Small businesses must withhold federal income taxes from their employee’s wages and pay them directly to the IRS. The amount depends on the size of the payments, the number of exemptions claimed by each employee, their marital status, and the frequency of the payments. Each employee must complete a W-4 form to determine withholding exemptions.
An excise tax is a tax paid for the sale or manufacture of certain commodities. For example, environmental taxes, communications taxes, or fuel taxes could be excise taxes levied on a particular business. Depending on what the business manufactures or sells, some businesses might not be required to pay these at all.
A sole proprietorship is a company with only one owner that is not registered with the state as a limited liability company or corporation. The owner does not pay income tax separately for the company, but he/she reports business income or losses on his/her individual income tax return. The owner is inseparable from the sole proprietorship, so he/she is liable for any business debts.
Self-employed or sole proprietors report their taxes through Form1040 and Schedule C for net profit and loss from their business. Employers are also required to make quarterly estimated tax payments if they expect their business to earn more than $1,000.
A partnership is a business, which has one or more owners and that is not a limited liability company or corporation. Partners share equal responsibility for the company’s profits and losses, and its debts and liabilities. The partnership itself does not pay income taxes, but each partner has to report their share of business profits or losses on their individual tax return. Estimated tax payments are also necessary for each of the partners for the year in progress.
Partnerships must file a return on Form 1065 showing income and deductions. Estimated tax payments are also required if they expect their income to be greater than $1,000.
Limited Liability partnerships
A limited liability partnership is a business organization that has one or more general partners who manage the business and assume legal debts and obligations, and one or more limited partners who do not participate in the day-to-day operations and are liable only to the extent of their investments. As a limited partner, you share in the profits and losses, and these are taxable events to you. This means that if the partnership makes money at a point in the year and the general partners reinvest those profits instead of paying them to you, you may have to pay taxes even if you do not receive cash in return. Be sure to consult with a tax professional if you participate in a limited partnership.
A corporation is an independent legal entity, structured and regulated by state law. This implies that the owners of the corporation are not directly liable for business losses or debts. There are “C” corporations, which we will discuss below, and “S” Corporations, which are those who elect partnership-style taxation, as discussed in the Partnerships section above. Owners pay taxes on profits paid to them through salary, bonuses or dividends. The corporation itself pays taxes on annual profits, called net income. There are special tax rates that apply to this type of business. If a corporation were to pay out its yearly after-tax net income to its owners in the form of dividends, the owners would be taxed on the dividends. This is called double taxation because the corporation’s gross income is taxed and the dividends paid out to owners are taxed again. The double taxation only applies to dividends since salary and bonuses are part of the corporation’s expenses and are tax deductible.
Corporations must file an income tax return, regardless of whether or not they received income, by filing Form 1120. “S” Corporations use Form 1120S and are also required to make estimated tax payments.
Non-profit corporations are those which are charitable, educational, scientific, literary or religious. These corporations do not pay federal or state income taxes on profits. Non-profit organizations also have the ability to raise public or private funds and receive donations from companies or individuals.
You can deduct up to 60% of your health insurance for yourself, your spouse and your dependents if you are self-employed or are an “S” corporation shareholder, or if you are not eligible to participate in an employer-subsidized health plan.
You can decide to make your home your primary place for business and be eligible for a home office deduction. In order to make this claim, you need to identify the percentage of your home that is used for business purposes. To calculate this, divide the cube-footage of your home used for business purposes by the total cube-footage of your home. This percentage is applied to indirectly related expenses like utility bills, mortgage interest or rent, real estate taxes, repairs, trash removal, and maintenance. Expenses directly related to your business such as computers and printers are 100% deductible. Your primary phone line is not deductible, but a secondary line and long-distance business calls are deductible.
Before taking advantage of these deductions, be aware of the consequences of selling your house. You might have to pay taxes on past depreciation claims and gains relative to the business portion of your home. Also, since your home office is no longer treated as part of your entire home, that part will not be subject to gain exclusion provisions for sale of a personal residence (up to $500,000 for married couples).
Also, be aware that since some taxpayers have abused home office deductions, the IRS is tightening the rules on home office deductions, so be sure to read the latest IRS information to confirm that you’re following the rules.