Tax Basics Guide for Small Business

As a small business owner, you’ll face many challenges. One is understanding your tax responsibilities. Unlike personal tax returns, which are usually completed with a few forms once a year, preparing and filing your business taxes is much more involved.

If this is your first time filing small business taxes, you probably have a number of questions about deadlines and forms.

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In this guide, we’ll explain small business taxes—including the types of taxes you may be responsible for, how to identify your tax responsibilities based on your business structure, and finally, when and how to pay and file your business tax return.

What you need to know: The information provided through SmartBiz® are for educational purposes only. Use of this information is not a replacement for personal, professional advice or assistance regarding your finances, taxes, or credit history.

2020 PPP Tax Responsibilities

Small business owners who borrowed funds through the Paycheck Protection Program (PPP) this year may be facing substantial unexpected tax bills as a result. While PPP loan proceeds are not taxable, business expenses paid with the loan proceeds can't be deducted from gross income. Check with your lender or a tax professional for additional information.

What is Your Business Structure?

Your business structure determines the taxes you pay. Your legal structure can even impact your ability to secure a business loan or attract investors. Choose your structure wisely, the right one can even lower your personal risk if you get into legal hot water.

Here are the 6 most common business entities and taxes you might be responsible for. Every business is unique so consult with a tax professional before you file to avoid fines or other penalties.

Sole proprietorship

The main difference between reporting income from your sole proprietorship and reporting income from a job is that you list business income and losses on Schedule C. Submit this form to the IRS along with Form 1040.

General partnership

General partnerships do not pay income tax. However, the owners or partners of a general partnership do. Partnerships are pass-through tax entities meaning profits and losses of a partnership trickle down to the business' owners. Those profits and losses must be declared on their share of the business' income on their personal tax returns. This avoids tax issues like double taxation of income. The business needs to file Form 1065. General partnerships do not have to pay an annual tax like limited partnerships.

Limited partnership

Limited partnerships have a tax advantage over general partnerships. Partners in a limited partnership have limited personal liability for debts of fellow partners, as long as they are not directly involved in management. In certain states, like California, limited partnerships are responsible for an annual tax of $800.

Limited liability company (LLC)

The Rocket Lawyer blog describes an LLC as “a type of legal business entity that was developed to provide business owners with a lower level of liability. According to the IRS, LLC owners face significantly lower caps on company actions and debts”. Legally, your business can be an LLC but have the option to be taxed as an S-corporation or C-corporation. You have pass-through taxation, like a partnership, so you won’t be double taxed like you would if you own a corporation. You must make quarterly tax payments on your personal income tax forms and submit Form 1065 each year for informational purposes.

C-corporation

If you operate as a C corporation, you have some advantages that the other business types don’t. A corporation operates as a separate entity. That means all debts, obligations, and liabilities are its own. Shareholders' losses are limited to the amount invested in the business. C-corporations are subject to a flat income tax rate and shareholders are taxed on their personal tax returns when profits are awarded as dividends. Form 1120 is the primary tax form for this type of entity.

S-corporation

Turbo Tax reports that “S corporations must always file its annual tax return by the 15th day of the third month following the end of the tax year, generally March 15. The business is responsible for reporting all financial activity on Form 1120S and attaching a Schedule K-1 for each shareholder”.

Due Dates for Quarterly Estimated Tax Filings

Small business owners are required to pay quarterly estimated taxes if the business owes income taxes of $1,000 or more. Corporations only have to pay quarterly estimated taxes if they expect to owe $500 or more in tax for the year. Deadlines for quarterly estimated taxes are:
1st Payment: January 1 – March 31 April 15, 2020*

*Filing and Payment Deadline Extended to July 15, 2020 due to the coronavirus pandemic

2nd Payment April 1 to May 31 July 15, 2020
3rd Payment June 1 to August 31 September 15, 2020
4th Payment September 1 to December 31 January 15, 2021

If you don't pay your tax bill by the above deadlines, the IRS will add on additional interest and penalties.

Tax Withholding Requirement if You Have Employees

If you operate with employees, there are several forms to file.

  • Federal income tax withholding (Form W-4): When a new employee starts, they need to fill out Form W-4 (Employee’s Withholding Certificate), which allows them to decide how much federal income tax to withhold from their pay. You’re responsible for submitting that form to the IRS. For more details on Form W-4, the IRS breaks down key information you need to know.
  • Federal wage and tax statement (Form W-2): For every employee you hire, you’re responsible for completing Form W-2, which breaks down their earnings and withheld taxes for the year. Then, you should send one copy to each employee by January 31st that covers the previous year and another to the Social Security Administration by the end of February. Head to the IRS website to learn more about Form W-2.
  • State taxes: Tax withholding isn’t just limited to the federal government

Many states require their own forms as well. Find yours on the Bureau of Labor Statistics website.

If you have questions about the federal tax filing process, like what forms to submit if you’re hiring an independent contractor or how to provide expense reimbursements, the IRS has a complete guide with everything you need to know.

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Small Business Tax Credits

According to Investopedia, “Business tax credits are used to lessen the tax obligation that a business may incur. Ideally, a business will try and use all credits that they are qualified to use to reduce the amount of money they owe the federal government come tax time.” Here’s a partial list of credits available for business owners:

Business Tax Credits for Energy Efficiency

Making your business equipment more energy efficient can help you earn this tax credit. You might also be eligible for tax deductions for environmentally friendly upgrades made to your business facilities.

Research and Development Tax Credit for Business Research Activities

Depending on your products or services, you can claim this credit for traditional scientific research, product development, improving product quality, reliability, or function, improving business performance, and making payments to outside researchers or employees who do research.

Access for Disabled Persons Tax Credit

If you upgrade your location to accommodate employees and customers with disabilities, you may be eligible for disabled access tax credits. You’ll increase access and decrease your taxes.

Alternative/Hybrid Vehicle Tax Credit

You can take advantage of this credit if you buy a new (not used) hybrid, electric, or diesel fuel vehicle. This tax credit applies to new cars and trucks that are certified for the credit by the IRS. Your vehicle must meet certain fuel efficiency and mileage guidelines.

Small Business Health Care Tax Credit

The Patient Protection and Affordable Care Act (Obamacare) includes a tax credit to encourage small employers to offer health insurance for the first time or maintain coverage they already have. Visit the IRS website for more information: Understanding the Small Business Health Care Tax Credit.

Work Opportunity Tax Credit

This credit allows employers to get a business tax credit for hiring new employees in categories that include veterans, food stamp recipients, ex-felons, and more. You must document the category, then complete IRS and Department of Labor forms. You then add the credit to your business tax return. Read more on the DOL’s website.

Top Tax Deductions for Small Businesses

Deductible business expenses help entrepreneurs lower the costs of running a business. Here are some of the most common tax deductions available for business owners.

Vehicle Expenses

Gas, repairs, parking, and mileage add up. You can take advantage of the standard mileage rate or deduct your actual expenses. Make sure to keep detailed records and avoid mixing personal expenses with business ones.

Home Office

The home office tax deduction can be complex, visit the SmartBiz Blog for detailed information: How to Take the Home Office Tax Deduction.

Professional Services

If you hire outside professionals (like a social media specialist or an attorney), the fees and overall expense you pay for their services are deductible.

Salaries and Wages

Sole proprietors or those running an LLC may not be able to deduct income you take from your business. However, salaries and wages that you pay to part-time and full-time employees, payments like bonuses, meals, lodging, per diem, and some employer-paid taxes are eligible.

Office Supplies, Expenses, Furniture, and Equipment

You can deduct the above, as long as they are used within the year they’re purchased. You might also be able to deduct the cost of postage, shipping, and delivery services. Keep those receipts! There are various guidelines for depreciation so look this one up or discuss with your tax professional before claiming.

Client and Employee Entertainment

Make sure the entertainment occurs in a business setting and for business purposes.

Employee Benefits

The benefits that businesses like yours offer to employees do more than attract high-quality talent to your team. They also have tax benefits. Keep track of all contributions you make to your employees’ health plans, life insurance, pensions, profit-sharing, education reimbursement programs, and more. They’re all tax-deductible.

Computer Software

Computer software costs or subscriptions, used for business only, are deductible. You are also able write off the cost of your internet provider fees.

Business Location Rent

Rent is any amount you pay for the use of property you do not own. It’s deductible.

Utilities

Keep track of your electricity, phone, and other utilities. If you’re claiming the home office deduction, your landline must be dedicated to your business.

Travel Expenses

If you travel to trade shows or for other professional business, you can take a small business deduction for all your expenses.

Machinery and Equipment Rental

You can deduct rental expenses in the year they occur with no depreciation.

This isn’t a complete list of deductions you might be able to write off. Visit the IRS website for more information: Deducting Business Expenses.

Small Business Tax Tips

1. Deduct Startup Expenses

If you keep your receipts in order, you can deduct as much as $5,000 spent on startup costs, infrastructure, and research and development. The cost of office furniture, computers, office equipment, and everything else use needed to get your business off the ground are tax deductible if they are properly documented. Even a portion of the money entrepreneurs and small businesses spend to acquire the property from which they run their business can also be listed as a deduction when they are doing their tax returns at the end of the year.

2. Property Depreciation Is Tax Deductible

Many businesspeople see the depreciation of their vehicles, office equipment and everything else they use to run their business as a bad thing.

However, for entrepreneurs and small businesses the depreciation of their business property can actually be a valuable tax deduction. Depreciations can be listed on tax returns when filed with the federal, state, or local government. Small businesses and entrepreneurs have two options for how they can use the depreciation of their property as a tax deduction. They can claim all of the depreciation in one large chunk or take smaller deductions over a number of years.

3. Properly Handle Payroll Withholding

Small businesses and entrepreneurs have two options when it comes to hiring and payroll tax withholding. They can list the people they employ as independent contractor responsible for paying their own taxes or classify them as employees and withhold the required taxes from each paycheck.

The key is to clarify which method the Internal Revenue Service requires you to use for specific types of employees. Sometimes, businesses are required to make periodic payments and filings in order to be in compliance with the applicable tax regulations. It's essential to make sure no filings are late or missing. This can lead to an IRS fine.

Hiring a professional accountant to make sure the small business or entrepreneur provides all required data and meets all filing deadlines is a wise investment. Plus, a percentage of that cost is tax deductible. This can save time and money in the long term and prevent the business owner from dealing with the stress of properly handling tax withholding for their employees and independent contractors. Failure to do so properly may make it appear that a business is trying to avoid paying the appropriate amount of taxes. This can result in a fine being levied from the IRS.

4. Don’t Mix Personal and Business Finances

A common mistake many entrepreneurs make is using their personal accounts as business accounts. This type of misappropriation of funds can lead to tax problems. Keeping business and personal finances separated enables entrepreneurs and small businesses to better track their spending and be able to identify and document all their expenses and revenue.

Failure to do so can lead to confusion and inaccuracies at tax time. This can lead to unnecessary tax audits and penalties if the IRS decides the small business or entrepreneur is guilty of misappropriating funds.

To avoid this, open a business account and use it for all business transactions.

Tax Software

Intuit TurboTax

“Ease of Use” is generally named as the best feature for this software. For the price, TurboTax offers the most features and users can tailor TurboTax to their specific needs.

There’s a self-employed edition, a business edition and even extra guidance for new businesses, showing startup tax deductions. TurboTax runs an accuracy check on every return to make sure everything is filled out and will alert you if anything seems amiss before filing. The company guarantees 100 percent accuracy.

Check the prices of various packages and purchase TurboTax Business here.

H&R Block

If you’re e-filing self-employed or small business taxes, H&R Block is a good alternative to TurboTax because of its lower price. A unique feature of this software is the ability to create payroll tax returns. You also have the ability to store your tax documents and returns for 6 years.

Technical support by chat is offered. The price for the small business and self-employed tax edition is lower than TurboTax. Like TurboTax, you don’t pay until you file.

Purchase H&R Block here.

TaxAct

The TaxAct website touts their software as "the best deal in tax". Price is a big upside for small business owners on a budget. However, TurboTax and H&R Block allow you to file multiple returns for one price. TaxAct charges you for each additional return.

Because of the lower price, some features are not as good as others. The customer support is limited as are the importing capabilities. Users have reported that the navigation can hinder your ability to work through a return.

Purchase TaxAct here.

TaxSlayer

Right upfront you should know that TaxSlayer only supports Schedule C filers. If you’re an S Corp, C Corp or multi-member LLC, you’ll need to explore other options. The software does cost less than H&R and TurboTax so if you’re filing Schedule C and looking to save money, TaxSlayer might be a good fit.

The big advantage of TaxSlayer is the support from tax professionals available via chat, phone or email. There’s also a comprehensive database of frequently asked questions that’s easy to navigate.

Register for TaxSlayer here.

eSmart Tax

eSmart Tax is Liberty Tax's online tax filing service that uses a straight-forward, easy-to-use interview style. The interview style means that you’re asked a series of yes-or-no questions used to evaluate your tax situation and determine what you need to complete your return. eSmart Tax allows you to prepare and e-file multiple tax returns.

An often mentioned disadvantage of eSmart Tax is that support is not as robust as other tax filing software. They do have a live chat feature and email support but it can take up to three days to get an email response and the live chat isn’t available 24 hours.

Overall, eSmart Tax is best for those comfortable with the filing process who are looking for an affordable option.
Purchase eSmart Tax here.

Should Business Owners hire a Tax Professional or DIY?

DIY isn’t a great strategy when it comes to tax preparation. Unless you have a background in tax preparation or accounting, financial tasks-especially taxes-can be daunting. You might be losing out on deductions or facing penalties and fines without a professional in place. Our blog post has valuable information to review before you hire a financial professional: How to Hire an Accountant for Your Small Business.

Additional Resources

The SmartBiz Small Business Blog provides a wealth of information for business owners across America. Here are some additional resources to explore about small business taxes.

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