Small business taxes are much more complex than individual income tax returns because stipulations vary greatly depending on the type of services a business offers and the business’s ownership structure. As a small business owner, you are expected to keep detailed and concise financial records on a daily basis.
All federal income tax is a pay-as-you-go tax.
This means that whenever a taxpayer earns income, or business earns profit, both are supposed to pay the IRS taxes on this income/profit on a regular basis. Understanding this seemingly simple statute is difficult for many small business owners. It can be confusing because payments are due to the IRS quarterly, however, the actual amount of taxes owed by the small business owner is not calculated absolutely until the end of the tax year.
Every small business is classified into one of five forms of business that the IRS uses to determine how the business will pay taxes. Tax codes and regulations vary depending on which form your business takes but even the simplest small business structures will spend a lot of time and manpower calculating and adhering to tax codes.
The simplest form of small business ownership is a sole proprietorship, or independent contractor
This means that the business is unincorporated and owned by a single individual. The business has no existence apart from the owner who is personally responsible for the business’s liabilities. The income and expenses of the business are included in the owner’s personal tax return.
Although sole proprietorship is the simplest form of business to start and maintain, it is also the most common to miscalculate their tax liabilities either by overpaying or, more commonly, underpaying. Often times a small business owner will have enough knowledge of tax code to feel comfortable filing taxes on their own. This can be successful if the business owner is very meticulous and maintains accurate records on a daily basis.
Using the 1040-ES to estimate and pay taxes to the IRS each quarter can become a very difficult task for some small businesses especially those with fluctuating income. After filing a Schedule C at the end of the tax year many small businesses will find that their quarterly estimations and payment amounts were not as accurate as they thought. Now they are responsible for paying the difference which can create very serious financial hardship for the business and consequently for the sole proprietor whose personal property and assets will be at risk if the business does not resolve its debt with the IRS.
PARTNERSHIPS are similar to sole proprietorships but with more than one proprietor. Each partner is expected to contribute their personal assets to the trade or business and share their portion of the profits and therefore tax liabilities.
The partnership is expected to file the same information as any other small business- profits, losses, deductions etc. but the business itself does not pay income tax instead it is passed through to each of the partners to file on their personal tax return.
Partners are not considered employees and do not receive a W-2. Each partner is considered to be self-employed and must also pay self-employment taxes.
A partnership files an information-only return form 1065, to document profits, losses, and deductions etc. for the business that year. Each partner is then issued a Schedule K-1 to document their portion of the business’s income. The information on the Schedule K-1 is transferred to the Schedule E portion of the partner’s 1040 tax return.
Additional employees, fluctuating income, multiple partners and the amount of assets the partnership owns are all factors that can require additional paperwork and can jeopardize the integrity of the partner’s personal tax returns.
Limited Liability Company’s, LLC, are not recognized by the federal government as a classification for tax purposes.
An LLC is a business structure mandated by each state and is a blend between a corporation and a partnership. It protects the owners from personal responsibility for any debt or business losses, like a corporation, but if the LLC files as a partnership they are able to benefit from the pass through tax status of a partnership.
Corporations are owned by shareholders who buy capital stock in the company and pay taxes on their profits by having it taken out of their dividends whenever they take them.
Shareholders in a company are not allowed to deduct any losses from the corporation. Corporations themselves are the only business structure that directly pays taxes on its profits instead of passing it through to the business owners. However, corporations are allowed special deductions that other business structures are not.
S Corporations are corporations that want the option to pass the businesses federal taxes through to their shareholders. Because shareholders in a corporation are already taxed on their dividends, an S Corporation is able to avoid double taxation on their businesses income.
To qualify to be an S Corporation the business may have no more than 100 shareholders and cannot include other partnerships or corporations.
Corporations are required to file an 1120 and 1120S form for the IRS which is much more detailed and complicated than other business structure’s tax forms. Typically corporations, large or small, employ a full time accountant or accounting team in order to properly file taxes and for bookkeeping purposes.
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