you have two or more owners. Alternatively, you can complete IRS form 8832 and request that your LLC be treated as a corporation.
If you structure your business as an LLC and you are the sole member of your company, the IRS views your business as a "disregarded entity" and you will file your business taxes as part of your personal tax return.
If you structure your company as an LLC with multiple members, the IRS will treat your business as a partnership and you will use partnership tax forms to file your business taxes.
If you structure your business as a corporation, you can sell shares of stock to raise funds for business operations. Your business would also have access to special tax deductions that aren't available to sole proprietors or partnerships. As the owner of a corporation, you are also not personally liable for any business debts or lawsuits.
However, one drawback is that corporations experience what is often referred to as "double taxation." The business is taxed on its profits, then the individual shareholders are taxed on the profits they receive as dividends. Since shareholders are often owners or partial owners of the corporation, they are essentially taxed twice on the same money.
Corporations are viewed as separate tax-paying entities by the IRS and have their own corporation tax forms. As a corporation, your business will need to file quarterly and annual tax returns, and you may be required to pay an estimated tax each quarter if your expected tax liability is $500 or more.
If you'd like the personal liability protection of a corporation without the double taxation, you may prefer to incorporate your business as an S-corp, or a Small Business Corporation. You must meet certain criteria to qualify, and your S-corporation is limited to 100 shareholders and one class of stock.
To become an S-corporation, you must meet certain IRS requirements and submit IRS form 2553. As an S-corporation, your business must also file quarterly and annual tax returns, and you may be required to pay estimated taxes if your tax liability on built-in gains, excess net passive income tax or investment credit recapture tax is $500 or more.
Partnerships are referred to as "pass-through" entities because the partnership itself is not taxed at the federal level. Instead, business income and losses are "passed through" to the personal tax returns of their owners.
Even though a business partnership does not directly pay taxes, it must still file annual information to report gains and losses. Typically, any partners in the business are equally and personally liable for any business debts.
Separating your personal and business expenses
If there is any question about the taxes owed for your business, the IRS will want to see itemized records of any business revenues and expenses. You should be able to produce bank account records showing all cash inflows and outflows and receipts for any major purchases or expenses claimed.
Providing proof of your business expenses can be messy and time-consuming if you are using your personal bank accounts to fund your business. Even if you are using personal funds to keep your business afloat, you should still use separate accounts for personal and business expenses. Not only can this help you track expenses more accurately, but it can also save you time when filing your taxes.
On your personal income tax returns, you can take tax deductions for things like child care, medical expenses or mortgage interest. As a business owner, you have access to other business-related tax deductions that can help offset some of the taxes you owe and minimize your out-of-pocket tax expenses.
The first step in taking advantage of business tax deductions is to keep accurate records of all expenses you incur during your business. Here are a few of the most common business tax deductions along with what you should track for tax purposes:
Cost of goods sold: If your business sells tangible goods, you can deduct certain expenses associated with buying, storing, manufacturing and distributing your goods. To claim this deduction, track the purchasing costs of any items you buy for resale or any materials you buy to produce a finished good.
Mileage deduction: If you travel for any part of your business and you use your personal vehicle, keep a logbook of your business mileage. The IRS allows you to take the standard mileage deduction or track and deduct your actual business-related auto expenses.
Home office: If you work from your home, you may qualify for a home office deduction. You should keep track of any expenses you would have if you operated from a traditional office. This may include physical space, internet service, public utility costs and office supplies.
Insurance premiums: If you pay for health insurance, business insurance, commercial auto insurance or workers' compensation coverage, your insurance premiums are often deductible through your business.
Employee Pay: If your small business has employees, any payroll costs you incur are tax-deductible.
Start-up costs: Certain start-up costs, such as purchasing equipment that will be used strictly for business purposes, can be deducted, depending on the amount. As you are starting your business, keep receipts for any business purchases.
Don't let the filing deadline sneak up on you
Missing IRS filing deadlines can result in costly fees and interest charges. To avoid these additional penalties, you should be aware of any quarterly and annual tax deadlines that apply to your business.
Have your tax forms printed in advance and be sure you know whether you can file business taxes online or if you can mail your returns instead.
Tax returns can also be time-consuming to complete, especially if you are new to filing business tax forms. Have all your business tax documentation in the same place, including a complete listing of any allowable expenses. Start preparing your returns early so you don't run out of time before a filing deadline. Taxes are also much easier to submit on time when you keep a running list of expenses such as payroll, healthcare premiums and utilities.
Tax planning requires ongoing effort on your part, and your tax system will be most effective when you keep careful records throughout the year. If you are just starting your small business, think about how you plan to organize your tax records and start out right from the beginning.
Consult with a licensed tax professional to ensure you are not missing any steps and to maximize your deductions.
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