Small Business Tax Basics
April 18, 2022, which is Tax Day in the U.S., is generally considered most Americans’ annual financial headache. How much of a headache depends on how well you’ve planned and the strategies you have in place to mitigate the impact that unexpected taxes can have on your business.
Most business owners understand the importance of annual planning for labor, cash flow, inventory, sales, and marketing. Just as important, yet often overlooked, is a plan to pay federal, state, and local taxes, as well as strategies to minimize your overall tax burden. Understanding small business tax basics and planning for taxes at the beginning of each year will ensure accuracy, reduce the risk of tax penalties, and keep your tax outgo to a minimum.
Types of Business Taxes
The legal structure (sole proprietorship, limited liability company (LLC), corporation, etc.) of your business will determine much about your taxes, including how and where you file your returns. Taking time to investigate the advantages and disadvantages of each business type should be paramount when launching a new business.
If this is your first tax year as a business owner, you need to be aware that paying taxes on business income and paying taxes on employment income differ in several ways. You should familiarize yourself with the different types of taxes you may be required to pay, which include:
- State income taxes
- Estimated quarterly taxes
- Federal income taxes
- Social security & Medicare Taxes
- Federal Unemployment Taxes
- Self-Employment Taxes
- Excise Taxes
Quarterly Estimated Taxes
Individuals, including sole proprietors, partners, and S corporation shareholders who will owe tax of $1,000 or more when filing their tax return, are required to make estimated tax payments each quarter. Corporations generally are required to make estimated tax payments if they expect to owe tax of $500 or more when their return is filed. Depending on where your business is located, there may be estimated tax to the federal government and possibly one or more states. For complete information regarding quarterly, estimated tax payments, see the IRS Estimated Taxes Guide.
Failing to pay your estimated taxes every quarter could result in having to pay a hefty penalty with interest. Penalties are generally assessed based on the estimated tax you should have paid each quarter and the length of delay in payment.
Calculating Business Taxes
When paying quarterly estimated taxes, you generally pay both the tax on income you made plus the self-employment tax, which refers to Social Security and Medicare taxes. For information on the current self-employment tax rate, see the IRS Self-Employment Tax guide. Keep in mind that for self-employment tax, in your own business, you are often both the employer and employee.
Due Dates for Filing Business Taxes
Most tax due dates are the same each year. However, if a date falls on a weekend or holiday, the date is pushed back to the next business day. Here are the important dates you need to mark in your calendar for 2022:
4th Q estimated taxes (previous year) – January 15
Individual income tax return – April 15
Individual income tax return extension – April 15
1st Q estimated taxes – April 15
2nd Q estimated taxes – June 15
3rd Q estimated taxes – September 15
Individual income tax return (with extension) – October 15
Small Business Tax Strategies
After you understand business tax basics, you should look for ways to minimize your tax liability and save money when Tax Day rolls around. Consider implementing any of the following strategies:
1. Find ways to reduce your adjusted gross income (AGI)
As a business owner, many of the taxes you pay are based on your adjusted gross income, or AGI. To lower your AGI, either reduce your salary or:
- Contribute to a tax-deferred retirement plan
- Itemize deductions if they exceed your standard deduction
- Contribute to a health savings plan, or HSP
2. Get creative with tax elections
You can reduce your taxable income by implementing some strategies to handle business expenses. For instance, if you purchase new business equipment or machinery, you can deduct the cost upfront, to $1 million under the 2018 tax law. If you are a new business owner, you should consider depreciation as an alternative. This allows you to deduct the value of your acquisitions in future tax years instead of all at once. That’s beneficial if you expect your profits to increase and push you into a higher tax bracket.
3. Defer taxable income
If you are using cash-method accounting for your business, you can minimize your taxes by carefully managing your business taxable income. If you foresee that your business income tax will be at the same (or lower) rate next year, here are some tips to help you defer some of that income:
- Use your business credit card for recurring expenses. You can deduct the expenses in the current tax year but won’t pay the credit card bill until next year.
- If your cash flow allows, mail out checks and pay invoices a few days before the end of the year rather than waiting until the actual due date. You will deduct the expenses in the year you made the payments, which will lower that year’s business income.
- Prepay expenses like office rent, or possibly your insurance premiums at the end of the year.
- Delay sending invoices until the last few days of the year. That way, you’ll receive payment in the new year and can report the income in the new year as well.
4. Hire your spouse or children
Many small business owners hire their spouse or children, if they can contribute to the business. Children work tax-free if their income is below the IRS threshold, and thanks to the Tax Cuts and Jobs Act of 2018, the exemption amount for minor children nearly doubled. An added bonus is that you put the money you pay your children into an education savings account or Roth IRA. And bonus: you won’t need to withhold payroll taxes!
5. Pay Down Your Debt
If you have the cash available, consider making extra payments or even paying off outstanding business loans so that you can deduct the interest when filing your tax return. Just remember that the IRS does not allow an interest deduction for personal expenses paid with a credit card.
6. Consider changing your business entity type
As mentioned previously, the business entity type you choose will impact your tax liability. If you are a sole proprietor, a Limited Partnership, or certain types of Limited Liability Company, you may also have to pay an additional 0.9% Medicare tax. If your estimated taxes are on the high side, you may want to take a step back and reorganize your business. For example, if you are an LLC and reorganize as a C Corp, you will obtain additional tax benefits. Understanding the pros and cons of different business entities can be confusing. It may be worthwhile for you to work with a tax professional to reorganize.
7. Hire a tax professional
Business tax filings are complex and if not done properly, can result in hefty, unwanted penalties and interest. Many small business owners would rather chance paying a tax advisor than chance being on the hook for mistakes with the IRS. At the end of the day, consulting with a tax accountant is one of the smartest ways to minimize your tax liability and prevent expensive errors.
Paying taxes is an obligation of all for-profit business owners, but the amount you owe shouldn’t be a burden or surprise. It’s critical to understand how business taxes work and estimate the amount you need to pay each quarter and year to ensure you have the appropriate amount of money on hand.
In addition to having a tax advisor, you need a trusted business banking partner who will listen to your goals and help you achieve them financially. Allegiance Bank’s full and flexible suite of treasury management services can help with the heavy operational lifting, making your business stronger and your job easier. If you’re ready to get started, contact us and one of our business banking associates will reach out to you.
Want to keep growing your knowledge of financial basics? Check out the Allegiance Bank Financial Education page.