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Tax 101 for Small Business Owners: The Complete Guide

Tax 101 for Small Business Owners: The Complete Guide

Starting and running your own business may be a dream come true for those with an entrepreneurial spirit, but being a business owner definitely come with many challenges. Doing your own taxes can be one of them, especially if you don’t know what you’re doing. But don’t sweat it! Doing your taxes can actually be pretty straightforward. We have prepare this simple-to-follow tax 101 for small business owners. Also checkout our 101 guides on business structures and entity registration and bookkeeping.

Let’s jump into it.

Applicable Taxes for Small Business Owners

The amount and procedure of paying taxes depend on how you registered your business. If you applied for self-employment, your income would attract-

  • Income tax
  • Self-employment tax

The Nuances of Self-Employment Tax

Self-employment is taxed at 15.23% of the business’s net annual income. The tax applies to 92.35% income you earned initially in the year.

Along with that, you will pay-

Federal Insurance Contributions Act (FICA): You are liable to pay Medicare tax at 2.9% and Social Security tax at 12.4% on an initial $137,700 of your income. (2020)

Medicare tax: Your income will attract an extra Medicare tax at 0.9%, should your income cross-

  • $200,000 for individual taxpayers
  • $250,000 for joint taxpayers

How Much Income Tax Will You Pay?

Everyone pays income tax, and you are not an exception. The taxable income from your business will be subjected to income tax based on the current tax brackets. Consult the 2020 income tax brackets table below to find out how much tax you need to pay-

For tax year 2020-2021

Do I Need to Pay Sales Tax?

Some states may need you to submit sales tax in addition to the taxes above. You can seek details from your local government whether you should pay sales tax and at what rates.

Remember that paying sales tax is mandatory if the state enforces it. You can collect the tax as part of your invoice from your customers.

If you fail to collect taxes even when it’s mandated, you have to pay them out of your own pockets.

Here are two resources you can use-

Tax Deductions and Tax Credits: What’s the Difference

Tax Deductions

Small business owners are eligible for tax deductions on their taxable income. These deductions are your costs of running the business and include expenses like salaries, interest on loan, electricity charges, and so on. 

Deductions are subtracted from your total tax amount and provide you some tax relief. These expenses are allowed by the IRS and are more or less common for all businesses. The amount of deductions you can make depends on the applicable tax bracket, just like income tax.

Tax Credits

Tax credits are like discounts you can enjoy on your tax returns, provided you fulfill some specific conditions. Some of these tax credits are available to all businesses, like the solar power tax credit, where you can deduct a percentage of the cost of solar power installation from your returns. 

On the other hand, tax credits like the mine rescue team training credit are applicable only if you are in the mining industry. The best part of tax credits is you can deduct the amount dollar-by-dollar from your tax returns. This is a great relief for small business owners who don’t earn a high income. 

You need to have a thorough idea about the taxation scenario to take advantage of tax credits. A tax expert or registered accountant can be your best guide to maximize tax credits.

You may also be eligible for another 20% deduction if you use IRS Form 1040 Schedule C to daft your operational expenses and earnings. This can help you cut back your self-employment tax along with lowering your marginal tax rate below 30%.

Common Small Business Tax Deductions

Tax credits are like discounts you can enjoy on your tax returns, provided you fulfill some specific conditions. Some of these tax credits are available to all businesses, like the solar power tax credit, where you can deduct a percentage of the cost of solar power installation from your returns. 

Here are some common deductions you can get as a small business owner-

Home Office

You can deduct expenses related to your property if you run your business from your home. The office should be entirely used for your business, including management and administration. You will be able to deduct rental charges, building depreciation, and more.

Startup Deduction

If you are running a startup, you will be able to subtract $5,000 from your taxes. You can then amortize the rest of the startup cost over a period of 15-years when you commence operations. This deduction is ideal if you sell online or operate remotely.

Retirement Deductions

You can deduct a percentage of your contributions made to retirement plans for your employees. These include contributions IRAs, 401 (k), SIMPLE plan, and personal plans. You will be able to take away 50% from the first $1,000 for the contribution.

Vehicular Deductions

You can deduct the fuel and transport costs you incur for your business. Apart from your business vehicle, you will be able to claim all cab and public transport expenses. Keep a record of your mileage and expenses to claim them on your returns. Else, you can also go for the standard mileage rate if that makes more sense in your case.

R&D Deductions

The expenses made for research and development of products or services form a part of your regular deductions. R&D can be in any field that improves the productivity or efficiency of your processes or services.

Examples of allowable R&D deductions include adding new features in case of software or mobile apps. Or, you may deduct the cost of developing a better technology for your generator, which reduces power consumption by 25%.

Business Traveling

Reasonable expenses under business travel can be deducted from your taxable income. The expenses shouldn’t be extravagant and made solely for business activities in some other city or state. For instance, the cost of staying at a decent BnB will be allowed, whereas putting up at a 7-star resort may not be!

20% Tax Deduction for Small Business Owners

The IRS provides tax relief in the form of the 20% passthrough deduction. You can just go ahead and subtract 20% from your taxable income if your business income is lower than-

  • $157,500 for individual taxpayers
  • $315,000 for joint taxpayers

For self-employed professionals, the 20% deduction ceases to work if they have incomes over-

  • $207,500 for individual taxpayers
  • $415,000 for joint taxpayers

Business owners who earn above the threshold will need to satisfy specific conditions to claim the deduction. For instance, the amount you will be able to subtract will be decided by the salaries you pay to your employees. Other factors like capital investments are also taken into account to determine how much you will be able to deduct.

Filing and Paying Your Taxes

Do I Need to Pay Quarterly Taxes?

If you generate over $1,000 in business income, you will need to fill in your taxes every quarter. That means your annual tax will be paid in four instalments in a year.

You can find out the applicable quarterly taxes based on the tax you paid in the previous year. However, do account for growth or decline of business profits that impact the total tax payable.

The best way to avoid penalties is to pay what you paid last year.

Tax due dates for small business owners

You will need to pay your taxes within the due dates to avoid any late fees or penalties. The deadlines will be set by the IRS and your state tax-collecting agencies and municipalities.

As of 2020, the deadlines are as follows-

  • July 15 for Jan – March
  • June 15 for March – June
  • September 15 for July- Sept
  • January 15 for Oct-Dec

In the face of COVID, the US Treasury is allowing more time to file your taxes. The due date for the first quarter is now July 15. The other due dates may also be changed, but there are no official announcements yet.

How much tax to pay each quarter

  1. Work out how much you may earn in the current tax year. You can start with your last year’s income and make changes based on the present year’s situations. Then work out your expenses and subtract them from your estimated earnings
  2. Use this online resource if you are preparing your tax for the first time.
  3. Now, find out how much you need to pay for applicable taxes like income tax
  4. Now split the total annual payable tax into four parts to be paid for each quarter

How to Pay Your Taxes

How to Play Safe With the IRS

You don’t need to worry about paying penalties if-

  • The tax you pay is equal to what you paid last year
  • You pay 110% more tax than your previous year (if your income crosses $150,000 annually)
  • You don’t miss any quarterly tax due dates

What is the Best Way to File My Taxes?

Go for a Professional Accountant

A registered accountant is the best person to guide you across the tricky path of taxation. A CPA can help you file taxes accurately without making any errors or wrong estimations. They are also great for unearthing the applicable tax credits you can claim for your business.

An accountant may cost $150 to $300, but may enable you to save more taxes than the fees.

File Taxes Yourself

Doing your taxes can make sense if your business transactions are more or less simple. It’s suitable if you don’t have complex operations, and your business hasn’t faced much change in recent years.

You have two ways to file your taxes- online and by mail.

Online filings: You need to register on the IRS website. Then you can make wire transfers deposit to send money directly to the IRS. You may also be able to use your credit cards.

Pay taxes by mail: First, collect all the forms you need to file your return. Fill up the forms, attach your check or money order, and drop the envelope in the post box.

We have a detailed guide assisting you in each step of filing your taxes. Additionally, use a tax solution to improve accuracy and increase refunds. 

Guidance on Tax Forms for Different Business Models

Form 1040 for sole proprietorship

You need to pay the income tax for your business for 2019 by July 15, 2020. The form 1040 will help you record your income and expenses.

 In case you need more time, seek an extension for your due date using Form 4868 (Automatic Extension of Time to File US Individual Income Tax Return). If approved, you will get time till January 15, 2021, to pay your taxes.

Both the extension deadlines have been extended due to the pandemic that is haunting the whole world. Read more on the nuances of getting a tax extension.

Form 1065 for partnerships

Partnership firms will have to file their business income with the IRS, even if you pay your taxes individually. You can report your expenses and earnings using the form 1065 with the deadline of March 16, 2020.

Form 1120S  for S corporation

Shareholders of an S corp must submit form 1120S to the IRS. The US Income Tax Return form records your partnership financial transactions and the number of shares in your name.

Form 1099-MISC for subcontractors

Any business owner that uses the service of a subcontractor has to report to the IRS. You will need to send a form 1099-MISC to the subcontractor by January 31 of the following year. Along with that, you need to send the completed copy of the form to the IRS.

That’s it for the taxes you have to pay. If things are making you confused, you need to take the guidance of a tax expert or accountant. A professional tax expert can make things simple and help you breathe a sigh of relief. S Corporation

Shareholders of an S corp must submit form 1120S to the IRS. The U.S. Income Tax Return form records your partnership financial transactions, along with the number of shares in your name.

About Zoey Wen

Content contributor and website admin @ Exper.

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