Did you know that nearly 50% of small business owners say that handling taxes is one of the most challenging aspects of running their business? In fact, recent data shows that tax issues are a major problem for small businesses. Out of the top ten challenges they face, four are related to taxes.
Understanding and managing your taxes effectively can make a huge difference in your business’s success and growth. Whether you’re a new entrepreneur or a seasoned business owner, getting a grip on your taxes can free up valuable time and resources, allowing you to focus on what you do best: growing your business.
Keep reading to find out more about the various taxes you should be aware of, the specific forms you’ll need to fill out, and some handy tips to make tax time a bit easier. Let’s break down small business taxes, making them less confusing and helping your business thrive financially!
Understanding Your Rights as a Taxpayer: The Taxpayer Bill of Rights
Recently, the IRS adopted a Taxpayer Bill of Rights proposed by former National Taxpayer Advocate Nina Olson. This bill outlines ten fundamental rights that all taxpayers have in their dealings with the IRS, making these rights clear, understandable, and accessible.
1. The Right to Be Informed
You have the right to know what you need to do to comply with tax laws. This includes clear explanations of the law and IRS procedures in all tax forms, instructions, publications, notices, and correspondence. You also have the right to be informed of IRS decisions about your tax accounts and to receive clear explanations of the outcomes.
2. The Right to Quality Service
You have the right to receive prompt, courteous, and professional assistance from the IRS. Communications from the IRS should be clear and easy to understand, and you should have a way to file complaints about inadequate service.
3. The Right to Pay No More Than the Correct Amount of Tax
You have the right to pay only the amount of tax legally due and to have the IRS apply all your tax payments properly.
4. The Right to Challenge the IRS’s Position and Be Heard
You can raise objections and provide additional documentation in response to formal IRS actions or proposed actions. The IRS is required to consider your timely objections and documentation promptly and fairly. If the IRS does not agree with your position, you have the right to receive a response.
5. The Right to Appeal an IRS Decision in an Independent Forum
You are entitled to a fair and impartial administrative appeal of most IRS decisions, including many penalties. You have the right to receive a written response regarding the Office of Appeals’ decision and can generally take your case to court.
6. The Right to Finality
You have the right to know the maximum amount of time you have to challenge the IRS’s position and the maximum amount of time the IRS has to audit a particular tax year. You also have the right to know when the IRS has finished an audit.
7. The Right to Privacy
You have the right to expect that any IRS inquiry, examination, or enforcement action will comply with the law, be no more intrusive than necessary, and respect all due process rights, including search and seizure protections and a collection due process hearing where applicable.
8. The Right to Confidentiality
You have the right to expect that any information you provide to the IRS will not be disclosed unless authorized by you or by law. You can expect the IRS to investigate and take appropriate action against its employees, return preparers, and others who wrongfully use or disclose your information.
9. The Right to Retain Representation
You have the right to retain an authorized representative of your choice to represent you in your dealings with the IRS. If you cannot afford to hire a representative, you may be eligible for assistance from a low-income taxpayer clinic.
10. The Right to a Fair and Just Tax System
You have the right to expect the tax system to consider facts and circumstances that might affect your underlying liabilities, ability to pay, or ability to provide information timely. You also have the right to receive assistance from the Taxpayer Advocate Service if you are experiencing financial difficulty or if the IRS has not resolved your tax issues properly and timely through its normal channels.
Understanding Small Business Taxes
Small businesses face various taxes at both the federal and local levels. Here’s a simple guide to help you understand the key types of taxes that may apply to your business:
Income Tax
- All businesses, except partnerships, must file a federal income tax return annually.
- These file an information return (Form 1065) because income is taxed individually to partners, not at the business level.
- The tax return form varies by business structure:
- Sole Proprietorships and single-owner LLCs file using Form 1040 with Schedule C.
- Partners and S corporation shareholders file Form 1040 and Schedule E.
- C corporations file Form 1120; S corporations file Form 1120-S.
Self-Employment Tax
- It applies to sole proprietors and partners covering Social Security and Medicare.
- Must attach Schedule SE to their personal tax return.
Employment Tax
- Businesses with employees must handle taxes for Social Security, Medicare, and income tax withholding.
- They also cover unemployment taxes (FUTA), paid entirely by the employer.
- Most employment taxes are filed using Forms 941, 943, or 944, except for FUTA, which uses Form 940.
Estimated Tax
- This prepayment method covers income tax and self-employment tax throughout the year.
- Sole proprietors, partners, and S corporation shareholders use Form 1040-ES.
- C corporations use Form 1120-W.
- It’s crucial to make these payments to avoid underpayment penalties.
Excise Tax
- Levied on specific goods and services like fuel, airline tickets, and luxury items.
- Paid by manufacturers, retailers, importers, or consumers, depending on the product.
- Excise taxes are reported on Forms 720, 730, 2290, and 11-C
Sales Tax
- Most states, as well as some local jurisdictions, require businesses to collect sales tax on taxable goods and services.
- Businesses must register with their state’s taxing authority to collect sales taxes.
Other State and Local Taxes
- Income Taxes: Varies by state. Sole proprietors, partners, and S corporation shareholders pay via personal tax returns. C and S corporations may have different state corporate tax obligations.
- Property Taxes: Applied to real and tangible personal property owned by businesses.
- Franchise Taxes: Imposed by some states on businesses operating within their borders.
- Business License Fees: Many local governments require businesses to obtain licenses and pay fees, which are regulatory rather than tax-related.
Tax Deductions and Credits for Small Businesses
Small businesses, like individual taxpayers, can take advantage of various deductions and credits to reduce their tax liabilities. Here’s a simplified overview to help you understand these tax preparation benefits for small businesses:
Business Expenses
Most expenses involved in running a business can significantly lower your taxable income. These expenses include:
- Operational Costs: Wages, rent, utilities, and office supplies.
- Travel and Mileage: Costs associated with business travel.
- Marketing: Advertising expenses.
- Technology: Internet and wireless services.
- Taxes: State and local taxes may also be deductible on your federal tax returns.
Depreciation
For certain business properties, you can’t deduct the full cost in the year of purchase. Instead, you spread the cost over several years through depreciation. This process provides a tax deduction spread out over the useful life of the property.
Home Office Deduction
If you’re a sole proprietor using part of your home regularly and exclusively for business, you might deduct a portion of your home-related expenses. These can include proportional costs which means a percentage of mortgage interest, insurance, utilities, and repairs based on the office’s size relative to your home.
Tax Credits
Tax credits provide a dollar-for-dollar reduction in your tax bill, which is more beneficial than deductions that only reduce the amount of income subject to tax. Notable small business tax credits include:
- Work Opportunity Tax Credit (WOTC): For hiring individuals from certain target groups, like veterans or those on public assistance.
- Employer-Provided Childcare Credit: Helps cover the costs of childcare provided to employees.
- Small Business Health Care Tax Credit: Offers a credit for the health insurance premiums paid on behalf of employees.
- Payroll Tax Credit for Increasing Research Activities: Rewards businesses for investments in research and development.
These deductions and credits are designed to encourage business activities and growth by easing the tax burden. With this, if you are looking for more personalized guidance? Our CFO services and individual tax planning can help you optimize your financial strategies.
Red Flags for IRS Audits
The Internal Revenue Service (IRS) uses automated systems and human evaluations to select which tax returns to audit. All tax returns are screened against statistical norms, and those that deviate undergo thorough reviews. Here are some common red flags that can increase the likelihood of an audit:
1. Not Reporting All of Your Income: Failing to report income is a significant trigger. Institutions report your income to the IRS, and the IRS compares these reports to your tax return. Missing income from sources like old brokerage accounts or Form 1099s can prompt an IRS audit.
2. Breaking the Rules on Foreign Accounts: Strict rules apply under the Foreign Account Tax Compliance Act (FATCA) for reporting foreign bank accounts. U.S. taxpayers must report foreign assets worth at least $50,000 on Form 8938. Noncompliance with FATCA can result in severe penalties and increase audit risk.
3. Blurring the Lines on Business Expenses: The IRS pays close attention to excessive business tax deductions, particularly if they exceed the norm for your profession by 20% or more, which might prompt further scrutiny. Vehicle-related deductions require clear documentation of business use, as personal use is not deductible. It’s also important to strictly separate personal and business expenses, as mixing the two, especially with business meals, can lead to an audit.
4. Earning More Than $200,000: Higher incomes are more closely monitored by the IRS. Last year, individuals earning less than $200,000 had a 1% audit rate, while those earning more faced nearly 4% and those over $1 million saw 12.5%. For corporations, those with assets under $10 million had a 1% audit rate, but it rose to 17.6% for those with more. Complex tax returns from higher earners are more likely to have audit triggers. Despite only a slight increase in enforcement personnel, the IRS significantly boosted its collections to $55.2 billion last year, focusing on maximizing returns.
Knowing these audit triggers can help you prepare your tax returns more carefully and possibly avoid unwanted attention from the IRS.
Tax Relief Options for Small Businesses
If your small business is dealing with tax burdens, here are some simplified relief options to help you manage and reduce your debt:
Debt Consolidation Loans
Debt consolidation loans combine multiple debts into a single loan with one monthly payment. This can simplify your debt management and potentially lower your interest rates. Instead of juggling multiple payments to various creditors, you make just one payment each month, which can make budgeting easier and more predictable.
Bankruptcy
Bankruptcy can be a last resort for small businesses struggling with overwhelming debt. There are two main types: Chapter 11 and Chapter 13. Chapter 11 is typically used for larger businesses and allows for the restructuring of debts. Chapter 13 is often used by sole proprietors and involves a strict debt limit. Both types help reorganize your debt, potentially selling non-essential assets to satisfy secured debts while renegotiating terms for unsecured debts.
Debt Settlement
Debt settlement involves negotiating with creditors to reduce the total amount of debt owed. This can significantly lower your debt and is often quicker than consolidating loans. For example, if you owe $50,000, you might negotiate to settle for $30,000. This can provide substantial relief, though it may impact your credit score.
Currently Not Collectible (CNC) Status
If your business is experiencing severe financial hardship, you might qualify for Currently Not Collectible (CNC) status. This means the IRS temporarily stops trying to collect your tax debt because they recognize you can’t pay both your tax debt and your basic living expenses. This pause can provide you with some breathing room to get your finances in order.
Penalty Abatement
Penalty abatement can help if you have a valid reason for not meeting your tax obligations, such as a natural disaster or severe illness. This program allows the IRS to waive certain penalties, reducing the overall amount you owe. Proper documentation is needed to support your claim, but this relief can significantly lessen your financial burden.
Innocent Spouse Relief
If you filed a joint tax return and your spouse made errors or omissions, innocent spouse relief might apply to you. This relief removes your responsibility for paying tax, interest, and penalties if you can prove you didn’t know about the mistakes. This can protect you from unfair tax liabilities caused by your spouse’s actions.
Employee Retention Credit (ERC)
The Employee Retention Credit (ERC) is a tax credit designed to help businesses that kept employees on the payroll during the COVID-19 pandemic. This credit can reduce your employment tax liabilities, provide financial relief, and help you retain your workforce during difficult times.
Net Operating Loss (NOL) Carrybacks
Net Operating Loss (NOL) carrybacks allow businesses to use losses from the current year to offset past taxable income. This can provide immediate tax relief and potentially result in refunds. For example, if your business experienced a loss this year, you could apply it to last year’s income, reducing your taxable income and possibly receiving a tax refund.
By understanding and utilizing these options, small business owners can manage and reduce their tax burdens, allowing them to focus on the growth and stability of their businesses.
Special Tax Considerations for Self-Employed Individuals
Handling taxes when you’re self-employed requires planning and organization. Here’s a guide to managing your self-employed tax responsibilities more effectively.
Who Counts as Self-Employed?
You’re considered self-employed by the IRS if you:
- Operate your own business as a sole proprietor or independent contractor.
- Are part of a partnership conducting business.
- Manage any form of business, even part-time.
Understanding Self-Employment Tax
As a self-employed individual, you don’t have taxes automatically withheld from your earnings, so you need to handle this yourself. This includes self-employment tax, which is 15.3% of your earnings. This tax covers your contributions to Social Security (12.4%) and Medicare (2.9%). The Social Security tax is only on earnings up to $147,000 (as of 2022), but the Medicare tax applies to all your earnings. You’ll need to pay this tax if your net earnings exceed $400, or if you earn $108.28 or more as a church employee.
Filing Your Taxes
To handle your self-employment tax:
- Subtract business expenses from your income to determine net profit.
- Apply 15.3% to your net profit for self-employment tax.
- File a tax return with Schedule C if you earn more than $400. Make quarterly tax payments if your self-employment tax exceeds $1,000 using Form 1040-ES or the IRS’s EFTPS system.
Need help with long-term financial planning? Check out our life insurance planning and retirement planning services. For ongoing support and a comprehensive approach to managing your taxes, explore our Family Tax Office.
Reducing Your Tax Bill
There are several ways to lower your taxes, including:
You can reduce your taxes with deductions such as:
- Home Office Deduction: Deduct expenses like rent or mortgage interest if part of your home is used exclusively for business.
- Education Expenses: Deduct costs for business-related classes or workshops.
- Mileage Deduction: Deduct business-related mileage at the standard rate.
- Self-Employment Tax Deduction: Deduct half of your self-employment tax from your income.
- Phone and Internet Costs: Deduct expenses based on business usage.
By understanding and using these tax rules and deductions, you can better manage your finances and potentially reduce the amount you owe in taxes each year.
Stay Ahead with Proactive Tax Strategies
As a small business owner, managing taxes can be one of your biggest challenges. However, with the right strategies and understanding of your taxpayer rights, you can overcome the difficulties and potentially reduce your tax burden.
Consider conducting a mid-year tax review. This proactive approach allows you to adjust your financial strategies, take advantage of any tax-saving opportunities, and ensure you are on track with your tax obligations. By reviewing your finances mid-year, you can make necessary changes well before the year-end rush, potentially saving your business time and money.
Remember, you don’t have to handle this alone. If you need assistance, whether it’s understanding deductions, managing quarterly payments, or addressing any tax-related concerns, we are here to help. Additionally, take a look at our tax planner in California (and beyond) for tax planning and advice. We also offer advanced tax planning for those seeking specialized strategies.
