Business Taxes

Understanding Business Tax

There are only two things which are inevitable in this world. Death and taxes. Understanding business taxes can be quite daunting for business owners, new and seasoned alike. Most business owners tend to bypass this head wrenching responsibility by delegating it to accountants, book-keepers and financial advisors. However, as the owner, you are more vested than your accountant or financial adviser and would be most affected if the business is shut down due to tax issues. Understanding your various tax choices is very important for running your business. Since the government gives incentives to (small) firms in the form of tax credits and special deductions, understanding business tax can save your company money as well.

The amount of tax a business is required to pay depends on a multiplicity of factors. Understanding business taxes can help business owners avoid missed deductions and losing tax credits, not to talk of averting trouble with the Internal Revenue Service. It’s perfectly legal to use all available means within the tax code to reduce your tax liabilities. One good thing about scrutinizing business taxes is that you can view them through impersonal lenses than you would do with your individual taxes. 

Types Of Businnes Tax 

According to the IRS, there are five types of business taxes which all businesses excluding partnerships must file for. They are:

Income Tax

Income taxes are taxes applied by the Internal Revenue Service (IRS) on all forms of earnings that make up a taxpayer’s annual taxable income. These earnings include employment earnings, dividends, and capital gains. All businesses except partnerships must file a yearly income tax return. 

Self-Employment Tax

This is a tax for individuals who work for themselves, which consists of Social Security and Medicare taxes. Generally, your net earnings in the form of combined wages, tips, interests and dividends from self-employment are subject to self-employment tax. As a business owner, you can deduct your self-employment tax by estimating your adjusted gross income. 

Employment Taxes

This refers to taxes which are withheld from the employee’s pay and paid directly to the IRS by the employer. On the employee’s behalf. Taxes which are subsumed under the employment tax are the Federal income tax, Federal Insurance Contribution Act (FICA) tax, Federal Unemployment Tax Act (FUTA) tax and the Additional Medicare Tax. The Federal Insurance Contribution Act (FICA) taxes are taxes paid for social security and Medicare. This is a form of tax imposed on higher-earning employees. The Federal Unemployment Tax is tax paid to fund the unemployment account of the federal government, for employees who leave a company involuntarily. Traditionally, employers are expected to deposit either monthly or semi-weekly takes withheld from their employees’ income. These can be done by filing forms 941, 944 or 945.

Excise Tax

Excise taxes are indirect taxes that are paid by the customers directly, but are levied on the sale of specific goods and services, such as alcohol, fuel and tobacco. Excise taxes are imposed on the supplier or manufacturer who then transfers the cost to the consumer. In the U.S., excise taxes are factored into overall costs during production or when the service is being rendered. This implies that the consumer doesn’t know he’s paying excise tax. 

State Unemployment Tax

Businesses are also expected to contribute to the state’s coffers to enable it to take care of its unemployed.  State unemployment taxes are imposed on businesses to provide for employees who leave their jobs involuntarily.

Estimated Tax

This is a periodic advance payment of taxes based on the income earned and the amount of estimated tax liability that will be incurred as a result. These are taxes paid the method on income that is not subject to withholding. Such income may include earnings from self-employment, interest, dividends, rents, and alimony. Whenever you earn income, through wages, dividends, or rent, taxes are meant to be paid on it. 

However, while employees are able to have their taxes calculated because of steady wages, self-employed people and business owners have to estimate how much tax they owe because revenue may fluctuate. Business owners make an estimation of the current year’s tax based on the previous year’s income and submit payments based on that estimate. If their estimated payments are too high or too low, this will reflect in their yearly tax return. 

If you don’t pay enough tax through withholding and estimated tax payments, you may be charged a penalty. You also may be charged a penalty if your estimated tax payments are late, even if you are due a refund when you file your tax return.

Individuals, including sole proprietors, partners, and S corporation shareholders, can figure out their estimated tax by using  Form 1040-ES. Variables which may be used to calculate your estimated tax are your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year for the prior year.

Planning Your Taxes

Tax planning involves evaluating options to determine when, whether, and how to pay your taxes. It also involves strategies transacting business to minimize taxes. As a business owner, you can seek avenues to reduce your taxes legitimately. While tax avoidance is generally expected, after all, no one likes to pay taxes, tax evasion, i.e. reducing tax through deceit or concealment—is not. 

There are several ways to determine and plan your taxes. Let’s walk through these steps below. 

 Your business type: The type of business you own, determines the kind of taxes you would have to pay and how you would pay them. Depending on if your business is a sole proprietorship, partnership, limited liability company, or a corporation, there are significant income tax consequences that come with each. See this page to determine which taxes are expected for your business structure.

Determine business income and deductions: Calculating your income tax requires diligent record-keeping of your business income. This implies recording sales, purchases, and miscellaneous expenses. You can determine the tax accrued to your business by adding your sales and expenses and subtracting them from your income to arrive at your gross profit (or loss). 

Choosing tax year and accounting methods: As a business owner, your choices have tax implications. Two of such choices are your tax year and accounting method. Your tax year determines the period which your taxable income will be computed. All the income received or accrued within that period would be reported on that year’s return, along with expenses paid or accrued. The accounting method also has tax implications for your business and must be reported to the IRS. The two primary accounting methods are cash and accrual. Your business can use a hybrid that combines elements of both. Special accounting methods are also allowed under tax law.

Dealing With Uncle Sam

As a business owner, you know that Uncle Sam always comes to collect. There’s no worse feeling than having your surplus disappear because of an impending IRS payment. More disheartening is the fact that funds which could have been used to pay taxes were spent on other frivolous projects. This is why business owners need to have a good awareness of tax laws and requirements. Lack of appropriate knowledge can raise audit issues with the IRS.

IRS Audit Issues

You may be surprised, but keeping records may not be enough to protect a business in the event of an audit. Leaving out even the minutest of details could result in a criminal conviction and jail time. When the IRS comes to audit, they evaluate business and as well as personal factors. The strategy is to learn the basics of the tax laws that apply to the company and document all aspects of the business’s assets, income, expenses and liabilities. It is also worthwhile to seek professional assistance when possible.

Red Flags The IRS Look Out For

There are red flags which IRS officials look out for when auditing a business. These are:

  • A cash-driven business or one that lists many miscellaneous costs.
  • Lifestyle doesn’t match income
  • Misclassification of employees. Such occurs when employers may hire independent contractors
  • When business and personal expenses overlap 
  • Failure to report income is a criminal matter and should be taken with the utmost seriousness.
  • Mismatched taxes and employees – when payroll taxes are incomplete or inaccurate, this can trigger an investigation.