Understanding Small Business Taxes

Running your own small business means you’re the boss! You never have to worry about getting fired, so that’s one great reward! While you think about how you’re the one in charge who’s calls all the shots, you should be worrying about something more far more important that could be thrown your way without warning -- business taxes. You don’t want an unexpected visit from Uncle Sam and the IRS, do you?

Now that you’re a self-employed small business owner and entrepreneur, you need to learn everything you can about three general types of taxes: income, estimated, and employment. You can’t avoid paying your taxes so you might as well learn more about them!

1. Income tax:

All businesses have to file an annual income tax return. The federal income tax is a pay-as-you-go tax, which means you must pay the tax as you earn or receive income during the year. Small businesses, unlike C corporations that pay their income tax at the corporate rate, are considered “pass-through” entities and are taxed at an individual rate. We’ll talk in more detail about C corporations and pass-through entities in a few moments.

1. Estimated tax:

Individuals who expect to owe $1,000 or more make estimated tax payments. Freelancers, independent contractors, and small business owners usually pay estimated taxes, covering not only income taxes, but other taxes such as self-employment tax and alternative minimum tax. With estimated taxes, the year is divided into four payment periods. Make sure you fully pay them or you’ll face tons of penalties and interest from the IRS.

When do you make your quarterly estimated tax payments? Use the chart below to help you stay on track. Due to the ongoing coronavirus pandemic, some due dates may be extended. Check for any updates at www.irs.gov/faqs/estimated-tax.

Payment Period:Due Date:January 1 - March 31April 15April 1 - May 31June 15June 1 - August 31September 15September 1 - December 31January 15 of the following year

1. Self-employment tax:

Small business owners and entrepreneurs must pay self-employment taxes for social security and Medicare. This tax funds your social security coverage, providing you with retirement benefits, disability benefits, survivor benefits, and hospital insurance benefits.

Still unsure if you need to pay the self-employment tax? Well, if your net earnings from self-employment were $400 or more, or you’re a church employee who receives $108.28 or more in wages, you are responsible for paying the self-employment tax.

The Business Tax Rate You Need to Know:

Want to know the tax rates the government expects you to pay? Well, that solely depends on your business structure. Here are two important ways you could figure this out:

1. C corporations:

Due to the Tax Cuts and Jobs Act that passed in 2018, the income tax rate was permanently set at 21% for all businesses set up as C corporations. However, if the corporation pays dividends, shareholders must also pay taxes on their stock on their personal tax returns, meaning profits from C corporations are taxed twice. There are two types of dividends you need to know: qualified and unqualified. Let’s take a closer look at both of them:

• Qualified: If you own the stock for more than 60 days, the dividend is qualified and you will receive favorable tax rates. You’ll also be taxed at long-term capital gain rates.

• Unqualified: Commonly known as ordinary dividends, these stocks are taxed at the shareholder’s regular income tax rate.

1. Pass-through entities:

If you’re a pass-through entity, your tax rate will be the same as your personal income tax rate. Just so you know, there’s also an alternative minimum tax, but that only applies to wealthy taxpayers who use loopholes to avoid paying taxes. This specific law uses a different set of rules to ensure high-income earners pay at least the minimum amount of income tax.

Want to learn what type of businesses are considered pass-through entities? Here’s an introductory crash course that will describe each one to you:

• Sole proprietorship: You’re the only owner and you’re solely responsible for everything. Please remember to keep your personal and business finances separate so you don’t mix the two and get into trouble with the IRS.

• Partnership (limited and limited liability): A business that’s owned by two or more people. With limited partnerships (LPs), the general partner oversees and runs the business while limited partners do not partake in managing the business. However, the general partner has unlimited liability for the debt while any limited partners have limited liability up to the amount of their investment. On the other hand, limited liability partnerships (LLPs) protect all partners from being held responsible or liable for another partner’s misconduct.

• Limited liability company: This business structure combines the characteristics of a corporation with a partnership or sole proprietorship. Limited liability companies (LLCs) separate personal assets and liabilities from business ones, reducing your personal risk if the business fails. You don’t deal with corporate taxes with an LLC, but you’re considered self-employed and need to pay self-employment taxes.

• S corporation: With an S corporation, you avoid the double taxation that happens with C corporations. You’re not subjected to corporate tax rates as S corporations allow profits and losses to pass through your personal income. However, there are a few limits you need to consider: you’re not allowed to have more than 100 shareholders and they all need to be U.S. citizens. S corporations continue to follow traditional filing and operational process, which can be extremely frustrating.

While we’re all staying safe at home as we fight against COVID-19, learn as much as you can about small business taxes. Understanding the taxes you’ll pay is vital as you’ll have benefits available to you when you need them. You can also have faith knowing that wealthy taxpayers aren’t using sneaky loopholes to avoid paying their fair share of taxes. If you’re still unsure about small business taxes, seeking out help from a dependable tax professional who will get you on the right track and make sure you’re not underpaying or overpaying your taxes!

References:

“Business Taxes.” IRS, 25 Nov. 2020.

“Small-Business Taxes 101.” Dave Ramsey, 12 Nov. 2020.

Tarver, Evan. “Limited Partnership (LP).” Investopedia, 29 Apr. 2020.