According to the Small Business Administration, a small business of any type is liable to pay a tax rate of approximately 19.8%.
Specifically, on average, a small business with just one owner typically pays a tax rate of under 14% while a business with more than one owner often owes over 23%.
These percentages may be daunting for an owner filing small business taxes for the first time, especially when the business isn’t prepared to pay them. In fact, failing to have a plan to pay taxes is one of the main reasons small businesses fail within the first few years:
This means that you need to be strategic when considering how to pay your taxes. You must have a plan, know what to expect and be prepared for it; sometimes even hiring a professional to ensure you reduce your taxes as much as possible with strategies that fit into the business’s cash flow management
In this article, we will break down tax reducing strategies, and key considerations for when you file your taxes for the first time. But before that, you must understand your business structure and why it is so important in determining the amount of tax you owe both as a business, and an individual.
Business Structure and Why it Matters
A business structure defines the legal organization of a company, and the way it is treated when the IRS reviews your taxes owed. There are many types of business structures, each with different ownership rules, personal liability for you as a business owner, and filing requirements that vary from from state to state, so check your state’s Secretary of State and Business Entity guidance here to ensure you operate accordingly.
Most importantly, you must be aware of how your business and your personal income from the business will be taxed. Some business structures shift the profits of a company to the business owner’s individual income tax return as an additional source of income for the business owner, and are often referred to as “pass through entities” for this reason.
Alternatively, some business structures require a tax return to be filed for the business itself to calculate the tax owed by the business. It is important to note that as a business owner of this type of structure, you would still be a paid employee and still pay individual taxes on the salary, commissions, or income you are paid from the business on your own tax return. While it may seem like this is being “double taxed”, this typically reduces your total tax as the business owner because you are able to take advantage of more deductions and be taxed at a lower individual tax rate through this method. Review the chart below to understand the considerations of business structures and consult with the appropriate professionals to determine the right entity type for your business based on your needs.
|Business Structure||Number of Owners or Partners||Business Owner’s Personal Liability||How Taxes Are Assessed|
|Sole Proprietorship||Single Owner||Unlimited personal liability||Personal income tax filing|
|Single Member LLC||Single Owner||Not personally liable||Passes through income to personal tax filings|
|Multiple Member LLC||Two or More Owners||Not personally liable||Passes through income to personal tax filings|
|General Partnership||2 of more owners||Unlimited liability, except in a few specific cases||Passes through income to personal tax filings|
|S Corporation||Between 1 and 100 owners||Not personally liable||Corporate and personal tax filings|
|C Corporation||One or more owners||Not personally liable||Corporate and personal tax filings|
As you can see, the considerations of personal liability and the overall tax impact on your business can vary greatly, and often have exceptions. One key exception is that as an LLC you can elect to be taxed as an S Corp as long as you follow the requirements to do so. This often isn’t a useful strategy the first time you file your taxes, but it could impact your future years of business tax filings if you plan accordingly. Again, planning for tax is a key measure for success as you launch your business and file your taxes for the first time, but is often a key determination of long term success, and why we always recommend paying the small cost for professional advice.
The Bureau of Labor Statistics has published data on private sector companies that shows roughly 20% of small businesses fail within the first year. This percentage rises to 30% by the second year and roughly half of them shut down by the fifth year. A significant reason for the failure is inability to pay taxes correctly. New business owners are unaware of the complexities of the business taxes, how to reduce their taxes, and managing cash flow to pay taxes owed on time. This often leads to mistakes and issues when making required quarterly tax payments and filing taxes each year; sometimes costing the business additional penalties and interest assessed by the IRS.
These mistakes are easily prevented with the correct professional guidance, so the question arises, “Does a small business actually require any professional help”? Let’s find out.
Do You Need a CPA?
Miscalculation of what you owe, and the payment you send in often becomes costly as a small business filing taxes for the first time. Hence, hiring a CPA can prove to be a good decision. A qualified CPA is far more familiar with the tax laws, and often can advise simple changes that save more money on taxes, while costing very little.
A professional can carry out a variety of tasks including, but not limited to accounting, payroll, budgeting, restructuring your company, and preparing your taxes. A CPA can help you with responding to IRS letters, assist with audits, and prepare quarterly and annual reports to analyze your company’s financial condition, and pain points for improvement.
We believe it is best to have a CPA on board from the start. While you may not need ongoing services, a simple consultation about which business structure to choose and how it may change over time could end up saving you thousands in taxes, and share ideas on how to track your income and expenses to file your taxes efficiently when the time comes.
We are fans of outsourcing the work you are not best at, such as accounting and tax planning services. This allows you to focus on driving revenue to keep your business growing, while providing you the expertise necessary to reduce your taxes, abide by state and federal laws, and prevent any mishaps.
What do You Need to File your Business Taxes?
In the United States you may have to pay a variety of business and personal taxes as a small business startup. The list below displays some of the common taxes you may be required to pay, depending on what you are selling:
- Income Tax
- Sales Tax
- Property Tax
- Payroll Tax
- Self Employment Tax
Other Taxes such as excise or on goods such as gross receipts taxes, alcohol, franchise taxes and dividend taxes on corporations.
Further, in order to appropriately file taxes in any year, a small business should seek to build the following financial statements:
- Cash flow statement
- Profit and loss statement
- Balance sheet
Cash Flow Statement
This showcases cash inflow into the business account within a specific period. However, it must be noted that it is different from an income statement.
A cash flow statement should be prepared every month to help you stay on top of your finances as a business. Keeping quality records of cash flow is key when your business needs help from others, to create projections of the tax you owe, or how to grow your business to make more money.
Profit and Loss Statement
The profit and loss statement will help you monitor ongoing revenues and expenses during any given time period. This will allow you to calculate profit margin, project necessary expenses, and know the profitability of your venture. We believe keeping up with this monthly or quarterly is a good start, and should be reviewed at the end of each year whether you do small time frames or not. This is a key metric to follow, and will quickly help you project your taxes due.
This report maintains record of three things: assets, liabilities and owner held equity.
- Assets: things the company owns such as physical items, intellectual property, prepaid expenses, among other items.
- Liabilities: anything you owe to a vendor, creditor, or customer that you have been paid for, but have not followed through on yet.
- Owner-held Equity: the amount of value you own in the company. It is the total cash value of the company. Equity = (Total) Assets – (Total) Liabilities. This can be used for assigning a valuation to a company in determining how much to sell the whole company for.
Developing these statements can seem daunting, but having the right tools can simplify things greatly. We suggest using something such as Quickbooks to help you automate tracking the income expenses, and report building your business needs. This will free up time and reduce the worry of tracking things correctly to a simple task of categorizing purchases and income appropriately.
In addition to the reports, you need certain forms for filing small business taxes for the first time depending on your business structure, and should always consult with a professional to file your taxes correctly.
Below are some of the forms you should evaluate if you or your business needs to file:
Form 1040: The basic form for individuals to file, often called their “tax return.” This is often all you need as a sole proprietor, unless you have some special circumstances. If you qualify as a senior you may want to be filing Form 1040-SR instead. (View instructions for Form 1040 and Form 1040-SR.)
Schedule C: to report the profit or loss for your business as a sole proprietor or single member LLC owner that does not elect S Corp tax treatment. (View instructions for Schedule C.)
Schedule SE: to calculate the self-employment tax you may owe in a variety of business structures. (View instructions for Schedule SE.)
Form 1065: for partners of certain companies to report their portion of profit from the business. (View instructions for Form 1065.)
Form 1120-S: Specific reporting for S Corporations at the company level. (View instructions for Form 1120-S.)
Form 1120: Specific reporting for C Corporations at the company level. (View instructions for Form 1120.)
Apart from the above, there can be other “excise” tax forms you are required to fill out if you are self-employed or a small business owner. Some of the excise tax categories include:
Use of different kinds of products, facilities, and equipment
- Manufacture or sell certain kinds of products
- Receive remuneration for certain services
- Operate some kinds of businesses
These are some of the forms and the corresponding categories that are required to pay excise tax. If these apply to you, we suggest just getting a CPA. They will be worth the price to ensure you don’t create any headaches for yourself.
Form 720 includes some business categories such as:
Sale or manufacture of several articles
Air transportation and communication taxes
(View instructions for Form 720.)
Form 2290: Applies to businesses that employ vehicles weighing 55,000 pounds or more. (View instructions for Form 2290.)
Form 730: A wager or gambling business is liable for federal income tax. (View instructions for Form 730.)
Make sure to fill out all of the forms you need since filing incorrectly will likely launch an audit within two – three years of filing, and come back to bite you when you least expect it.
Deductible Business Expenses
Knowing how many of the expenses you pay can be deductible is the best start to drastically reducing your taxes. For example, life insurance premium payments, or health insurance payments can be deducted by certain business structures, while they are not allowed by others. As a small business, to claim these deductions you must ensure that they are, in fact, “essential and ordinary”.
An essential expense is one that is required to operate your business, while An ordinary expense is one commonly accepted in your business structure.
For figuring out what is deductible for your business you should consider the following expense categories:
- Capital Expenses
- Price of Goods Sold
- Personal Expenses
This cost is nothing, but your investment in your small business. These are basically your assets you capitalize on.
- Business Assets
- Business start up cost
- Personal Expenses
Price of Sold Goods
While filing taxes for the first year, a small business must subtract the cost of goods sold from the gross receipts. This is the gross profit you make in that financial year.
To make things clearer, here is what you need to remove
- Cost of raw materials or products, including freight
- Rent or home office cost
- Mileage expense
- Utility cost
- Labor cost (including annuity plans or pension contribution into their account)
Generally, you cannot deduct personal expenses used for family or general living such as food at home. However, if a part of it is used for the business, such as a cell phone plan or car cost, estimate the percentage of time you use the item for the business and multiply the annual cost by that percentage to determine how much is deductible for the given year.
It is important to note that the items listed above do not cover all expenses you may deduct. This is why working with a CPA that knows your situation, and can provide insight regarding your cash flow and profit and loss statements is critical. They will likely be able to uncover additional costs such as health care, or meals and entertainment that are allowed to be deducted if you make a small change to the way you operate. Once you have identified your revenues, expenses, and review what you are allowed to deduct you can start work on determining how much you owe in tax.
How to Calculate What You Owe in Taxes?
Small business owners are often perplexed and find it difficult to calculate the taxes they owe with confidence. They are right to do so as it can be a tedious and confusing process, that in the first time you file taxes shows you spent more than you made. Good news, this can actually offset any income you may have from other sources if you do it right, however it is important ensure you have good records to back up whatever it is you submit.
The start up cost of the small business combined with just starting to generate revenue is most times what accounts for this error.
With this being said it is important to understand that if your business is profitable, your taxable income is not the profit your business makes. Instead, you are liable to pay the tax on the income you make after reducing the credits or deductibles. Be prepared to see a loss in your first year or two when you reach this step, and if you have any questions be sure to talk with a licensed professional.
We know filing small business taxes for the first time is not easy. This experience can be tedious, time consuming, and frustrating. So we hope that the information listed above helps you understand some of the basics for filing your taxes in the first year, but if you have any questions it is worth the small cost of hiring a professional to look everything over with you. You can even use Turbo tax and speak with a professional directly through their platform to ensure you are filing your tax returns correctly from the convenience of being at home.
Keep in mind if you decide to file your tax return yourself that you should also consider what type of business entity you are before the calendar year ends, keeping good records along the way, and to determine what is a legally deductible expense when you file your returns.
With this said, we strongly suggest finding a CPA to help you with these processes to prevent audits, tax penalties or interest, and with new gig-working sites such as Thumbtack and Upwork being free to sign up, it is easier than ever to find virtual CPAs that specialize in tax preparation, tax planning, and accounting services that to ensure you are operating correctly.