Small Business Tax Basics
Next to profits, taxes is also the foremost important issue facing every small business. You’ll want to make certain that you simply are meeting all of your responsibilities to the tax collector—and also seizing every opportunity to reduce taxes. Use these tax tips to create sure you’re not giving Uncle Sam quite his due.
Writing It Off: Deductions
You can deduct all “ordinary and necessary” business expenses from revenues to scale back taxable income (see “Tax Deductions” subsection later within the chapter). Some deductions are obvious—expenditures in such areas as business travel, equipment, salaries, or rent. But the principles governing write-offs aren’t always simple. Don’t overlook the subsequent potential deductions:
✔ Business losses. Business losses is deducted against personal income to cut back taxes. If losses exceed income this year, you’ll use a number of this year’s business loss to scale back a taxable income in future years.
✔ Employee taxes. If you hire employees, you’ll must pay—or withhold from their salaries—a style of taxes:
Withholding. social insurance (FICA), Medicare, and federal and state income taxes must be withheld from employees’ pay.
Employer matching. you want to match the FICA and Medicare taxes and pay them together with employees.
Unemployment tax. Federal and state unemployment taxes.
Quarterly Estimated Taxes
This area of the tax code trips up many a entrepreneur and is very vexing for home-based businesses. Failure to stay up with an estimated tax bill can create income problems similarly because the potential for punishing tax income Service (IRS) penalties. The antidote is simple—know your responsibilities:
✔ Who should pay? you most likely must pay quarterly estimated taxes if you expect a complete invoice during a given year to exceed $500.
✔ what proportion do you have to pay? By the top of the year, you must pay either 90 percent of the tax you owe for the year or 100 percent of last year’s tax amount (the figure is 110 percent if your income exceeds $150,000). An accountant can facilitate your calculate payments. Otherwise, you’ll be able to subtract expenses from your income each quarter and apply an taxation rate (and any self-employment tax rate) to the resulting figure (your quarterly profit).
Many services are under the taxable radar screen, but most products are taxable (typical exceptions are food and prescription drugs). States keep adding to the list of taxable services, however, so see a state’s department of taxation to seek out out if you must charge excise tax on services. If you are doing sell a product or service that’s subject to excise tax, you want to register with the state’s tax department. Then you want to track taxable and nontaxable sales and include that information on a sales tax return.
As a salaried worker, you have got to recollect only 1 or two tax-related dates: April 15 and maybe December 31. But other dates may matter just as much or more once you are involved in your own business:
✔ Annual returns. Most annual returns are due April 15 for unincorporated companies and S corporations. A C corporation, though, must file an annual corporate return within two and a half months after the close of its yr.
✔ Estimated taxes. Estimated taxes are due fourfold a year: April 15, June 15, September 15, and January 15.
✔ Sales taxes. Sales taxes are due quarterly or monthly, depending on the foundations in a very state.
✔ Employee taxes. reckoning on the scale of a payroll, employee taxes are due weekly, monthly, or quarterly.
Taxes and Incorporation
For federal tax purposes, it’s often best for a start-up company to be an S corporation instead of a daily corporation. this can be so while recent changes in tax rates have made the choice a touch more complex.
Still, to form sure an S corporation is best for you, speak to a knowledgeable accountant or tax adviser. Also detain mind that a liability company (LLC) is also an excellent more sensible choice.
Starting as an S corporation instead of a daily corporation may be wise for 2 reasons:
- Income from an S corporation is taxed at only 1 level rather than two—a total bill will likely be less.
- If a business operates at a loss the primary year, you’ll be able to pass that loss through to a private tax return, using it to offset income that you simply (and a spouse, if you’re married) may have from other sources.
Your decision to be an S corporation isn’t permanent. If you later find there are tax advantages to being an everyday corporation, you can easily change an S corporation status.
A business is liable for collecting and filing some taxes on behalf of employees. the subsequent is an summary of what you have got to try and do to withhold and match taxes on an employee’s paychecks:
✔ Get an employer number (EIN). A business must report employment taxes or give tax statements to employees;
you need an EIN to try to to this. Get Form SS-4 (Application for Employer Identification Number) from the net, or by calling 1-800-Tax-Form (1-800-829-3676).
✔ Deposit employee withholdings on time. rather than paying the federal government directly, you deposit with a licensed financial institution like a billboard bank (1) the income tax you have got withheld and (2) both the employer portion and also the employee portion of Social Security and Medicare taxes.
✔ Issue Form 1099-Misc to independent contractors. Doctors, lawyers, veterinarians, contractors, direct sellers, qualified real estate agents, et al who pursue an independent trade in which they provide their services to the general public are usually not employees but independent contractors. A worker is defined as an independent contractor if he controls what he does and the way the work is performed. What matters is that you have the correct to manage the small print of how the services are performed.
✔ Avoid payment penalties. For an employer, paying and reporting employment taxes could be a “fiduciary responsibility,” and that responsibility is taken very seriously by Congress, the IRS, and therefore the arm of the govt. The IRS can impose deposit penalties starting from 2 percent of the quantity due (for payments that are one to 5 days late) to fifteen percent (for amounts not paid within 10 days after receiving the primary IRS notice).
Preparing for a Tax Audit
A tax audit is an experience every businessperson hopes to avoid. If the IRS does pay a business a visit, however, understanding what an auditor might rummage around for can make the difference between a minor inconvenience and a significant hardship. During a full-fledged audit, an IRS agent may study several specific items in an exceedingly official document and business records, including:
✔ Income. The IRS will compare bank statements and deposits to the income you reported. they’ll also review invoices, sales records, and receipts, together with a account book and other formal bookkeeping records. If you received gifts of cash or an inheritance, keep records to document what proportion you received.
Without proof, the IRS may classify these as income and tax them intrinsically. they’re going to also classify any exchange of goods or services in lieu of money (such as barter transactions) as taxable income.
✔ Expenses and deductions. An auditor may compare canceled checks, bills marked “paid,” bank statements, mastercard statements, receipts for payment or charitable gifts, and other business records to the expenses and deductions you reported on a return. they will pay special attention to reported debts or business losses; charitable gifts; and travel, meal, and entertainment expenses. Keep a log to substantiate travel, meal, and entertainment expenses and take care to deduct only legitimate business expenses.
✔ Loans and interest. An auditor may review loan paperwork, deposits, bank statements, mastercard statements, receipts, and canceled checks to verify that you simply used borrowed money only to hide business expenses. this can be important, because you’re allowed to deduct interest on business-related loans.
✔ Employee classifications. The IRS will review employee classifications on a return and check this data against the clock cards, job descriptions, benefit plans, invoices, canceled checks, contracts, and other business records. Auditors will pay particular attention to independent contractor classifications, because many firms improperly classify regular employees as contractors.
✔ Payroll. Auditors will examine canceled checks, tax returns, deposits, business records, and other forms to test for completeness, accuracy, and timely filing. they’ll also review records documenting state, federal, and Social Security (FICA) withholding, Medicare taxes, advance earned income credit, unemployment compensation, and workers’ compensation premiums. The IRS will examine salaries and bonuses paid to owners and officers of a business to make certain they’re legitimate and within industry standards.
✔ Other records. An auditor can even inspect records from a tax preparer or accountant, bank or other financial organization, suppliers, and customers. additionally to inspecting a business, an auditor may inspect personal finances. The IRS may compare a current lifestyle with the income presented on a return to determine if they’re compatible. An auditor can also talk with others who are intimate you and your financial situation.
Taxes are an inevitable—and painful—part of each business owner’s life. But there are ways to cut back, if not eliminate, a company’s tax burden, if you recognize the way to use business-expense tax deductions to an advantage.
Most business owners know they owe business taxes only on their net business profit—that is, their total profits after they subtract their deductions. As a result, knowing a way to take full advantage of a deductible disbursement can dramatically lower taxable profits.
You can legally deduct variety of expenses commonly associated with a trade or business. Common deductions include:
✔ Employee wages and most employee benefits.
✔ Rent or lease payments.
✔ Interest on business loans.
✔ property taxes on business property.
✔ State, local, and foreign income taxes assessed to a business.
✔ Business insurance.
✔ Advertising and promotion costs.
✔ Employee education and training.
✔ Education to keep up or improve required business skills.
✔ Legal and professional fees.
✔ Telephone costs.
✔ Office repairs.
If you’ve got a home-based business or a business office, you can also deduct a little of residential land taxes, utilities, and telephone expenses as long as you’ll be able to prove the legitimacy of the home-based business.
Finally, always maintain complete and accurate business records to document deposits, income, expenses, and deductions. If the interior Revenue Service audits a business, it should require you to demonstrate that each entry on a legal document is correct.
Tax laws change annually, and that they may be very complex. Always consult an accountant or tax attorney for assistance, strategies, and recommendations for a personal situation.