Tax Planning for Small Businesses

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by Advice Chaser
by Advice Chaser
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If you own a business, you’ve hopefully done your taxes already. The deadline for partnerships and S-corporations to file is March 15, though owners of sole proprietorships file with their personal taxes by April 15.

That means that now an excellent time to think about planning for your 2021 taxes. If your tax bill was painful this year, you might want to think about ways to reduce it for this year. You’ll also need to estimate your taxes ahead of time in order to pay your quarterly taxes on time and as accurately as possible.

How Your Business Structure Affects Your Taxes

Many types of small businesses are, for tax purposes, pass-through entities. That means the profits of the business pass through to the owners and are reported on the owners’ taxes. Pass-through business types include sole proprietorships, limited liability companies (LLCs), partnerships, and S-corporations. 

Sole proprietors and single-member LLCs report profits as the sole owner’s income on the Schedule C tax form. When there are joint owners, the business calculates its profits first, using Form 1065. Then these profits are divided by each owner’s share in the company and reported as income for each owner on Schedule K-1 of their individual tax return.

A C-corporation, on the other hand, does file taxes as a business, using Form 1120. Once the profits are distributed to the shareholders as dividends, the shareholders must also pay personal income tax on them.

S-corporations calculate their taxes the same way that C-corporations do: filing them on Form 1120-S. But instead of paying this tax, the business divides it among the shareholders. Each shareholder pays their share of the taxes on Schedule K-1.

Changing the structure of your business can change your tax situation. For instance, corporations are taxed at a lower rate than private income, which is the rate you’ll pay if your business is a pass-through entity. But organizing as a corporation can be burdensome. Another possibility is to elect to be taxed as a corporation, even if you aren’t one. All you need to do in that case is file Form 8832.

If you’re considering making a change, talk to your financial advisor about what effects this may have on your taxes in the coming year.

Types of Small Business Taxes

Even if your business is taxed along with your personal income, that doesn’t make the process simple. Businesses owe a large variety of taxes that private individuals never have to consider.

  • Income tax: Any profits you receive from the business are taxed as income, according to your regular tax rate.
  • Self-employment tax: Without an employer to make Social Security and Medicare deductions, you will need to pay self-employment tax on all your earnings.
  • Employment tax: You need to deduct the necessary taxes for everyone you employ: federal income tax withholdings, unemployment tax, Social Security, and Medicare taxes.
  • Excise taxes: Depending on what your business provides, there may be special state or federal taxes on these products. 

Since no deductions are made from your paycheck, you may need to pay estimated taxes quarterly. Estimate your taxes for the year and pay one-fourth each by each of these dates: April 15, June 15, September 15, and January 15. 

If you overpay, you will receive a refund when you file your annual return. That isn’t ideal, because it means you’ve given the government an interest-free loan with money you could have used during the year. However, it certainly beats underpaying and facing a fine.

Important Deductions to Know

Many of the expenses of running a business are tax deductible. As you may know, deducting an expense on your taxes reduces the total amount of taxable income you have. In the case of your business, this means you will pay less tax on your business profits.

Deductible expenses include:

  • Rent for your business location
  • Salaries of your employees
  • Benefits for your employees
  • Utilities used for your business
  • Business travel and vehicles used for your business
  • Expenses involved in running a home office
  • Advertising for your business

You may be able to save money on taxes by planning to have and deduct these expenses. For instance, you might begin a 401(k) or Simplified Employee Pension (SEP) plan, which benefits your employees while lowering your taxable profits.

The Qualified Business Income (QBI) deduction may reduce your taxable income from a pass-through company by 20%. Not everyone qualifies: the IRS excludes certain business types, as well as individuals earning more than $210,700 and married couples earning more than $421,400.

Tax Credits to Earn

Even better than a tax deduction is a tax credit. While a deduction only reduces your taxable income, a tax credit reduces the total amount of tax you have to pay.

You can earn tax credits for:

  • Paying health insurance premiums for your employees
  • Paying for employees to take family and medical leave
  • Making your facilities accessible for disabled people
  • Providing childcare for employees
  • Starting an employee pension plan for the first time
  • Employing workers who have barriers to employment, such as ex-felons or disabled veterans
  • Building or renovating key resources in high-poverty areas
  • Providing expanded sick leave for employees with COVID-19
  • Keeping employees even when the business closes or loses money

Each comes with limitations and requirements. If you hope to accomplish some of these in the coming year, research the regulations on each credit to make sure you qualify.

Get Advice Before Tax Time

Don’t wait until you’re filing your taxes to look at the tax picture for this year. Now is the time to make changes that could save your business thousands. A financial advisor can help make a plan that reduces your tax liability in advance. Contact us to connect with someone who knows the special needs of small businesses.

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