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Whether big or small, businesses typically hire professional advisors to handle their taxes and conform with all the requirements of the tax code. Nevertheless, as a prospective business owner, knowing what your responsibilities are tax wise and understanding the choices before you, will help you in your endeavors to achieve success with your business.
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The first thing to consider from the taxation point of view is the choices you have on the type of structure for your business.
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The type of business you choose will determine which tax forms you need to file and what type of business taxes you may have to pay. From the IRS perspective, your business may be organized as a sole proprietorship, partnership or corporation.
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- A sole proprietorship is an unincorporated business owned by an individual. A sole proprietorship has no existence apart from its owner. Business debts are personal debts of the owner. A limited liability company (LLC) owned by one individual is treated as a sole proprietorship for federal income tax purposes, unless the owner elects to treat the LLC as a corporation.
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A sole proprietor files Schedule C, Profit or Loss from Business (Sole Proprietorship), or Schedule C-EZ, Net Profit From Business, to report the income and expenses of the business and reports the net business earnings on Form 1040, U.S. Individual Income Tax Return.
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A partnership is an unincorporated business organization that is the result of two or more persons joining to carry on a trade or business, a financial operation or venture. Each person contributes money, property or services in return for a right to share in the profits and losses of the partnership. An LLC with more than one owner is treated as a partnership for tax purposes, unless the LLC elects to be treated as a corporation.
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The partnership does not itself pay income tax. A partnership reports its income and expenses on Form 1065, U.S. Return of Partnership Income. No tax is calculated or paid from Form 1065, any tax due is paid by the partners or LLC members. Each partner receives a Form 1065, Schedule K-1, Partner's Share of Income, Deductions, Credits, etc., that indicates the partner's distributive share of partnership income, expenses and other items, determined in accordance with the terms of the partnership agreement. Partners report on their income tax returns the amounts reported on the Schedule K-1.
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| The term corporation, for federal income tax purposes, generally includes a legal entity separate from the persons who formed it under federal or state law or the shareholders who own it. It also includes certain businesses that elect to be taxed as a corporation by filing Form 8832, Entity Classification Election. Corporations report their income and expenses, and calculate their tax on Form 1120, U.S. Corporation Income Tax Return. |
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A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, and you should check with your state if you are interested in starting a Limited Liability Company.
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At federal level, there are four general types of business taxes: income tax, self-employment tax, employment tax and excise tax. In most cases, the types of tax your business pays depends on the type of business structure you set up. You may also need to make estimated tax payments.
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Your accounting method is also an important factor as far as taxes are concerned as it will determine when to report income and expenses. You must use a consistent method. The two that are most common are the cash and accrual methods. Under the cash method, you normally report income and deduct expenses in the year that you receive or pay them. Under the accrual method, you generally report income and deduct expenses in the year that you earn or incur them. This is true even if you get the income or pay the expense in a later year.
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Income Tax.
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| All businesses, except partnerships, must file an annual income tax return. Partnerships file an information return. The form you use depends on how your business is organized. |
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| Calculating your income tax requires computing your business income, which means taking your gross business receipts or sales and subtracting your cost of goods sold to arrive at your gross profit, then deducting your other business expenses. |
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| Generally, any income you receive connected with your business is business income and should be reported on your business tax return. Income is connected with your business if the payment would not have been made if you did not have the business. |
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| Business income may include income received from the sale of products or services; for example fees received by a person from the regular practice of a profession are business income. Rents received by a person in the real estate business are business income. A business must include income payments received in the form of property or services at the fair market value of the property or services. |
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The federal income tax is a pay-as-you-go tax, so you must pay the tax as you earn or receive income during the year. An employee usually has income tax withheld from his or her pay. If you do not pay your tax through withholding, or do not pay enough tax that way, you might have to pay estimated tax. If you are not required to make estimated tax payments, you may pay any tax due when you file your return.
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Self-Employment Tax
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Self-employment (SE) tax is a social security and Medicare tax primarily for individuals who work for themselves. Social security coverage provides you with retirement benefits, disability benefits, survivor benefits, and Medicare benefits.
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| Generally, you must pay SE tax and file Schedule SE (Form 1040) if either of the following applies: |
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- If your net earnings from self-employment were $400 or more;
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- If you work for a church or a qualified church-controlled organization (other than as a minister or member of a religious order) that elected an exemption from social security and Medicare taxes, you are subject to SE tax if you receive $108.28 or more in wages from the church or organization.
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| Employment Taxes |
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When you have employees, you have certain employment tax responsibilities that you must pay and forms you must file. Employment taxes include the following:
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- Social security and Medicare taxes;
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- Federal income tax withholding;
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- Federal unemployment (FUTA) tax.
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| Generally, employers must report wages, tips and other compensation paid to an employee by filing Form W-2, Wage and Tax Statement at the end of the year. You must also report taxes you deposit by filing Forms 940, 941 and 944. |
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| You can choose to use independent contractors instead of employees in your business, in this case you may have to file Form 1099-MISC, Miscellaneous Income, to report payments for services performed for your trade or business. If the following four conditions are met, you must generally report a payment as non-employee compensation. |
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- You made the payment to someone who is not your employee;
- You made the payment for services in the course of your trade or business (including government agencies and nonprofit organizations);
- You made the payment to an individual, partnership, estate, or in some cases, a corporation; and
- You made payments to the payee of at least $600 during the year.
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| Excise Tax |
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| Excise taxes are taxes paid when purchases are made on a specific good, such as gasoline. Excise taxes are often included in the price of the product. There are also excise taxes on activities, such as on wagering or on highway usage by trucks. One of the major components of the excise program is motor fuel. |
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| You may have to pay excise taxes and file certain forms (such as Forms 720, 2290, 730) if you manufacture or sell certain products; operate certain kinds of businesses; use various kinds of equipment, facilities, or products; or receive payment for certain services. |
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| Employee Health Care |
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| The Affordable Care Act contains benefits and responsibilities for employers according to the size and structure of the workforce. An employer’s workforce size is determined by the number of its full-time employees, including full-time equivalents. |
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| If you have fewer than 25 full-time employees, including full-time equivalent employees, you may be eligible for a Small Business Health Care Tax Credit to help cover the cost of providing coverage. |
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| Generally, employers with 50 or fewer employees may be eligible to buy coverage through the Small Business Health Options Program or (SHOP Marketplace). You can use the SHOP Marketplace to get lower costs on group plans and claim tax credits. |
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| If you have 50 or more full-time employees, including full-time equivalent employees, you are an applicable full-time employer and need to issue statements to employees and file an annual information return reporting whether and what health insurance you offered employees. |
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| If you’re a freelancer, consultant, independent contractor, or other self- employed worker who doesn’t have any employees, you have to enroll through the individual Health Insurance Marketplace. |
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| Each item mentioned above can easily become the subject for a separate newsletter, our aim for now was to summarize different tax aspects you may have to deal with when you have your own business. |
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