What’s Different about the Tax Filing Process Starting Out?
Shawn Hessinger: What do beginning small business owners need to know about taxes that’s different than paying taxes when you’re running a small business?
Barbara Weltman: Well, taxes are just part of doing business, and there are different kinds of taxes you must deal with. You have income taxes. You have employment taxes. If you’re self-employed, you’re going to be paying self-employment tax. There are excise taxes. There are various penalties. So, you have to know about all of these different aspects.
Small business owners need to know what’s going on at the federal level, state and local levels regarding their tax filings. In essence, there are certainly a lot of moving parts you must know about. I think the important thing to know is that most small businesses use CPAs or other tax professionals, perhaps just to prepare returns or do payroll. But the important thing for small business owners is knowing they must understand what taxes are all about because it influences business decisions.
How to File Taxes for the First Time as a Business Owner
Shawn Hessinger: How does a business owner file taxes for the first time? You talked about getting a CPA. I mean, maybe that’s the first step. But how do you go about this process? What’s different than, say, filing your personal income taxes?
Barbara Weltman: The first step is keeping good books and records. As a small business owner, you must do so for your personal finances. For business, you’re required by tax rules to keep good books and records. And having those good books and records enables you to do your taxes. Add you may be able to do it yourself using the software.
I certainly don’t recommend doing paper returns anymore. There is too much opportunity for math errors and missed opportunities. At least with software, it prompts you to do what you need to do. Or you can turn to a tax professional – there are various types of tax professionals –a CPA isn’t the only option.
If you don’t know a tax professional, get a referral. Ask other local business owners who they use and get a good referral for an expert.
Some experts are enrolled agents who are licensed, in a sense, by the IRS. They get that certification. They have continuing education requirements. So, they’re supposed to be knowledgeable in what they do.
There are CPAs, but there are also regular accountants who may act as enrolled agents. There are H&R Block-kind of storefront places that will handle those kinds of things. There is an IRS website where you can find a tax professional and see their certifications, and you can search by ZIP Code.
What Tax Forms Do Small Business Owners Use for their Tax Returns?
Shawn Hessinger: What form or forms does a small business owner use to file their tax returns? Obviously, the different kinds of tax forms for different kinds of tax returns, and it depends on how your business is set up. But what tax form do you use for this in the first place?
Barbara Weltman: It depends on how your business is set up. So, for example, if you are a sole proprietor, and you haven’t taken any legal steps to form anything else, or you are a one-member limited liability company (a one-member is only one owner of an LLC). If you’re a one-member LLC, you’re treated like a sole proprietor.
For LLC taxes, you will file a Schedule C with your personal income tax return. Therefore, Schedule C will be used to report all your business income and expenses, and that goes along with your Form 1040 – your personal income tax return.
There’s no separate filing if you fall into that category – an independent contractor, same thing. A one-member LLC can opt to be treated like a corporation and tax, let’s say like an S Corporation – you have that option. So, if you are a limited liability company with two or more members, you’re a partnership and will file Form 1065.
Now, this means that the entity, the partnership, the LLC have you, don’t pay taxes. What it does is it reports its income and expenses on the tax forms. Then it issues to you the owner of Schedule K-1, which reports your share of all of this, your share of the business income or loss, your share of certain items that pass through separately to you – like – if the partnership made charitable contributions that passes separately to you, but it’s your share of that. So, if you’re 50% owner, you will get 50% of what the partnership reported.
The next kind of business would be an S Corporation – you just didn’t incorporate. But for tax purposes you are a pass-through entity and treated more like a partnership than a corporation, meaning that the S Corporation files Form 1120S. Then it’s up to the Schedule K-1 to tell the shareholder your portion of business income and expenses that you report on your personal return.
So again, the S Corporation, in most situations, there are some exceptions we won’t go into, but most times the S corporation never pays taxes. You’re doing this on your personal return, and each owner does it separately.
Let’s say you have an S Corporation with two owners. You will file the 1120S, and each owner gets 50% of what’s there. The owners may be in different tax brackets, so the owners may be paying a different tax rate on the profits. And then, of course, the last entity is a C Corporation or regular corporation that’s its own taxpaying entity. It files form 1120; it pays its own taxes, its own estimated taxes, and you, as the shareholder, get either salary if you’re working for the corporation, or maybe the corporation is paying dividends to you. You report what’s distributed to you.
Shawn Hessinger: I think a lot of beginning small businesses, particularly solopreneurs, they might go the LLC route. Could you tell us a little about the differences between taxes for an LLC and those of an individual?
Barbara Weltman: From a tax perspective, it depends on if you have just one member, one owner or two or more. So, if you have one owner, you’re pretty much the same as if you didn’t take any legal action. Now, legal action is great because it gives you the needed personal liability protection. But from a tax perspective, it really doesn’t make any difference.
But if you have two or more owners in the LLC, you’re more like a partnership. You’re going to be treated tax-wise as a partnership. The LLC is probably the most popular kind of entity these days because it gives you that personal liability protection. But from a tax perspective, it’s not that dramatically different from the other options.
Shawn Hessinger: You mentioned it a little bit; this LLC, that is likely to be treated as something else, say an S Corporation. Does that make any significant changes in the way you pay your tax?
Barbara Weltman: That’s primarily the driver for doing that. If you elect to be treated as a corporation, then you elect S Corporation status. It enables you to take a salary and have the withholding on it, covering the taxes you’d have to pay on, not only the salary you get, but also on your share of the business profits.
It eliminates, for many owners, the need to pay separate estimated taxes, which I think is challenging for owners who are just starting out. Because for many, this is a new concept. I like to think that most of these people are, you know, their W-2 employees. So, they’ve always had withholding handle their tax obligations. But now the burden is on you to ante up.
Shawn Hessinger: Does an LLC just pay quarterly taxes?
Barbara Weltman: Remember the LLC, the partnership, the SE corporation. They’re not taxpayers. They’re pass- through entities. Everything passes through to owners. The burden of paying taxes falls on owners. And they must pay estimated taxes, which happens four times a year. It’s called quarterly, but it doesn’t fall evenly into quarters.
One of the good things about being a pass-through entity is you may be able to qualify for this deduction called a qualified business income deduction. Essentially, 20% of your profits is a personal deduction on your tax return. It’s based on your business income. It’s not a business deduction. It’s a personal deduction, but it doesn’t cost you anything. You get it because you qualify, and that’s a really good write-off.
To find out which business expenses are non-deductible, you can go to the following: 16 Nondeductible Expenses for the 2022 Tax Year.
Barbara Weltman: The other thing I want to talk about and just mention is that there’s a growing number of tax credits, and tax credits are a dollar-for-dollar reduction on your taxes.
If you think of a tax deduction, the deduction is worth only as much as the tax bracket you’re in. Say you’re in the 22% tax bracket; the thousand-dollar deduction saves you $220 in taxes. But a $1,000 credit saves you $1,000 in taxes.
We hope you enjoyed our interview with Barbara Weltman. If you’d like to know more about the tax credit and tax deduction opportunities you can claim, check out these articles: The Top 25 Small Business Tax Deductions for the 2022 Tax Year and Your Guide to Business Tax Credits (2022 Tax Year).
Also, to find out how the Federal Income Tax Deductions have changed for 2022 and 2023, you can find out in this guide by Small Business Trends.
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