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Taxes probably aren't why you started a business (unless you’re an accountant), but understanding your business’s tax obligations and how to fulfill them can alleviate the stress of missing deadlines and facing penalties. Here’s what you need to know about business taxes.
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What are business taxes?
Business taxes are money deducted from the business’s or an employee’s income and paid to a government entity. Business owners must pay a percentage of business income to the Internal Revenue Service (IRS) quarterly or at least four times a year. Otherwise, they risk a penalty for underpayment.
Business taxes include a variety of levies, such as income and excise taxes, which business owners pay directly or withhold from their employees’ income to remit to the IRS. The federal government, states, or local municipalities can levy taxes. Some business taxes fund federal social programs such as Medicare and Social Security.
Types of business taxes
Your tax filing responsibilities depend on the type of business you run and whether you have employees. Here are the main types of business taxes:
FICA stands for Federal Insurance Contributions Act and is the Social Security and Medicare federal payroll taxes deducted from employee paychecks by their employers. The Social Security tax deducts 6.2% from gross income, and Medicare deducts 1.45%. The employer must match this 7.65% contribution for a total FICA tax of 15.3%.
Income tax is an annual federal tax paid to the IRS and is submitted by filing an income tax return. Most states—excluding Florida, Nevada, Wyoming, South Dakota, Texas, Tennessee, Washington, and Alaska—impose a state income tax, which requires a separate payment.
Every self-employed person in the US making more than $400 in annual net income is required to pay income tax to the federal government. By law, all employers must withhold taxes, including income taxes, from employee wages. The employer must then pay the withheld amounts to the IRS.
Self-employment tax is like the FICA tax usually deducted from an employee’s paycheck. This tax is how self-employed individuals pay their Social Security and Medicare taxes. When deducting FICA from an employee’s salary, the employer must remit both the employee and employer’s portion as taxes. Self-employment tax is 15.3% of the business owner’s income. The self-employment tax is the same as the total FICA percentage because the self-employed individual pays both employee and employer portions.
Employment taxes apply to businesses with one or more employees. Business owners are responsible for calculating, withholding, and remitting federal taxes from their employee’s income to the IRS. Employment taxes include federal income tax, Social Security tax, Medicare tax, and federal unemployment tax. Employers are required to pay a matching portion for their employees’ Social Security and Medicare taxes. Employers, rather than employees, must pay federal unemployment tax, which is 6% of the first $7,000 of the employee’s income.
Excise tax is an additional tax some businesses pay depending on their industry and activities. Excise tax imposes a fee on specific items or imported goods. It’s commonly referred to as a “sin tax” because it applies to products and services the government deems unhealthy or unnecessary, such as alcohol, cigarettes, gambling, and indoor tanning services. Federal, state, and local governments can impose excise taxes. For example, a federal fuel tax is an excise tax of 18.4¢ a gallon on gasoline and 24.4¢ per gallon of diesel.
Common tax deductions for small businesses
One way to reduce the amount of taxes you owe is to take advantage of tax deductions, which can reduce your business’s taxable income. Here are a few standard business tax deductions:
- Office supplies. Business-related items, such as paper, postage, boxes, and shipping materials and packaging, are deductible expenses.
- Business use of a home. If you work out of your home, you may be eligible to deduct a portion of your rent or mortgage payment as a business-related expense. The IRS can help you determine how much may be deductible.
- Rental fees. Rental payments for office, warehouse, or commercial space are tax deductible.
- Insurance. Business insurance premiums, such as those paid for malpractice or liability insurance, may be deductible expenses, as long as the insurance is deemed necessary. Self-employed individuals paying for health insurance may also deduct insurance premium expenses.
- Employee salaries or contractors. Employee salaries and benefits are tax-deductible expenses. Fees paid to freelancers and independent contractors are also deductible.
- Professional services. If you hire a lawyer or accountant to help with your business needs, their fees are tax-deductible.
- Other business expenses. Money spent on advertising, web hosting, software, and education to improve business skills can qualify as tax-deductible expenses.
How to file income taxes for your business
- Determine your business structure
- Gather your records
- Estimate income
- Fill out the form
Making business tax payments is easy if you plan ahead. Make it a regular practice to avoid late fees and penalties. As a business owner, you must make estimated tax payments every quarter in addition to the annual filing. Your estimated tax payments include your income taxes and self-employment taxes.
The quickest way to pay estimated taxes is through the IRS website. Navigate to the “Make a Payment” section, where you can pay directly from your bank account with no fees. You can also make payments by phone or mailing.
Before April 15 rolls around, get ready to file annual tax returns for your business. Here’s how:
1. Determine your business structure
Your business structure determines how you will file your annual return. Self-employed individuals working as sole proprietors, independent contractors, or sole LLC owners file their individual returns on Schedule C. Business owners with corporations or partnerships file separate corporate tax returns.
2. Gather your records
Have records of your income and expenses so you can calculate your deductions. Gather all records of the income received or produced during the quarter. These include deposit slips, pay stubs, 1099 forms, and bank statements.
3. Estimate income
Estimate how much income you expect to receive during the year. Estimating future income ensures you don’t underpay taxes, which can result in a penalty. If you pay enough to avoid the underpayment penalty—typically 90% of the total tax due—but still owe a portion, it’s added to the following year’s amount.
Generally, the IRS requires businesses to pay estimated taxes if they expect to owe tax of $1,000 or more when they file their tax return. This applies to sole proprietors, partners, and S corporation shareholders who expect to owe taxes on their share of the income from the business. Corporation owners must also pay estimated taxes if they expect to owe taxes of $500 or more. The IRS offers a worksheet to help calculate what you owe.
4. Fill out the form
Fill out the appropriate form (or have your tax preparer fill it out) based on your business type and file it by the deadline. Sole proprietors file Schedule C for their business with their personal tax return, which must be postmarked with correct postage and deposited in the mail by April 15. (Corporate tax returns are typically due by March 15.) These dates can fluctuate if they fall on a weekend or holiday.