Each year, roughly 400,000 new business owners take the leap to fulfill unmet needs they recognize in the market, become their boss, or build an empire.
If you are one of the thousands embarking on the journey of owning a small business, then congratulations! Launching your own small business is exciting, but it also comes with some serious responsibilities: filing a small business tax return. Fortunately, you don’t have to become a tax law expert or live in fear of IRS auditors knocking at your door. We’ve prepared the following guide about how to file small business taxes. This guide can help greenhorn small business owners who want to take advantage of tax-saving strategies..
Step 1: Know Which Forms You Need
Small businesses are not created equal. There’s not even a standard tax form for all small business owners. The form you use depends on how your business is structured.
Here’s a quick rundown of the tax forms required for different types of businesses.
The default structure for a solopreneur is a sole proprietorship. In most cases, a solo business owner doesn’t even have to file paperwork with their state to start a sole proprietorship – it’s the default structure for an unincorporated business with only one owner.
Technically, a sole proprietorship is not a separate legal entity from the business owner, and the way the business files and pays taxes reflects this. As a sole proprietor, you’ll report your business income and expenses on Schedule C, Profit or Loss From Business, which gets filed along with your Form 1040. Your business’s net income is taxed at the same rate as your other ordinary income. Individuals' tax rates range from 10% to 37%, depending on your total taxable income.
Partnerships are the default structure for a business owned by two or more people sharing profits and losses.
To report business income and expenses, partnerships must file their tax returns, Form 1065, U.S. Return of Partnership Income. Each partner then receives a Schedule K saying their share of business profits or losses, which they use to complete their tax return and pay tax on their share of profits.
A corporation is a legal entity separate from the company’s owners. For tax purposes, there are two different kinds of corporations:
- C Corporations file Form 1120, U.S. Corporation Income Tax Return, and pay tax on any business profits. If the company’s shareholders receive dividends, those are taxed again at the shareholder level. This means corporate profits are double-taxed, first at the business level and then again on each owner’s income tax return. The corporate tax rate is a flat 21%.
- S Corporations file Form 1120-S, U.S. Income Tax Return for an S Corporation. Rather than paying tax at the corporate level, S Corporation shareholders receive Schedule K-1 reporting their share of business profits and losses. They use this form to complete their individual tax return and pay tax on their share of profits.
Limited Liability Company (LLC)
Businesses structured as LLCs have several options for how they’re taxed. The IRS may treat an LLC as a sole proprietorship if only one owner or a partnership if two or more people own the LLC. An LLC may also elect to be taxed as an S Corporation or a C Corporation.
Step 2: Maximize Your Deductions
When you’re getting your business started, keep track of all of your income and expenses from day one. It’s easy to put bookkeeping on the back burner when you’re focused on the dozens of other things you need to do to launch your business and turn a profit. Monitoring your accounting and saving receipts ensures you can take advantage of all available deductions.
So how do you know what’s deductible? The IRS considers a business expense deductible if it is “ordinary and necessary.” An ordinary expense is common and accepted in your business. A necessary expense is helpful and appropriate for your business.
While what’s ordinary and necessary depends on your industry and your unique business needs, some ordinary deductible business expenses include:
- Advertising and marketing
- Bank fees
- Business meals (limited to 50%)
- Business insurance
- Business use of your car
- Dues and subscriptions
- Employee benefits
- Home office expenses
- Interest expense
- Legal and professional fees
- Rent expense
- Repairs and maintenance
- Salaries and wages
- Taxes and licenses
- Telephone and internet expenses
Even if you’re not sure whether an expense is deductible or not, it’s a good idea to save the receipt. Your professional tax preparer can help you figure out what you can and can’t deduct.
Step 3: Don’t Forget Self-Employment Taxes
When you work for someone else, your employer withholds Social Security and Medicare taxes (also known as FICA tax) from your paycheck. When you’re self-employed, you have to pay these taxes on your own. That’s where self-employment tax comes in.
Self-employment tax covers Social Security and Medicare taxes for self-employed people, including freelancers, independent contractors, and small business owners. You’re required to pay self-employment taxes if you have self-employment earnings of $400 or more.
The self-employment tax rate is 15.3%, of which 12.4% applies to Social Security, and 2.9% applies to Medicare. However, the Social Security portion has an upper limit, based on the Social Security wage base.
The Social Security wage base is $142,800 in 2021, meaning the 12.4% Social Security portion of self-employment tax applies only to the first $142,800 of your income (including self-employment earnings and wages if you have a full- or part-time job).
So, let’s say you have a net self-employment income of $100,000 in 2021. Since your income isn’t over the Social Security wage base, we don’t need to worry about capping the calculation. To estimate your self-employment tax:
- Figure your net earnings subject to self-employment tax. Multiply $100,000 by 92.35%. Reducing your earnings by 7.65% takes into account the employer-half of your FICA taxes, which the business would deduct if you were paid as an employee. $100,000 x 92.35% is $92,350.
- Calculate your self-employment taxes. Multiply your self-employment taxable income by 15.3%. $92,350 x 15.3% is $14,130. That’s your estimated self-employment tax liability.
You’ll include this calculation on Schedule SE, which gets filed with your Form 1040.
Step 4: Make Estimated Tax Payments
If you expect to owe $1,000 or more in combined income and self-employment taxes, the IRS requires you to make estimated quarterly payments.
These payments are due April 15, June 15, September 15, and January 15. If those dates fall on a weekend or holiday, the deadline shifts to the next business day.
You can estimate the amount you need to pay using the worksheet on page 8 of Form 1040-ES or get help calculating your estimated payments from a Taxfyle tax pro.
Once you know the amount you need to pay, you have a few options for making your payments:
- Pay via check. Form 1040-ES includes vouchers with a check or money order if you prefer to send your payment via snail mail. The form also consists of the address to mail your payment. Make your check payable to U.S. Treasury, and you might consider sending it Certified Return Receipt, so you have proof you sent your payment on time. The IRS recommends including the following information on your check to ensure your payment gets applied to the proper account:
- Your Social Security number or employer identification number (EIN)
- The tax year to apply the payment to
- The tax form number, such as Form 1040-ES for an estimated tax payment
- Pay online via electronic funds transfer. The IRS allows taxpayers to make payments directly from a checking or savings account using its free Direct Pay service.
- Pay via credit or debit card. The IRS doesn’t accept credit cards or debit cards directly, but they work with third-party payment processors who accept most credit cards and debit cards. Keep in mind. These payment processors charge a fee, depending on the service provider and your payment method.
- Pay with cash. You should never mail cash to the IRS, but you can still pay your taxes with money if that’s your preferred payment method. Certain retailers can accept cash payments of up to $1,000 on behalf of the U.S. Treasury. However, the IRS recommends making your payment at one of their retail partners at least seven days before the due date, so this isn’t a good option for last-minute payments.
Filing Small Business Taxes for Dummies: Don’t Go It Alone!
Dealing with taxes is complicated enough when you work for someone else, but it gets a lot more complex as a small business owner. But you don’t have to handle it all on your own.
Taxfyle can connect you with a licensed CPA who understands small business taxes and can help you make sense of the rules and take advantage of valuable deductions that can maximize your tax refund.