How much does a small business have to make to file taxes?
Handling taxes as a new or startup business
If you’re a business owner, you know the difficulty of getting your business up-and-running. As you begin your business journey, you undoubtedly have many questions. One important aspect of running a small business is knowing how to pay taxes on the revenue you make. Even more, you may not even know when you have to pay taxes on your income. So, in this article, we’ll talk more about taxes for small businesses. To start, let’s talk about when you’re required to pay taxes as a small business.
When does a small business have to pay taxes?
As a small business, chances are you’re operating using one of the following business structures: Sole proprietorship, partnership, S corporation, or Limited Liability Company (LLC). If you operate your own business as any of these, you don't pay income taxes from the business. That’s because the Internal Revenue Service (IRS) considers each of these business structures to be pass-through business entities. That means that the IRS taxes any income you make from these types of businesses at your individual tax rate.
It’s important to note that if your business is set up as a C corporation or you’ve elected to have your small business taxed as a C corporation, you’ll pay taxes on business income at the corporate tax rate. As a C corporation, the IRS views your business as a separate taxpayer from you as an individual.
When it comes to business taxes on the pass-through entities, there’s no set formula or tax rate that small business owners like you can estimate in order to calculate how much money you can earn without having to pay taxes. This is because there are so many factors that determine the amount of tax you’ll pay. In large part, those factors include the combination of your business income and any other income you’ve received. Plus, there are other considerations, including your filing status, how much you can claim in itemized deductions (both business and personal), and any other deductions. All of these factors help to accurately calculate your taxable income and therefore the tax bracket you’ll be in.
Don’t forget, as a pass-through entity, you’ll also most likely be responsible for paying the Federal Insurance Contributions Act tax, commonly known as the FICA tax.
For self-employed earners (which includes independent contractors), this includes paying both portions – the employer and the employee – of the tax. As of this writing, the self-employment tax rate is 15.3%. This rate consists of two parts: 12.4% for Social Security taxes (old-age, survivors, and disability insurance) and 2.9% for Medicare taxes (hospital insurance).
So, who must pay the self-employment tax? There are two conditions. If you fulfill either of these, you must pay self-employment tax and file a Schedule SE form:
- Your net earnings from self-employment (excluding church employee income) were $400 or more.
- You had church employee income of $108.28 or more.
If you are a business who has employees, you’ll have to pay payroll taxes on W-2 wages.
Now that you know more about small business income taxes, let’s discuss how to determine your business’s taxable income and tax bill.
How do I figure out my small business taxable income?
When it comes to figuring out your taxable business income as a sole proprietor, the best way to do so is by completing a Schedule C. This form is one you’ll submit with your personal Form 1040 tax return. With the Schedule C form, you report your income and any allowable business deductions or write-offs. The Schedule C helps you calculate your net income. If the number is positive, you made a profit; if the number is negative, you sustained a loss.
In contrast to the Schedule C, those who own a partnership or S corporation file a separate tax return. For partnerships, it’s Form 1065; for S corporations, it’s Form 1120. These forms report the business’s income and expenses. However, no tax comes from these returns as they’re simply informational in nature. Owners receive a Schedule K-1 which reports each partner's share of the partnership's earnings, losses, deductions, and credits. You’ll then use this form much like a 1099 on your individual income tax return.
One important consideration to remember when it comes to business expenses is the deductions that you are allowed to claim. A common business expense is a home office or workspace – a dedicated part of your living space used only for business purposes. This allows you to deduct a percentage of your rent or mortgage payments, utilities, real estate property taxes, and insurance. There are a few ways you can calculate this deduction, but it’s best to speak with a tax professional who is knowledgeable about tax laws to learn more. Other common deductions include business tools, supplies, vehicle expenses, advertising, website fees, legal expenses, telephone charges, and internet costs.
As a small business owner, it’s important to keep receipts, bank statements, and other records that can help substantiate not only your business income but also the deductions you’re claiming as a business owner. These can help you explain your tax calculations should you get audited by the IRS. For specific tax information or questions, it’s in your best interest to contact your tax professional who is trained to answer questions specific to your business and circumstances.
Next, let’s look at a few other things you should know about small business taxes.
What else do I need to know as a small business owner?
As a small business owner, there are a couple of other things you should know in regard to your taxes. The following are some important considerations as a new business owner:
Don’t forget to claim startup tax deductions for eligible expenses
This one only applies to those who are starting a new business. You can deduct up to $5,000 of your costs to get your business up and running, and up to $5,000 of your organizational costs in the year your business begins. Startup costs include expenses like market research, marketing and advertising, employee training, and any professional fees that are a result of you establishing the business. You can deduct the full dollar amounts listed here if your total business startup costs are less than $50,000.
Even if you reinvest your income into your business, it’s still taxable
Any profit your business makes is taxable. That means even if you reinvest all of your profits into the business, you’re still required to pay taxes on that income. However, utilizing business deductions and tax credits can help you offset that taxable income. Speak with a tax professional for more details.
Keep in mind that you’ll be responsible for quarterly estimated tax payments
One significant difference between being employed by a company and being a small business owner is that tax responsibilities are different. One responsibility of self-employed individuals is submitting quarterly estimated tax payments. While most employees satisfy their tax obligations when their employer withholds the necessary taxes from their paychecks, taxes are solely your responsibility as a small business owner.
In order to satisfy this requirement, you’ll have to make estimated tax payments. You can do this online or via the mail. The tax year is divided into four periods to pay estimated taxes. Each period has a specific payment deadline, typically:
- April 15
- June 15
- September 15
- January 15 of the following year
Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe taxes of $1,000 or more when their return is filed. If you expect your income to be similar to the prior tax year, you can use last year’s tax return. Otherwise, you’ll need to use Form 1040-ES to help you calculate your estimated tax. If you experience an increase in revenue during the year, you can always increase the amount of the remaining quarterly tax payments. The goal is to come as close as possible to what your taxes are at the end of the year.
You may be subject to greater tax scrutiny as a new business
One of the IRS’s favorite audit groups is self-employed individuals. As a new business owner, you should be familiar with how the audit process works and prepare for the possibility of being audited. While an audit doesn’t indicate you’ve done anything wrong, it’s important to make sure you can prove your income, expenses, and deductions. In particular, each of the business deductions you take should also have a record. It’s much easier to proactively collect these records – including automobile, gas, entertainment, and home-office expenses – than try to collect them once you’ve been notified that you’ll be audited.
Pay attention to deadlines
While operating a business as a pass-through entity, you’ll be submitting your business income with a Schedule C and therefore the filing deadline is the same as a personal tax return.
However, if your business is a C corporation or an S corporation, different filing requirements apply. For those businesses taxed as a C-Corp, you’ll file a Form 1120 and must file it by April 15 or the next business day if the 15th falls on a weekend. However, those taxed as an S-Corp need to file a Form 1120S by March 15 or the next business day if the 15th falls on a weekend. This form must be filed separately from your personal income tax return.
As you can see, there’s a lot of information you have to keep track of as a small business owner when it comes to taxes. After reading this article, you should have a better understanding of how to handle your taxes as a small business owner. The bottom line is that much of the work of filing taxes as a business comes down to preparation. Having a good grasp on the amount of income you make, knowing the deductions and tax breaks you can take as a business, and keeping meticulous records can all help you ease the burden of preparing your taxes during tax season. For more help with tax preparation, seek the advice of a tax professional.
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