As a small business owner, you’ll need to pay taxes on your net income to the IRS. Small businesses are required to pay various types of taxes using an assortment of tax forms, so you might be wondering where to start.
Although it can be onerous and time-consuming, filing your taxes doesn’t have to be daunting. You can smoothen out the process with these key steps:
Gather Your Business & Financial Records
Ensuring that you have all the relevant business documents is the first stage of the tax-filing process. Depending on your business entity, you’ll need different documents, but begin by collecting your Employer Identification Number, last year’s tax returns, your SSN, and your financial statements (including balance sheet and income statement).
You’ll also need detailed financial records of all your business expenses, including invoices, paid and outstanding bills, deposit slips, cancelled checks, cash register receipts, credit card and bank statements, payroll reports and employment tax records.
It’s a good idea to track and categorize every single transaction starting from the first day of the tax year, utilizing business expense tracking software, rather than gathering all the data right before tax season. Many platforms have a built-in option to separate and classify expenses, and can be adapted to the specific needs and preferences of your business. A tax professional can provide tailored advice specific to your business, so consultations, even on a freelance basis, can be very useful.
Maximize Your Tax Deductions
While accurate, up-to-date bookkeeping is essential for meeting IRS tax requirements, small businesses are also eligible for a variety of tax deductions, so keeping meticulous records of your expenses can help you lower your tax bill and reduce your overall tax liability. According to the IRS, deductible business expenses are those which can be defined as ‘ordinary and necessary’; the costs that are commonly accepted in your trade and appropriate for running your business and generating sales.
Some common tax-deductible expense categories include, but are not limited to:
- Home office space
- Office/commercial rent
- Utilities
- Office supplies
- Professional development
- Business travel
- Advertising & marketing
- Salaries & benefits
- Insurance
- Postage & shipping
Although your principal focus may be on customer service and providing quality products or services for your clients and customers, the importance of tracking all expenses with great attention to detail should not be overlooked.
Take a simple scenario where a freelance graphic designer is working from home, in part of his house delegated as an office. Throughout the year, he incurs numerous business expenses, for example, paying for home office space, marketing strategies and business travel (client meetings and conferences). However, when tax season arrives, the designer does not claim his allowable deductions, due to a lack of maintaining detailed expense records and a lack of awareness surrounding his tax deduction rights. In this instance, he neglected to claim a portion of his rent and utilities for his home office, along with the money he spent on website hosting. The designer also missed the opportunity to claim professional development and business travel costs, not keeping track of his receipts for airfares, hotels or the graphic design conferences that were aimed at improving the skills relevant to his trade.
Even if you were to find yourself in a similar situation, losing track of receipts or being behind on your bookkeeping, it’s never too late to catch up; working with a professional and availing catch-up bookkeeping services can help you identify outstanding tasks and get you up to date.
Determine Which Taxes Apply to You
Your particular tax situation is likely to be as unique as your organization. What taxes you need to pay depends on your business structure, which will fall under one of five principal categories:
Sole Proprietorship
As a sole proprietor, you’ll need to report your business income and expenses on a Schedule C form, and attach it to your personal income tax return (Form 1040) by April 15. Since there is no legal distinction between the business entity and its owner, this method informs the IRS about your business’s profit or loss.
Partnership
Partnerships are required to file with Form 1065, which provides an overview of the company’s profits and losses, before March 15. The individual members will file a Schedule K-1, issued by the partnership, before April 15, where they will report and pay taxes on their share of income.
C Corporation
C corporations that operate on a calendar year ending on December 31 will submit Form 1120 by April 15 of the following year. If your fiscal year ends on a different date, the tax return is due on the 15th day of the fourth month after the end of your tax year.
S Corporation
S corporations must file their annual tax return by March 15 using Form 1120-S to report their income, deductions and credits. Each shareholder will need to complete a Schedule K-1 on their personal taxes before April 15, reporting their share of profit or loss.
Limited Liability Corporation (LLC)
Since LLCs have a degree of flexibility in how they elect to be taxed, they can file as a sole proprietor, partnership or corporation.
If you are a single-member LLC, you will be taxed the same way as a sole proprietorship.
Most multi-member LLCs are typically treated as partnerships, unless they elect to be taxed as S or C corporations, so whichever small business structure applies to you, those are the tax rules to follow.
Self-Employment Tax
Self-Employment tax is a Social Security and Medicare tax that applies to sole proprietors, multi-member LLC members, and partners in partnerships. Since these business structures have pass-through status, individuals report their earnings as part of their personal income. S corporation shareholders do not pay self-employment taxes on their share of the corporation’s profits, but pay self-employment tax on the salary they receive as employees of the S corp.
Estimated Taxes
Self-employed individuals pay self-employment and federal income taxes through quarterly estimated tax payments, since they do not have an employer withholding these taxes. If you are a sole proprietor, partnership or S corporation expecting to owe $1000 or more in taxes in a calendar year, or if you’re a C corporation expecting to owe $500 or more, you will be required to pay estimated taxes. Small businesses can file with Form 1040-ES, and quarterly payments are due April 15, June 15, September 15, and January 15 of the following year.
Other Taxes
No matter the structure of your small business, if you have employees, you are responsible for withholding employment taxes from their wages, including Social Security, Medicare, Federal Unemployment, etc. Employment taxes for small businesses are typically due monthly or quarterly, depending on the amount of payroll and your specific tax requirements.
Depending on where your business is based, you may also need to pay additional local taxes; some cities levy income taxes on any business operating within their borders. It’s essential to understand your federal, state and local tax obligations, as your business structure, size, location and income all determine your tax burden.
Set Aside Money
It’s important to always have enough money in the bank to make those estimated payments, so saving about 25-30% of your net income in a separate bank account is recommended to ensure your balance is sufficient. Depending on whether your stream of income is consistent or variable, you can set up regular, automatic transfers to the separate account allocated for taxes, or make transfers manually upon receiving client payments.
Since estimated taxes are projected based on anticipated income for the entire year, your quarterly payments will be reconciled with the actual tax owed in your annual tax return. If you paid too much in estimated taxes, you may receive a refund; if you paid too little, you may face a larger tax bill at the end of the year. Either scenario is common among self-employed individuals who experience fluctuating income.
Complete Your Tax Forms
When filling out the forms applicable to your business, have all of your supporting documents to hand and ensure that you are providing accurate information at each stage. Bear in mind that some forms are more extensive than others; Form 1065, 1120 and 1120S will require more time to complete, while Schedule C is only 2 pages.
File Your Taxes
The IRS offers various filing options for individuals to choose from. While some taxpayers still file paper returns by mail, e-filing is more widely preferred, as it is easier, more efficient and more secure than mailing.
Many small businesses choose to enlist the help of a tax preparer or accountant to file returns on their behalf, as they are trained in accuracy, thoroughness and tax law compliance. Ongoing collaboration with a licensed professional can help ensure that you pay the proper amount in taxes and claim legitimate write-offs, minimizing your tax liability and maximizing your peace of mind.