For the uninformed, the small business tax process can lead to inaccuracies and money wasted on penalties. Get up to speed with this article.
In this article:
- Be Knowledgeable About the Structure of Business Ownership and Schedule of Taxes
- Know the Small Business Tax Rate
- Send the Proper, Accurate, and Timely Information to the IRS
- File and Pay the Small Business Tax
- What to Do If You Owe the IRS a Lot of Money
Small Business Taxes Made Easy
Beef Up Your Basic Understanding of Small Business Tax
Taxpayers who have to pay any kind of a small business tax to the federal government can testify on how complex the process is. Incorrect or late filing and payment of a small business tax can lead to dire consequences for tax delinquent businesses.
To add to the complexity, small businesses need to pay taxes not just to Uncle Sam, but also to the state. There are many kinds of taxes, like for the sale of goods, owned property, and even excise taxes.
This small business tax primer focuses on the federal side, specifically how the IRS deals with small businesses.
A taxpayer should know a few things before he or she starts preparing taxes. Important information for small business tax preparation includes:
- The structure of ownership, specifically, whether the small business is legally a sole proprietorship, partnership, or a corporation.
- Schedule of tax payments. Almost all businesses use the estimated tax system, which can actually benefit some taxpayers with a relatively flexible payment schedule and tax reporting.
- Documentation for business expenses that are legally tax deductibles. Reporting business travel expenses or home office bills should include proof to avoid possible tax audit triggers.
Other important information that can help taxpayers include knowing which assets the IRS cannot seize, how to negotiate with the IRS, and, how to find a good tax advocate in case the tax situation spirals out of control.
1. Be Knowledgeable About the Structure of Business Ownership and Schedule of Taxes
The legal structure of the small business dictates the filing of taxes. However, most small businesses pay quarterly payments through the estimated tax system.
For sole proprietorship, the taxpayer reports his or her taxes as if he or she is self-employed, as a sole proprietorship does not give rise to a separate business entity. Basically, the income and expenses of the business are the taxpayer’s income and expenses.
He or she can file the 1099-ES Form annually, but make payments quarterly or monthly.
Partnerships enjoy an interesting tax system; the business itself does not pay the tax, but the partners do. The partners in the business report income and expenses in their tax filing, but the business also sends an annual information return to the IRS to check if the numbers in the partners’ tax file match up with what the business reports.
Lastly, corporations interestingly practice double-taxation. Since the corporation is a separate legal entity from the shareholders, the IRS may see two taxes coming from a single source of income: the taxes of the corporation as a whole and taxes on the shareholders when dividends or profit-sharing occurs.
It is also important to note that businesses with employees not only have to pay FICA (Social Security and Medicare) contributions out of their pockets, but also to withhold taxes for the government. Non-compliance of withholding and contributing to FICA can lead to dire penalties, which means that the reporting taxpayer should also properly categorize who is an employee and an independent contractor.
Business owners should also calculate payroll taxes, basically the 15.3% total FICA contributions with the owner paying half and withholding the remainder from the employee. The IRS treats worker misclassification cases very seriously, and small businesses should make proper work documentation a high priority.
2. Know the Small Business Tax Rate
The legal status also directly affects the tax rate. The Tax Cuts and Jobs Act takes effect in 2019, which affects small businesses greatly.
Take the rates listed as a general approximation, as small businesses also have deductibles available.
- For a sole proprietorship, the taxes pass through to the taxpayer, making the personal tax rate effectively the tax rate for the business. Of course, the sole proprietor also pays the payroll taxes, and as per a Fundera 2019 Business Tax Guide, sole proprietorships typically approximately 13.3%.
- Like a sole proprietorship, partnership taxes do not exist, and the portion of income that goes to a partner merits that specific partner’s tax rate. Generally, a partnership has a 23.3% tax rate, but of course, the rate varies depending on a lot of factors.
- An S corporation has a 26.9% tax rate, which can be quite substantial as the income gets taxed again when received by the taxpayer in the form of dividends.
- On the other hand, a C corporation pays approximately a 17.5% tax rate, but taxation for C corporations typically varies due to tax credits and deductibles. C corporation companies pay the corporate income taxes, and almost all companies in the stock market are C corporations.
Of course, the business tax rate is not the only number that taxpayers should keep a close eye on.
Payroll taxes, specifically Social Security and Medicare, levies a 15.3% tax. Some states also have property taxes, as well as sales and excise taxes.
Corporations, sole proprietors and partnerships also have to worry about properly estimating taxes.
3. Send the Proper, Accurate, and Timely Information to the IRS
A taxpayer should prepare quite a few items beforehand to minimize any risk of inaccurate information or late payments:
- The previous year’s tax return. This document is extremely useful for estimating taxes, as well as providing a good guideline.
- Ownership paperwork. Specifically, the corporation charter, partnership contract, or business registration will prove to the IRS the legal status of the business.
- Payslips and payroll documents.
- Bank statements, especially for deposits to prove the flow of income.
- Any financial document showing activity with an impact on the business.
Since businesses also have expenses that can lower the tax rate, taxpayers should keep:
- Utility bills, especially if there is a home office and the home office has a separate bill.
- Receipts of inventory and materials
- Documents that show fees related to the operations of the business
- Receipts of expenses that are not directly related to operations but have a bearing on taxes, like new assets with mortgages and a 30-year depreciation calculation
- Important fees, like advertising and professional fees
4. File and Pay the Small Business Tax
Once the business has calculated its business taxes, the taxpayer can send the payments either electronically or through the payment stubs.
Business owners and the self-employed can use The Electronic Federal Tax Payment System for a more convenient way of sending and filing taxes. For a more in-depth discussion about filing taxes electronically, the IRS e-File system warrants a look.
For the more traditional taxpayer, they can send their estimated taxes quarterly or monthly. Usually, the IRS sends the previous tax return with 4 additional payment stubs, but taxpayers have the option to call the nearest IRS branch and request for more payment stubs if they prefer a monthly payment.
Sometimes, payment vouchers get lost in the mail before they reach the taxpayer. The taxpayer can call the IRS at 1-800-829-1040, preferably early in the morning, when the wait time is shorter.
5. What to Do If You Owe the IRS a Lot of Money
Estimated taxes are paid quarterly, which provides taxpayers a reasonable time to budget finances without shelling out relatively bigger amounts if done in one annual lump sum. However, some businesses may have bad years beyond their control. Unpaid or late taxes lead to tax debts, which can grow monthly until the IRS levies the whole business.
A taxpayer can:
- Possibly reach the IRS new tax debt through an Offer in Compromise. With an OIC, the taxpayer can obtain a lower tax debt.
- Request for a CNC (currently not collectible) tax status. A CNC can give delinquent business owners integral breathing time so that a business can get back on its feet.
- Declare bankruptcy after analyzing the pros and cons. Bankruptcy can affect your credit score for years, so taxpayers may want to assess this option thoroughly.
Small businesses have been the backbone of the US economy for generations, and thus have the clout to affect the tax revenues of the IRS. By knowing how to deal with the small business tax process, taxpayers can save money and time.
How will you file your business tax? Do you have any questions about how the IRS inspects small businesses for taxes? Share your insights below!
If you owe back taxes, visit taxreliefcenter.org for more information on tax relief options.