Taxes for Small Businesses
by Susannah McQuitty
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Does the phrase “taxes for small business” strike fear into your heart? My guess is that it doesn’t exactly conjure up rainbows and butterflies (has the mention of taxes ever done such a thing?), but a lot of fear surrounding taxes for small businesses is simply fear of the unknown.
Is running a small business going to be easy? Nope. As my mom is fond of saying, “If it was easy, everyone would do it.” But owning your enterprise has its rewards, too, especially if you understand how taxes are applied. My bet is that you end up saving a lot more money as an entrepreneur than you think you will, so let’s get into it and see how this is going to work.
The next step in self-employment
For small businesses, all those freelancing tasks we talked about last week – doing quarterly estimated taxes, keeping good records, paying self-employment taxes, and filing a return – are still on the checklist (oh, happy day). The big differences between freelancing and operating a small business are getting an Employer Identification Number, choosing a business structure, and deducting certain kinds of taxes.
Choosing a business structure
Choose a what-now? A business structure determines your personal liability, how you finance your enterprise, how you’re compensated for your work, and how your taxes are calculated. There are 4 basic types of business structures: Sole proprietorships, partnerships, corporations, and LLCs.
Sole proprietorships are the most common among small to very small businesses where there is one owner. You report your net income, or loss, on your individual tax return by filing a Schedule C. You’ll pay self-employment tax, but you’ll get to deduct half of it on your 1040 return.
Partnerships are exactly what they sound like: if your business is run by two or more people who share in contributions, profits, and losses, you’ve got yourself a partnership. A partnership is a type of pass-through entity, which means that income and loss from the partnership “pass through” the business and aren’t taxed until they get to the partners’ tax returns. Partnerships still have to file a return as a business, but it’s really just a way of acknowledging income and loss and then passing the actual taxes to the partners themselves.
Corporations are the next step up from partnerships, and there are two different kinds: C corporations and S corporations. Instead of being owned by partners, corporations are owned by shareholders. Corporations have the perk of limited liability; this means that if your company goes into debt, you as a shareholder aren’t personally responsible to repay the debt, so your personal assets are protected.
The difference between a C and an S corporation is that S corporations are pass-through entities, like partnerships. C corporations, on the other hand, actually get taxed twice, both at the corporate and shareholder levels. So why would anyone choose a C corporation? Well, S corporations have to be U.S.-based and are limited to 100 individual shareholders. There are other reasons as well, but that’s a bit beyond our scope for today.
And then we have LLCs. LLC owners, or “members,” are protected from liability like a corporation (or limited partnership), but the IRS considers LLCs “disregarded” entities, so they have to be taxed like a partnership, corporation, or sole proprietorship. LLCs with a single member are taxed as sole proprietorships or corporations, and multiple-member LLCs are taxed as partnerships or corporations. Each state has different LLC options, so be sure to do some digging on LLCs in your state when you’re ready to look into business structures.
Each business structure has a time and place, so it’s definitely worth it to do some research to see which one will be best for your business. For more info, there’s more about the wonderful world of business structures in our Tax Guide.
Getting an Employer Identification Number (EIN)
So after you’ve decided what sort of business structure you want to use, it’s time to get your Employer Identification Number (EIN). An EIN is a fancy name for a number that identifies you as a business for tax purposes.
Getting an EIN isn’t hard, and it’s free through the IRS. Just know that you’ll need a valid Taxpayer Identification Number (your SSN, most likely), your business information, and enough time to complete the application in one sitting, since you can’t save your place and come back later. To get an idea of what you’ll need for the online application, click here.
Don’t forget deductions
Now, we’ve talked a lot recently about what sorts of expenses you can deduct while self-employed. One of those awesome perks is that, as a small business owner, you can deduct part of certain federal, state, local, and foreign taxes that are directly related to your business. Some of these include personal property taxes, real estate taxes, and half of your self-employment taxes. Click here for the full list.
And there are plenty of other deductible expenses you can take advantage of, all outlined in our Tax Guide.
King of the Self-Employment Hill
Moving up in the business world is never going to be a walk in the park, but as you grow, you’ll learn how to jump the hurdles and keep jumping them. We’re here to make sure the tax leap isn’t as mountainous as you might have thought. And if you still want to know more, our Tax Guide is always there with more in-depth examinations of business structures, deductible expenses, and self-employment details.
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