Small business taxes can seem extremely overwhelming, especially if this is your first-time filing. However, once you learn the ropes and get a few processes in place, keeping up with tax obligations is far less intimidating.
Of course, filing your federal income taxes is essential for a small business. Ignoring this obligation will result in steep penalties and interest obligations. No matter what business entity you use, your company will have income tax requirements.
Business Entity Types: Sole Proprietorship, LLCs, and Corporations
Companies can operate as several different types of legal entities. However, most small businesses choose to operate as a sole proprietorship or a limited liability company (LLC) taxed as a “pass-through” entity. These entities are often simple to set up and maintain, and their tax obligations are less complicated compared to a corporation.
While small businesses certainly can operate as corporations, it often does not make sense. C-corporations are taxed separately, which means they have their own tax rate. The C-corporation gets taxed first, and then any income an owner receives is taxed as the owner’s individual tax rate. In most situations, this “double taxation” does not make sense for a small business owner.
An S-corporation does not have this double taxation problem. However, it has some formal maintenance requirements that are more cumbersome compared to a sole proprietorship or LLC. As a result, even though the tax treatment might be the same, small businesses often choose to stick with an LLC or sole proprietorship over an S-corp because maintenance costs and time requirements are often far less.
Filing Business Taxes as a Sole Proprietorship or LLC
Tax planning and tax preparation start long before April. Gathering and saving records throughout the year is the best way to ensure you have all the information you need to complete your income tax filings. In addition, ensuring you understand the process now, rather than two weeks before your tax deadline, can help you take advantage of tax savings.
Below is a step-by-step guide to filing your taxes as a sole proprietorship or LLC;
Gather Your Records
Accurate tax filing requires accurate reporting. Recordkeeping is the foundation upon which good tax preparation is built. If you already have a recordkeeping process or program in place, great. If not, you need to decide to track and maintain your records.
Some companies choose to use accounting programs like QuickBooks or Freshbooks. Other companies prefer to manually track their income and expenses. The larger or more complicated your company, the more likely you will need a formal system. If you operate as a sole proprietor with no employees, it is likely easier to track all of the critical information you need for tax purposes manually using a program like Excel or Google Sheets.
The method you use to track information does not matter nearly as much as actually tracking. One of the best practices you can use is to go through your income and expenses at least monthly. This information will allow you to see how the business is doing, make faster adjustments to address high-income or low-income months, and provide all the information you need for tax purposes.
Information related to earnings and expenses that you will need includes:
- Invoices you sent to clients and corresponding records of payments
- Records of any goods sold to customers
- Any other sales records that provide information about income coming into your company
- Receipts for office supplies
- Inventory cost information
- Rent or mortgage records
- Employee salary information or payments to independent contractors
- Any other expense that your company incurred throughout the year
Every small business will have different expenses. To get a full picture of costs, be sure to ask what expenses benefited your business. It is easy to overlook things like client lunches and mileage information, but travel expenses and marketing costs are expenses that you should track and include as part of your tax information.
To file your taxes, you might also need your employer identification number (EIN), if you use one. Many sole praetorships with no employees choose not to get an EIN. However, having this number for all other types of companies is a good idea.
Find the Right Forms for Your Entity.
Your tax obligations will vary based on the type of business you run. For example, if you have a C-corp or S-corp, you will need to fill out either Form 1120 or Form 1120-S. LLCs and sole praetorships have different forms as well.
Sole Proprietorships: Schedule C
A sole proprietorship is a business but not a separate legal entity. Instead, it operates as an extension of the business owner. As a result, filing taxes for a sole proprietorship looks extremely similar to filing your normal, personal taxes. The only real difference is that you will have to file a Schedule C and claim the income on Schedule C as “Other Income.”
On Form 1040 from 2021, Other income is listed on line 8, and it refers to Schedule 1. Then, Schedule 1 includes several categories of income, one of which is “Business Income,” as found in Schedule C.
Schedule C asks the taxpayer to list the business’s name and provide a description of the company’s industry. If there is a business name, the taxpayer should provide that as well. Schedule C then requests a listing of all income and all expenses.
Small business owners sometimes overlook expenses at tax time. Reviewing Schedule C could be a good way to remind yourself if you had any of the listed expenses as part of your business. However, the list included in Schedule C is not comprehensive. If you have an expense that is not explicitly stated, it should be included as “Other expenses.”
Limited Liability Companies: Schedule C or Form 1065
LLCs are extremely flexible business entities. Business owners can choose how they want their LLC to be treated for tax purposes. An LLC can be treated like a corporation, sole proprietorship, or partnership.
- Single Member LLCs: If you have a single-member LLC (you are the only owner), then the IRS will treat the LLC as a sole proprietorship unless you make an election otherwise. If the LLC is treated as a sole proprietorship, you will use Schedule C to report income and expenses.
- Multi-Member LLCs: If you have more than one owner of the LLC, the LLC will be treated like a partnership unless you elect to be treated like a corporation. Multi-member LLCs will file Form 1065, a partnership return, to report their income and expenses.
Form 1065 reports partnership income and expenses. It is set up much like Schedule C in that it requests an itemization of all income and costs for the partnership as a whole. However, it also has additional sections for taxes that the partnership may have paid throughout the year. It requires information about the type of partnership (including whether it is an LLC) and identification of the owners and their relative ownership percentages.
Fill Out Your Forms Using Your Books and Records.
Once you know which form to use and you have gathered your information, you can simply start filling out the forms. These are relatively straightforward forms, and they are short. Both forms come with comprehensive instruction booklets that you can review to help yourself through this process. You can also choose to file online if you qualify.
Many small businesses opt to use a professional tax service to help them complete their income tax obligations. These small businesses provide the information they have gathered to their tax preparer or accountant, and their tax professionals complete the forms on their behalf. Using a tax professional helps ensure that a small business does not miss any credits or deductions and provides the necessary information to the IRS.
Meet Filing Deadlines and Make Necessary Payments
Like individuals, small businesses must meet filing and tax payment deadlines. The deadline to file taxes for most sole proprietorships is April 15 of the following year after the close of the tax year. Partnerships or LLCs treated as partnerships must have their taxes filed no later than March 15 (for most taxpayers). Then, the individual owners or members of the LLC use that information to file their personal taxes by the April 15 deadline.
Many small business owners must also fulfill tax obligations throughout the year, including quarterly tax payments and other local tax costs. These obligations continue after filing their income taxes. If the payments made throughout the year do not cover the full value of the tax obligation, then the business will have to make an additional payment. Those payments are generally due by April 15 (or the next business day if April 15 is a holiday or weekend).
Tax filing can seem overwhelming, but with good recordkeeping and a thorough understanding of the process, it can be much more manageable. Good professional help can also be instrumental, especially for small businesses filing income taxes for the first time.