Understanding Small Business Taxes
You’ve heard it before - nothing in life is certain except death and taxes.
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When it comes to running a small business, the big and small decisions more often than not end up relating back to money. From sourcing funding to managing finances and paying taxes, there’s a lot of information to know. Of course, many businesses rely on financial advisors and accountants to manage their books, but it can literally pay you to understand the basics about small business taxes.
That’s why we’ve made this guide to outline the main aspects of small business taxes, from the kinds of taxes you may have to pay to the considerations to take when structuring your business.
What is a Business Tax?
The types of small business taxes that you will end up paying will depend on the way you structure your business (we’ll get to that later). But, the three main types of business taxes are:
- Income Tax: Every business must file an annual tax return. For corporations, they pay the corporate rate whereas pass-through entities pay an individual tax rate.
- Estimated Taxes: If you’re an independent contractor or freelancer who is expected to pay at least $1,000 in taxes, then you’ll be expected to pay estimated taxes on a quarterly basis. If you miss these deadlines, you may face penalties. The deadlines for quarterly estimated taxes are as follows: July 15, June 15, September 15 (in 2020) and January 15, 2021.
- Self-employment Taxes: Self-employed individuals pay Social Security and Medicare taxes. You are expected to pay this if you make more than $400 in net earnings or if you work for a religious affiliation that elected an exception.
Types of Small Business Taxes
Besides the aforementioned taxes, you may be required to pay these too:
- Sales Tax: Most states in America have their own defined sales tax rate. This is a tax that customers pay at the time of purchase of goods or services. The business owner is then responsible for both collecting and reporting these taxes to their state and local government.
- Excise Tax: Some goods and services are privy to being taxed, but it doesn’t get passed on to the consumer. Instead, it comes in the form of an excise tax, as with cigarettes, liquor and gas, for example.
- Payroll Tax: Even if you don’t have employees, you will have to pay a payroll tax. For sole proprietorships earning more than $400 in net earnings, it’s just called the self-employment tax (see above). If you have hired employees, then you have payroll tax withholdings and obligations. From an employee’s wages, you have to withhold federal taxes and FICA taxes (a 6.2 percent Social Security tax, a 1.45 percent regular Medicare tax (and a 0.9 percent Medicare surtax when the employee earns over $200,000).
- Property Tax: When you own a commercial property, you will have to pay property tax to the city or county in which the property is operating.
Business Structure Options
The way by which you structure your organization legally will undoubtedly affect your tax rates. Here’s a look at the types of businesses you can run and their respective tax implications.
- C Corp: Traditional corporations fall under the category of C corps. C corps consist of: a board of governors, directors, employees, and officers. When this comes to mind, you probably think of large businesses, but it could be that you structure your small business as a C corp. C corps pay taxes on the company level (they are the only legal structure that fits this bill). The flat and current corporate income tax rate is 21%. Shareholders have to pay taxes on their dividends received from C corps.
- S Corp: Unlike C corporations who face double taxation on the company and shareholder level, S Corps pass income to shareholders to avoid the double taxation. To set your small business up as a S corp, you must adhere to these stipulations: have no more than 100 shareholders, all shareholders are U.S. residents and there is only one class of stock. The S Corp is one of the most popular options for small businesses to elect because there is more tax flexibility and S corps may be eligible for a 20% tax dedication. Additionally, shareholders report their business expenses, deductions and income on their own personal tax returns.
- Sole Proprietorship: When you are the only owner of a business that is unincorporated, you’ll default to being considered a sole proprietorship. This is the most common type of small business that exists in America, but it’s also the riskiest. As a sole proprietor, your personal and business finances and legal obligations have no separation. However, taxes are the most straightforward because you would file your individual income and losses on your personal tax return (Form 1040 through a Schedule C). Sole proprietors can deduct 20% of net income from taxable income, thereby immediately lessening tax liability.
- LLCs: LLCs are limited liability companies and boast two tax advantages, namely: deductible business losses and no double taxation. LLCs are taxed on the individual level, in the same way that it occurs with an S corp or sole proprietorship. The term associated with this process is the “pass-through” tax treatment. With an LLC, you can have as many shareholders as you want, but you have to assign ownership percentages for each member. If you have an LLC with multiple members, you get to choose to be taxed as a C corp or partnership. Going down the C Corp route will result in double taxation. If you’re a single-member LLC, then you are taxed like a sole proprietorship. To set up your business as an LLC, you have to pay a certain amount of state taxes each month, no matter what your profits or losses amount to.
What Counts as Deductions?
When you run a business, you’ll have to keep track of income and expenses. Expenses get deducted from your revenue as pre-tax so that your tax liability is then lower based on profits (instead of revenue). To write off expenses, here’s a list of common ones that can be deducted:
- Hiring freelancers
- Business travel
- Depreciation of assets
- Business property utilities, repairs and insurance
- Vehicle expenses
The best way to find out what you can write off is to consult with your accountant or CPA. In most instances, small business software for taxes like QuickBooks will help to itemize expenses for you.
Also note, you can write off startup costs before you are fully operational. You can deduct up to $5,000 in startup expenses and up to $5,000 in organizational costs. This holds up as long as your total costs to get going is less than $50,000.
Taxes can surely get complicated. That’s why it’s so useful to know the basics when you’re setting up your own small business. If you have the opportunity to consult with an expert, it’s definitely advisable. As you can see, the way you set up your business as a legal entity will greatly affect your taxes. So, be sure to perform research before jumping right in.
Once you’re getting going, you may realize you need some help funding your small business. Don’t forget that’s what we are here for at Uplyft Capital. Whether we can provide you with a cash advance or not, we invite you to leverage our Marketplace to get connected to the best small business loan for you.