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Franchisee Guide

How To File Taxes For Small Business Owners

09-15-2021 by Norm Tedford
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Filing taxes for your small business can be a headache-inducing activity. And, if you’ve never filed small business taxes before, it can be overwhelming to contemplate filling out all those complicated forms to account for all your business income. However, it’s something that must be done so you don’t end up racking up massive tax penalties. 

 

If you adhere to the steps in this guide, you'll have an easier time completing your business tax return. That way, it’s not so mentally exhausting. 

 

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How Is Your Business Structured? 

The legal form your business takes affects how you file and pay taxes. Here are the ways a small business can be organized: 

 

Sole Proprietorship

A sole proprietorship is a business that only has one owner. While sole proprietors are responsible for all the business debts, they’re also entitled to 100% of the profits. If you’re a freelancer or contract worker, you’ll typically file taxes as a sole proprietor. 

 

With sole proprietorships, individuals and their businesses are one and the same for tax purposes. Sole proprietors must pay self-employment and quarterly estimated taxes on their own since an employer isn't doing it for them.

 

Partnership

A partnership is an enterprise that has more than one owner. It’s legally required to file an annual information return to report the income, deductions, gains, and losses from its operations. However, it doesn’t pay income tax. Instead, it passes through profits and losses to its partners. Each partner reports their share of these on their individual tax returns. 

 

Partners aren’t employees and don’t get W-2s. The partnership must furnish copies of Schedule K-1 from Form 1065 (US Return of Partnership Income).

 

The partnership will file this form, and the individual partners will have to file the Schedule K-1 alongside their personal returns. This reports their earnings, losses, and dividends. 

 

Division of earnings is decided amongst the partners themselves and is usually based on each partner's contributions. If a partner chooses to reinvest their earnings back into the business, no gains will be reported on the K-1. If a partnership employs additional staff, it also needs to file IRS Form 941 to report federal income, Social Security, and Medicare tax withheld from their employees' pay.

 

Limited Liability Company (LLC)

Exactly like a corporation, an LLC is a separate legal entity from its owners. Owners choose this type of setup, so they're not personally liable for any business debts. 

 

An LLC with at least two members is classified as a partnership for federal tax purposes unless it files Form 8832 and chooses to be treated as a corporation. An LLC taxed as a corporation must use Form 1120 to file taxes. 

 

If an LLC has more than one owner, it's taxed like a partnership. Therefore, file using Form 1065 and Schedule K-1.

 

S Corporations 

If a small business owner wants to enjoy a corporate tax rate, they can structure their business as a corporation. Legally, a corporation is its own entity, separate from its owners. 

 

One way of doing this is organizing the business as an S corporation. With an S corporation, if the business is sued, the owner's assets aren’t on the line. Many entrepreneurs are reluctant to structure their business as an S corporation because it’s more time-intensive than organizing as a partnership or an LLC.

 

However, entrepreneurs could be missing out on some terrific tax benefits if they forgo this route. An S-Corp (like an LLC) is structured as a pass-through tax entity. This means income flows through to the owner’s personal tax returns. If you form an S-Corp, you’re basically telling the IRS that you’d like your business to be taxed as a partnership.

 

This helps you avoid the double taxation you'd experience if you formed as a C Corp. With this type of business structure, income is taxed once at the corporate level and again when it’s distributed as income to shareholders. 

 

To receive S corporation tax treatment, you’ll need to register your company as a C corporation or LLC. Then, file IRS Form 2553 to elect S corporation taxation. S Corporations will use Form 1120-S to file a corporate tax return. Not all C corporations and LLCs can take advantage of the S corporation tax rate. If you want to find out if you can, check your eligibility status

 

Just like partnerships, S Corporations are legally required to file quarterly employment taxes. They'll use Form 941 to pay the employer portion of their employees' Social Security and Medicare taxes and the income tax withholdings from each employee's paycheck. Use Form 940 to file your Federal Unemployment Tax (FUTA). 

 

Benefits of S Corporation Filing 

No Double Taxation

C corporations (otherwise known as traditional corporations) are taxed twice—once as a company and once as a shareholder. On the other hand, S corporations are only taxed at the shareholder level. 

 

Shareholder-Employee Status 

Some LLC owners choose S corporation status so they can be classified as employees of their businesses. If they're shareholders in the company and actively participate in management, they can be considered employees. This saves them money come tax time. 

Owners who don’t choose this status are considered to be self-employed and must pay the employee and employer components of the Federal Insurance Contributions Act (FICA), which totals 15.3% of gross wages. 

 

However, S corporation shareholders-employees don’t have to do this as long as they collect a salary. While the compensation is subject to FICA taxes, any dividends they receive aren’t. For example, if a shareholder-employee gets $75,000 in salary and $10,000 in cash dividends, the $75,000 has FICA taxes taken out of it while the $10,000 doesn’t. 

 

Limited Liability

Because an S corporation started its life as either a C corporation or LLC, an owner of one will enjoy limited liability. This means that, unless you personally guarantee a business debt, your personal liability won’t extend past your investment in the business. 

 

C Corporations 

Almost all corporations with more than 100 shareholders and virtually all publicly traded companies are C corporations. That doesn't mean that a small business can't structure itself as a C corporation. 

 

A C corporation isn't a pass-through entity like an LLC or a partnership is. This means that it’s completely separate from its owners when it comes time to pay taxes, which are paid at the corporate level. As we already saw, any dividends earned by a shareholder are also taxed at the personal level. 

 

However, there are ways around double taxation if you want to structure your business as a C corporation. Also, the 2018 Tax Reform Bill reduced the corporate rate from 35% to 21%. This is lower than the tax rate for pass-through income. Because of the overall decrease in most individual tax brackets, even pass-through income will get taxed at a lower rate. 

 

All this decreases the tax advantages of filing your business as a pass-through entity. 

 

Tax Day is marked on a calendar with a red pin.

 

How to File Taxes For Small Business Owners 

  1. Gather Business Records

Before you start to fill out tax forms, gather all your business records. If you used software that recorded all your business transactions throughout the year (like QuickBooks), this information should be right at your fingertips. 

 

Here are the records you’ll need to have: 

 

  • THE PREVIOUS YEAR'S BUSINESS TAX RETURN: If you've been in business long enough to have a return for the previous year, use it. Details you need to file this year's taxes will already be on it. Tax-filing software saves this tax information so you can file faster next year.

  • TAXPAYER IDENTIFICATION NUMBER (TIN): A TIN is a unique number the government uses to identify your business. If you're a sole proprietor, your TIN is your social security number. If you’re a registered business owner, it will be your employer identification number.

  • ACCOUNTING RECORDS: These include income statements (otherwise known as profit and loss statements), balance sheets, and payroll documentation. Your income statement shows your gross and net income for the year. It helps determine your taxable income after you've figured out your deductions. Balance sheets show equity, assets, and liabilities. Payroll documents show how much your business paid employees, contractors, and yourself.

  • BANK AND CREDIT CARD STATEMENTS: Every entrepreneur needs to have a separate bank account and credit card for their enterprise. At the end of each year, your bank will generate a year-end report that shows what you've spent throughout the year. Use this report to double-check your financial records so you can make sure you're filing the right amount.

 

  1. Fill Out the Right Form 

Figure out what form you need to fill out. For example, if you're a sole proprietor, you'll fill out Schedule C. Schedule C is the form sole proprietors and single-member LLCs use to report net income. This income is included in the owner's tax return along with other revenue. 

 

If you've organized as a corporation or treat your LLC as one, you need to use Form 1120 to prepare a separate corporate tax return. If you're an S Corp, you’ll use Form 1120S. 

 

  1. Calculate Your Deductions 

Deductions decrease the amount of taxes you pay. What you can deduct depends on your type of business. However, there are some deductions every business owner can claim. For more information, consult IRS Publication 535. Here is where you can learn what you can deduct and how to calculate your deductions.

 

Vehicle Expenses

If you operate a vehicle for your business, you’re allowed to deduct certain expenses related to this. This includes mileage, gas, repairs, insurance, and registration. If you didn't record the exact number of miles you traveled for your business, you’d need to calculate actual car expenses instead. 

 

You can't just estimate—you need an exact number backed up with receipts. If you need more information, check out IRS Publication 463

 

Some accounting software like QuickBooks Online Self-Employed tracks mileage for you. There are also mileage tracking apps that automatically compile reports you can use to file taxes. 

 

Office Deduction

If you rent office space, you can deduct your rent payments. If you have a home office, you can also claim a deduction. However, the portion of your residence you deduct must only be used for business purposes. 

 

Also, to deduct office expenses, your home office must either be your business’s primary location or where you meet with clients. If you work from home every couple of days and in an office the rest of the time, you can’t claim this.  

 

To calculate your home deduction, you can either use the simplified or regular method. If you use the simplified method, you’ll deduct $5 for every square foot of your office for a maximum of 300 feet. If you use the regular method, you'll determine which percentage of your house you use for office space. IRS Publication 587 can help you figure this out. 

 

Insurance 

If you have small business insurance, you can deduct 100% of the premiums. 

 

  1. Be Mindful of Deadlines 

Make sure you know what filing deadlines are so you don’t incur any penalties. If you’re filing as a sole proprietor, you’ll use Schedule C, which is part of Form 1040. Therefore, no separate filing deadlines apply. So, if April 15th is the deadline to file your personal income taxes, this will be the deadline for your business taxes too. 

 

If you’re filing an S-Corp or partnership return, March 16th is the deadline.

 

However, if you’re taxed as a C Corp, Form 1120 must be filed by the 15th day of the third month following the close of the tax year. For most taxpayers, this is usually March 15th. 

 

If you have employees on your payroll, you'll need to provide your workers with W-2 forms and provide the IRS copies by January 31st. 

 

  1. Make Quarterly Estimated Tax Payments 

If your small business makes $1,000 or more and you’re filing as a sole proprietorship, you must make quarterly estimated tax payments. These payments must be made using Form 1040-ES. Here are the deadlines: 

 

  • April 15th (payment period of January 1st through March 31st)

  • June 15th ( payment period of April 1st through May 31st)

  • September 15th (payment period of June 1st through August 31st)

  • January 15th of the following year (payment period of September 1st through December 31st)

Sales Tax 

Usually, sales tax filing deadlines are January of each year. However, you should check with the state where you do business for filing frequencies for monthly, quarterly, and annual sales tax. Some states even have different deadlines depending on whether you file online or through the mail. 

 

  1. Consider Using an Accountant  

Some small businesses might choose to use accounting software for their tax preparation. However, if you don’t fully understand what you’re doing, it might be better to enlist the services of an accountant. 

 

Make sure you bring the correct documentation with you when you go. You'll need: 

 

  • INCOME: This includes gross receipts from sales and services, sales records, business checking/savings account interest, and returns and allowances.

  • COST OF GOODS SOLD: This might not apply to your business. However, if it does, bring along all information about your business’s inventory, inventory purchases, materials, and supplies.

  • EXPENSES: This is what your business spends money on, including advertising, phones, internet, computers, business insurance, travel, rent, and office supplies. 

Jot down any questions you have for your accountant. For example, you might have questions about what constitutes a small business tax deduction. 

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