Filing small business taxes for the first time can seem daunting, but it doesn't have to ruin your month. The Internal Revenue Service (IRS) provides in-depth resources on taxes for small business owners, and you can complete most federal tax returns online.
If you're just getting started with your small business and this is your first year filing taxes as an entrepreneur, this article can get you started in the right direction.
However, each business is unique, we recommend working with a professional accountant to make sure you meet all of your tax preparation requirements.
Understanding your tax obligations
As a first-time 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. It’s based on the type of business structure you choose, whether you have employees and the amount of profit generated.
Business structures and taxes
When you first form your small business, you must 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)
- C-Corporation or corporation
Each business entity has advantages, drawbacks and tax implications to consider before selecting one. 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. First, you typically have to pay a self-employment tax. Then, 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 individual 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. While LLCs are typically more complex and costly to start than a sole proprietorship, 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.
Suppose you structure your business as a single-member LLC, and you are the sole member of your company. In that case, the IRS views your business as a "disregarded entity," and you will file your business taxes as part of your personal tax return.
But, if you structure your company as a multiple-member LLC, the IRS will treat your business as a partnership. You will use partnership tax forms to file your business taxes..
C-Corporation or corporation
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 corporation's owner, you are not personally liable for business debts or lawsuits.
However, one drawback is that corporations experience what's called "double taxation." The business is taxed on its profits, and then 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. You will need to file quarterly and annual business tax returns. You also 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 double taxation, you may prefer to become 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. If your tax liability on built-in gains, excess net passive income tax or investment credit recapture tax is $500 or more, you may need to pay estimated taxes.
Partnerships are called "pass-through" entities. This is 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 file annual information to report gains and losses. Typically, any partners in the business are equally and personally liable for any business debts. The Schedule K-1 form (1065) is used to report the amount passed through to each partner’s share of tax.
Separating your personal and business expenses
If the IRS has questions about your business's taxes, they will want to see itemized records of your taxable income and expenses. You should be able to produce your bookkeeping, including 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 use your personal bank accounts to fund your business. Even if you use 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 small business tax deductions that helps offset some of the taxes you owe, minimizing your out-of-pocket costs.
The first step in taking advantage of business tax deductions is to keep accurate records of all incurred expenses during the tax year. Here are a few of the most common deductible business expenses, 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 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 use auto expenses.
Home office: If you work from home, you may qualify for a home office deduction. You should track any expenses you would have if you operated from a traditional office. This may include physical space, internet service, software (including tax software), public utility costs and office supplies.
Insurance premiums: If you pay for health insurance, LLC insurance, small 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: You can write off certain start-up costs, such as purchasing equipment that will be used strictly for business purposes, 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 on your tax bill. To avoid these additional penalties, you should be aware of any quarterly and annual tax due dates 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 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, plan how to organize your tax records right from the beginning.
Consult with a licensed tax professional to ensure you are not missing any steps and maximize your deductions.
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