Taxes can be complex, but understanding them is important, especially when you are a business owner. With proper tax planning, you can save money and support the growth of your business. Here is a breakdown of the essential tax basics for small businesses.
Types of Taxes
Income Tax: Income tax for businesses is calculated based on the net profit earned during the tax year, which is determined by subtracting allowable business expenses from total revenue. Your business structure affects how this tax is applied.
- Sole proprietorship: Owner reports business income on their personal tax return, leading to personal income tax rates.
- Partnership: Profits are shared among partners, who then report their share on their personal tax returns.
- Limited Liability Company (LLC): Owner can choose how they want to be taxed. Meaning, they can be taxed like a sole proprietorship, partnership or corporation.
Corporation: Corporations are taxed separately from their owners. Which means they can be taxed twice. Once at the corporate level on profits and at the individual level when dividends are distributed to shareholders.
Self-Employment Tax: Self-employment tax is a federal tax for individuals who work for themselves (i.e. business owners, freelancers, independent contractors) that is calculated based on net earnings. This tax primarily funds Social Security and Medicare. Unlike traditional employees, self-employed individuals must pay both the employer and employee portions of this tax.
Payroll Taxes: Payroll taxes apply to businesses with employees. Under this type of tax, there are Social Security and Medicare taxes that are mandatory to contribute to. Employers must match the employee contributions to these taxes, doubling the amount paid into the system. Additionally, businesses are required to pay federal and state unemployment taxes that vary by state.
Sales Tax: Sales tax is a consumption tax on the sale of goods and services that vary by state and jurisdiction. Businesses that sell products or taxable services are typically required to collect sales tax from their customers at the point of sale.
Excise Taxes: Excise taxes are only for specific goods, such as fuel, alcohol and tobacco. This tax is usually included in the price of the product and is levied at the federal, state or local level.
State and Local Taxes: State and local taxes vary widely, with each jurisdiction setting its own tax structures and rates. Business owners should review local tax laws to stay in compliance.
Tax Deductions
Common Deductible Expenses: Common deductions for businesses include rent, utilities, office supplies, travel and marketing. These deductions can significantly reduce taxable income, helping businesses save money and manage operational costs.
Home Office Deduction: The home office deduction allows business owners to claim a portion of their home expenses as tax deductions. To qualify, the home office must be the primary place of business for meeting clients and business activites. Expenses that can be deducted are rent, mortgage interest, utilities and home insurance, significantly reducing taxable income and lowering tax liability.
Depreciation: Depreciating assets (i.e. equipment, machinery) involves allocating their cost to their useful life, recognizing that they lose value over time due to wear and tear or uselessness. This allows the initial purchase cost to spread over several years, aligning expenses with the revenue generated.
Vehicle Expenses: There are two primary methods of vehicle deductions.
Standard Mileage Rate: Allows owners to deduct a fixed amount per mile driven for business purposes, simplifying record-keeping and making it easy to calculate deductions.
Actual Expenses: Involves tracking all costs related to operating the vehicle, such as fuel, maintenance, insurance, registration fees and depreciation. While this method may offer higher deductions, it requires more record-keeping.
Employee Benefits: Businesses can benefit from deductions for health insurance, retirement plans and other employee benefits. Offering health insurance allows companies to deduct premiums, lowering tax liability and aiding in employee retention. Contributions to retirement plans like 401(k)s are also tax-deductible, encouraging employee savings. Additionally, expenses for wellness programs, education assistance and paid time off can be deducted, enhancing employee satisfaction and efficiency.
Tax Forms
Form 1040 and Schedule C (Sole Proprietors): Form 1040 and Schedule C are forms for sole proprietors to report business income and expenses. Form 1040 is the individual income tax return, while Schedule C reports income, expenses and net profit or loss from the business, which is then transferred to Form 1040.
Form 1065 (Partnerships) and Schedule K-1: Partnerships use Form 1065 to report income, deductions, gain and losses to the IRS. Partnerships do not pay taxes at the entity level; instead, they file Form 1065 to outline their financial activity. Each partner receives a Schedule K-1, detailing their share of income, deductions and credits, which they report on their personal tax returns.
Form 1120 or 1120S (Corporations): Corporate income tax forms vary by structure. Generally, corporations file Form 1120, the U.S. Corporation Income Tax Return, to report income, gains, losses, deductions and credits. Additional schedule and state-level tax forms may be needed.
Payroll Tax Forms (941, 940): Form 941 is filed quarterly and reports wages and withheld taxes, including federal income tax, Social Security and Medicare. At the end of the year, employers must file Form 940, which summarizes wages and taxes withheld from employees (Form W-2). Employers may also need to submit Form W-3, the Transmittal of Wage and Tax Statements, which combines all W-2 forms submitted.
Quarterly Estimated Taxes
Most small businesses must pay estimated taxes quarterly as their income typically lacks withholding. To calculate these, owners should estimate annual income, subtract deductions and credits, and apply the tax rate to find their yearly tax liability, then divide by four for quarterly payments. Payments are due on April 15, June 15, September 15 and January 15.
Managing Taxes
Staying organized is important when managing taxes as accurate record-keeping keeps businesses in compliance and provides insights into business performance. To help stay on track, accounting software can be utilized to simplify financial management and streamline tax filings. You may want to also consult a CPA or tax expert as they can help navigate complex tax issues, maximize deductions and ensure compliance with tax laws. Additionally, you can check out the IRS website as a resource for more information.
How SESLOC Can Help
Our business banking and lending services are tailored to the unique needs of the local businesses making the Central Coast the best place to live, work and thrive. Whether your organization is small or large, the SESLOC Business Services Team offers personal, one-on-one service for commercial and business loans, as well as deposit solutions. With great rates and fewer fees, let us help support your goals and grow your business.
