Taxes. They’re as inevitable as, well…let’s just say you have to pay them. As we learned in the first article of this Tax Series, How to Get Ready for Tax Time, it’s really important to keep track all of your spending. As a small business owner, you’re not only responsible for your individual income tax based on how much money you make, but your business may also have to file a return and pay taxes, depending on the legal structure of the company.
There are federal taxes, state taxes, and in some cases, taxes for the city or municipality where you’re based. The kind of business you’re in will also affect the type of taxes you’re responsible for, as will whether or not you have employees. A certified professional accountant is your best source of information for your particular situation, but here’s an overview to get you started.
Whether they’re profitable or not, all businesses must file a yearly income tax return. Depending on how your business was set up, it will either be a part of your individual return or a separate one just for the company. The legal structure will also determine which form(s) you use for filing.
Even though a return has to be filed just once a year, income tax is paid as the income is earned throughout the year. Employees will usually have taxes deducted from their pay, and businesses will generally pay quarterly. Some businesses are required to make estimated tax payments so they’re never far behind in what they owe. Anything additional can be paid when you file your return.
A sole proprietorship is an unincorporated business owned by one person. For tax purposes, the business and the individual are the same, and the business is taxed through the personal tax return of the owner. The owner also pays a self-employment tax, which covers Social Security and Medicare, on any profit made. We’ll describe this in more detail below.
A partnership is a business owned by two or more people who have signed a partnership agreement and have invested in the business. The partnership itself doesn’t pay income tax as a company, the partners do so on their individual tax returns. The partnership does, however, have to file an information return that shows the total amount of income, expenses and other deductions, the net income of the partnership, and the share of the income attributed to each partner.
Limited Liability Corporation
An LLC can be set up in a number of different ways, and depending on how, will be treated by the Internal Revenue Service (IRS) as either a corporation, partnership, or as part of the LLC owner’s tax return. LLC owners are known as “members” and generally, an LLC with one member will be similar to a sole proprietorship. One with two or more members will be treated like a partnership. An LLC can also file a form with the government and elect to be treated as a corporation.
A corporation is made up of shareholders who own stock in the company, and is a separate taxpaying entity apart from its owners. Corporations pay taxes on income when it is earned. When profits are distributed to shareholders, they must pay taxes on those, as well, resulting in a form of double taxation. Corporate income taxes are paid at the corporate income tax rate, which is generally lower than the personal tax rate, although the shareholders will pay on their rate at the individual rate. Note that corporate tax returns are due on March 15, not April 18, which is the deadline for individual returns.
An S corporation is created through a special filing when it’s formed, allowing the profits of S corps “pass through” to its owners. This allows S corporations to avoid double taxation on the corporate income, as happens with C corporations described above. S corp income is taxable at the owners’ personal tax rates, although the deadline for S corp tax returns is also March 15.
Everyone who is employed in the U.S. has to pay taxes for Social Security and Medicare. If you work for an employer, they will kick in half of what’s due and deduct the other half directly from your paycheck. If you work for yourself, however (this is the case if you have a sole proprietorship or partnership), you must pay 100% and make these FICA (Federal Insurance Contributions Act) payments on your own so that you will still be provided with retirement, disability, survivor and Medicare benefits.
As we noted earlier, income taxes in the U.S. are pay-as-you-go, so if you don’t have taxes automatically withheld from your income by your employer, you are likely responsible for paying estimated tax on your income, interest, dividends, alimony, rent, profits from the sale of assets, and prizes or awards.
Even if you don’t know how much you’ll wind up making at the end of the year, you’re still responsible for paying taxes based on a good faith estimate. (You can be charged a penalty if you underestimate, so be careful!) These taxes are generally due quarterly, and include the self-employment tax described above.
Who has to pay? Usually, anyone who is self-employed, all sole proprietors, partners, and S corporation shareholders who expect to owe $1,000 or more in taxes when they file their annual return. If you are filing as a corporation, the threshold is even lower: $500. And no matter what you estimate for this year, you probably have to pay estimated tax if you owed money for taxes in the prior year.
Employment and Payroll Taxes
If you have employees, you have another set of forms to file and taxes to pay. Employment taxes include the FICA payments for Social Security and Medicare mentioned above, income tax you withhold from your workers’ paychecks, and federal unemployment tax (FUTA). Some businesses will have to deposit these funds with the government monthly, others will do it semi-weekly.
For Social Security and Medicare taxes, remember that you will withhold half of the amount from your employees’ wages and pay the other half yourself. As with all tax calculations, your accountant can help you figure the correct amount, and the IRS has worksheets on its very comprehensive website.
FUTA is reported and paid separately from income, Social Security and Medicare taxes, and is paid by you directly out of your funds. It is not paid by your employees or deducted from their paychecks.
At the end of the year, you’ll also need to prepare and file various forms related to how much was paid to each employee in the form of wages, tips and other compensation. The most common of these is the W-2, although others may apply depending on the form of payment.
This is an umbrella term covering certain kinds of environmental taxes, communications and air transportation taxes, fuel taxes, taxes on the sale or use of a variety of different articles, and tax on some sales of heavy trucks, trailers, and tractors.
Not every business has to pay excise taxes, but for those that do, it is due once a quarter. IRS Form 720 lists the items on which excise tax has to be paid.
In addition to the taxes the federal government requires, your state and local governments will have their own demands. As with federal taxes, the legal structure of your business will dictate how and when they’re paid. Additionally, most states will require payments toward state unemployment and workers’ compensation insurance.
California, Hawaii, New Jersey, New York, Rhode Island and Puerto Rico also mandate contributions toward temporary disability insurance.
If you do business in more than one state, you may be required to pay taxes in each of them, including both income and sales tax. You can find links to your state tax office on the website of the Small Business Administration.
Sales tax is imposed on the state and local level, and different places have different rules about which businesses must collect it, how much is levied, and what it is charged for. Generally speaking, if you sell products and some services, you’ll need to collect sales tax and turn it over to your state’s Department of Revenue. Staying on top of your business transactions regularly, as was mentioned in part one of this Tax Series, will make filing your sales taxes much easier.
Sales tax is charged on top of the price of the item you are selling, and is collected on what you sell within your state or to state residents. If you’re an online retailer, you only have to pay sales tax on sales made in states where you have a physical presence, although the federal government is considering a law that would change that. You can stay up to date by checking your state laws at the legal information site Nolo.com.
Alaska, Delaware, Hawaii, Montana, New Hampshire and Oregon don’t currently have a sales tax.
Franchise tax is charged by some US states to corporations, LLCs, and some partnerships simply for the privilege of doing business in that state. Typically, it’s based on the company’s net worth, which is usually based on its assets or the number of shares issued. Franchise taxes vary greatly from state to state, although states with higher corporate income taxes usually have lower franchise taxes.
Keep in mind that you don’t necessarily have to have a physical presence in a state to fall under its franchise tax. If you ship there, that may be enough. Each state has its own rules, so if you operate in multiple states, you may want to hire a tax professional to help you sort it out.
Real Estate Taxes
This is another class of local tax your business will have to pay if you own property. It’s assessed in just the same way as the property taxes you pay on your home, based on the value of the land and any buildings you own. It may be assessed by whatever local entity has the jurisdiction where you’re located, whether it’s the village town, county or city.
Corporate Tax Summary
This is a list of the taxes for which your business may be responsible. Most decent tax software available today will be able to walk you through a lot of it, but there’s no substitute for professional, expert advice from someone who knows you and your exact situation.