Here, we are going to cover the basic way that most small businesses are taxed. And while there are other tax consideration, like sales tax, we will leave those to our consultations.
Most small business entities (LLCs and S-Corps) are “flow-through” entities. That means that all profits and losses flow through the company and onto the personal tax returns of the owners. The company itself does not pay any tax (although may have to file a tax return!). Also, most small businesses have December 31 as their accounting year-end.
So, as of December 31 you must add up all the revenues you received and subtract off all your legitimate business expenses to arrive at your bottom line. If this is positive, you had profits. If it’s negative, you had losses. Profits will then become “income” to the owners and losses will become “deductions which must be included on your personal 1040 or its schedules.
TAX TIP 1: THE FIRST LESSON YOU MUST LEARN IS THAT YOU WILL PAY SOME TAX IF YOU MADE ANY PROFIT! AND UNLESS YOU PAID YOURSELF A SALARY AND WITHHELD TAXES FOR THIS, YOU WILL OWE THE IRS AT TAX TIME SO MAKE SURE YOU SET ASIDE FUNDS!
Now, if you made profits, it will normally be called “self-employment income” and you will owe three kinds of taxes on that money. First is self-employment (or, SE) tax, the second is federal income tax and the third is state income taxes.
TAX TIP 2: SINCE YOU WILL OWE TAXES ON THE MONEY YOU PROFIT IN YOUR BUSINESS, THE BEST WAY TO LOWER YOUR TAX BURDEN IS TO DECREASE YOUR PROFITS THROUGH LEGITIMATE BUSINESS DEDUCTIONS! IF YOU DIDN’T MAKE IT, IT’S NOT TAXED!
SE Taxes are essentially the employment taxes that are deducted off paychecks from an employer to contribute to social security and the medicare/medicaid funds. You probably remember this as the tax where your employer paid half and you paid half. But now, being self-employed, you owe the whole amount. This tax is around 15% (currently lower) and is taken on every dime of profit your company makes. There are ways of lowering the the SE taxes, like electing S-Status with the IRS. Please consult an attorney and accountant before making this election.
Federal Income Taxes are next. After you’ve paid the SE taxes, the profit gets added on to any other personal income you made. Hopefully you have some personal deductions (like the mortgage interest on your personal residence) to lower your overall income level. Your total taxable income is then put into an income tax bracket and taxed accordingly. Remember Tax Tip 1!
State Taxes come last. Your taxable income is then subject to whatever taxes imposed by your state. And these get paid through a separate filing.
NOTE: Quarterly Taxes: By law, you owe taxes when you EARN your money, not at April 15! Tax day is a reconciliation after all is said and done and to adjust the estimated taxes you paid all year. This is why employers are required to withhold taxes. If you are self-employed, then you must pay your taxes quarterly. Generally, you make an estimate of what your quarterly tax burden is and send that money off with a voucher. It make take some experience or consultation to estimate your tax but you can certainly do it yourself. See our Forms section.
NOTE: Salary: You can always pay yourself a salary and withhold the SE, Federal and State income taxes. You can learn to do this yourself or have your account take care of it. It is advisable for those who struggle to set aside money and might get stuck with a big bill come tax day.
TAX TIP 3: HIRE AN ACCOUNTANT. A GOOD ACCOUNTANT CAN SAVE YOU TIME, MONEY, HEADACHES, STRESS AND POSSIBLY EVEN TAXES. YOU KNOW OUR PHILOSOPHY: EMPOWER INDEPENDENT BUSINESS OWNERS TO TAKE CONTROL OF THEIR SUCCESS. BUT WE ALSO RECOMMEND THAT YOU KNOW YOUR OWN LIMITATIONS!
You will certainly have more questions, and Breglio Law Office is here to help you!
THIS INFORMATION IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL OR TAX ADVICE. PLEASE CONSULT AN ATTORNEY AND TAX ACCOUNTANT BEFORE MAKING ANY TAX DECISIONS.