If you are starting a business, it is essential that you familiarize yourself with all of the necessary tax forms that you will need to file with the IRS and the various taxes you will be required to pay.
Every business is required to file a federal tax or information return. The type of business entity you have selected (as discussed in Choosing Your Form of Business) will determine the manner in which you will file and subsequently pay taxes. A “C” Corporation, for example, will be responsible for paying corporate taxes, while the owner of a sole proprietorship will report the income or losses from his or her business on his or her personal income tax return. Payment will then be based on the sole proprietor’s personal income tax rate.
In this section we take a broad overview of the various types of taxes that you will encounter when going into business. It is highly advisable that you seek professional guidance from an accountant before filing your tax return. Look for someone who is familiar with your type of business.
It is also important to remember that as soon as you form a business you will need to obtain an employer identification number (EIN) from the IRS by filing Form SS-4. Your EIN, combined with the individual social security numbers of your employees, will provide the tax identification data needed by the IRS.
A business is typically expected to pay estimated taxes quarterly throughout the fiscal year. Such estimated taxes are due for businesses that will anticipate having a tax bill of at least $500 at the point of filing an annual return. Form 1040-ES from the IRS will help you determine how much in estimated taxes you should pay. Payments are made to the Federal Government, and in most cases (depending on the state tax laws) to the state as well.
With the potential of facing IRS penalties, it is important to pay such quarterly estimated taxes on time or request an extension in advance of the due date. To calculate your tax bill you need to consider the following options.
You will be expected to pay:
90% of the overall tax that you will owe
or 100% of last year’s tax figure (110% if the total income is over $150,000)
or annualize based on the previous quarters, minus expenses, and then pay at your personal income tax or corporate tax rate.
Your accountant should help you make the decision as to which method of calculation is best for you based on your business entity.
The steady rise in home-based businesses has created some gray area regarding business deductions. As is typically the case, you need to be able to justify each deduction in the event a tax auditor should question it. If you conduct business from a home-based office, for example, you can claim a deduction for the portion of your home that is being used for business purposes. Accordingly, you can also claim a percentage of your utilities, phone bill and other related costs such as Internet service used for business purposes. Save your bills and show the percentage you used as a business expense.
For all deductions you will want to maintain a paper trail including receipts listing the date, name of the person or the business that received the payment, the total amount paid and the category of the business expense.
Pass Through Taxes
The business entity you select will determine whether or not there will be pass through taxation. Partnerships, LLCs and S Corporations are examples of businesses that have pass through taxes. In each of these forms of business, taxes are passed through to the owners who then report the income or loss on their own personal income tax returns.
Unlike a C Corporation where there may be double taxation, since the corporation pays taxes as a separate entity, and any shareholder receiving dividends is also subject to tax, an LLC or S Corporation can pass through profits or losses without paying any additional corporate taxes.
According to the IRS, in the case of a pass-through entity classified as a partnership, tax returns must be filed by the 30th day of the 4th month following the end of a pass-through entity’s taxable year. In the case of a pass-through entity classified as an S corporation, tax returns must be filed by the 30th day of the 3rd month following the end of such a pass-through entity’s taxable year
Although congress has toyed several times over the years, there is still no federal sales tax. Most states, however, charge sales tax on retail products sold. Sales tax rates vary from state to state and may also be imposed by a city or local government. The amount is determined as a percentage of the gross receipts for the items sold, not the net profit the seller makes on the items. Some states allow for specific goods, such as food, clothing or footwear, to be exempt from carrying sales tax. Make sure you know which, if any, retail items are exempt from sales tax in your state. Sales tax may also be imposed on rentals, leases and certain services depending on statewide regulations. If you are doing business in any state that has a sales tax, as a business owner, you will be responsible for charging, collecting and recording the tax.
The manner in which sales taxes are imposed also varies. The sales tax is typically imposed on the purchaser of the item, but in some states, the tax is imposed on the seller who usually passes the tax liability along to the customer.
Prior to filing sales tax, you will need to apply for, and secure permits or licenses for your various business locations. Such permits or licenses should be displayed at each of your business locations.
Having what is considered a “presence” in a state is the criteria used by the IRS to determine whether or not you are liable for paying state sales tax.
If you do not have a physical presence in another state, but sell items via the Internet or by catalog in that state, you can be subject to a state’s “use tax”, but typically not to their state sales tax (although the law is evolving in this area). A “presence” in another state does not necessarily mean that you have a retail outlet in that state. If you have an office, warehouse or have employees working for you in that state, the IRS may consider you to have a presence in that state. Make sure you are aware of your sales tax responsibilities in all states in which you are doing business.
Sales tax must then be reported and paid in a timely manner to the appropriate state collection office. This is usually done on a monthly basis. You need to check the requirement carefully for your state. Failure to pay sales tax or making late payments might cause you to incur a tax audit and/or potentially heavy penalties.
Payroll taxes are due either semi-weekly or monthly depending on the size of your payroll. The IRS will dictate the schedule. If your total payroll won’t come to $2,500 for the quarter, you can file quarterly.
You may consider using a payroll software program to handle your payroll needs. If your company is growing and you have an increasing number of employees, you might opt for an outside payroll service. The largest such services are Automatic Data Processing (ADP) and Ceridian. Both specialize in handling your payroll needs. ADP alone provides paychecks to over 30 million workers.
Social Security & Medicare (FICA)
The Social Security Program, created in 1935, by an act of Congress (the Federal Insurance Contributions Act or FICA) has relied primarily on withheld payroll taxes from employee paychecks to generate retirement savings. The goal was to provide American citizens with retirement income or financial assistance in the event of disability or death of the primary wage earner. Today, more than 90% of retired Americans receive Social Security. Unfortunately, because the rate of inflation has outpaced Social Security, the impact of the program on retiree’s income is less significant than in the past.
Medicare, meanwhile, is designed to help people over the age of 65 pay for medical costs. While it does not pay for many types of medications, it does help nearly 98% of Americans over the age of 65 with some portion of their medical bills.
In addition to the money that, by law, is withheld from each employee’s paycheck for FICA, the employer is also required to match the amount. The amount for FICA is currently 7.65%, which is comprised of 6.2% for Social Security and 1.45% for Medicare. To determine how much Social Security and Medicare tax to pay, see IRS Publication 15.
The time frame in which you are required to pay FICA will depend on the size of the payroll. The larger the payroll, the faster you need to send in the payments. For example, a very small business with one employee might file quarterly, while a large company with a $100,000 weekly payroll, will need to file within three days after payroll is completed. Again, this schedule will be provided for you.
Some Common IRS Tax Forms You Should Know About
SS-4: Application For Your Employer Identification Number (EIN)
W-2: Employer’s Wage and Tax Statement
W-4: Employee’s Withholding Allowance Certificate
940: Employer’s Federal Unemployment Tax Return
941: Employer’s Federal Quarterly Tax Return
1040: Estimated Tax
1099: Miscellaneous Income: Used to report compensation for non-employees
1120: US Corporate Income Tax Return
8109: Federal Tax Deposit Coupon: Used to deposit taxes.
Each business is required by law to withhold federal income taxes from the wages of its employees.
Federal Withholding Taxes
Withholding taxes are filed in accordance with the W-4 Employee’s Withholding Allowance Certificate, which is filled out by each employee. The W‑4, in conjunction with IRS Publication 15, is used to determine how much federal income tax you are required to withhold. Amounts will vary depending on:
The number of withholding allowances claimed by the employee
The marital status of the employee
Any exemptions from withholding taxes claimed by the employee
Employees can change the amount withheld by submitting a new W-4 Withholding Certificate and changing the number of withholding allowances (dependents) and their tax status.
If you do not withhold the proper amount, fail to pay federal withholding taxes or pay late, you are subject to penalties by the IRS.
Note: All businesses that employ other people on the books must have an individual EIN, or Employment Identification Number. Therefore, if you are partners in more than one company, or you purchase a new business in addition to your own, you will need a separate EIN for each business entity or company. By filing an SS-4, Application for Employer Identification Number, you can obtain additional EIN’s from the IRS service center in your state for each business.
To insure that unemployment pay is available to employees who have lost their jobs, the Federal Unemployment Tax Act of 1939 was passed by a vote in Congress.
According to the Department of Labor, “The Federal-State Unemployment Insurance Program provides unemployment benefits to eligible workers who are unemployed through no fault of their own (as determined under state law), and meet other eligibility requirements of state law.”
Businesses are required to report federal unemployment tax on IRS form 940 and pay both federal and state unemployment tax. Unlike FICA and federal withholding taxes, unemployment taxes are not withheld from the employee’s wages, but are paid entirely by the business. The state unemployment tax rate is a percentage based on the total number of employees you have and the number of former employees that are collecting unemployment at any given time.
If you pay the full amount to the state, the federal government only requires you to pay .8% for up to $7,000 in income, for each employee on your payroll, which is a minimal amount ($56). However, the federal unemployment tax is 6.2% if you do not receive the maximum state credit.
Who Qualifies As An Employee?
The proliferation of contractors, freelancers and consultants can blur the definition of who qualifies as a company employee. For tax purposes it is important that you understand which individuals are considered your employees by the IRS, regardless of common terms such as “consultants” or “contractors”. Typically, an individual is considered an employee if he or she meets several requirements including, but not exclusive to:
Receiving his or her primary income through working for your business
Receiving direction from you on a regular basis
Having his or her pay rate controlled by your decisions
Being specifically trained to perform tasks or jobs for your company
Working on your schedule, in your facilities and not having a business location of their own
Receiving benefits from your company
Together these criteria can indicate, by IRS definition, that someone is considered your employee.
Non-employees, doing work for your company, including all independent contractors, freelancers and consultants, who earn over $600 in a given year from your business, are required to receive an IRS Form 1099. The form will state the amount of money earned from your business during the calendar year. You are not required to withhold any money, and the independent contractor is, therefore, responsible for reporting the income on his or her own personal tax return.
There are a number of software products on the market designed to handle your tax related needs including payroll taxes, sales taxes and tax planning. While in the market for tax software products you should:
Make sure the program meets your system requirements
Carefully evaluate the various features
Make sure the program interfaces with software programs that you may currently be using and can import tax data
Look for a program that is “user friendly” for your staff and offers a demo
Tax software programs are typically updated annually to take into account new tax laws and changes on tax forms. Be careful that you are not using a system that has become outdated.
Among the many popular software programs you’ll find are:
Turbo Tax Business: One among several popular business software programs from Intuit, TurboTax is designed to help various types of businesses prepare tax documents. Included are: tax saving tips, deduction finding capabilities, IRS approved forms and a tax reference library. It is also designed to interface smoothly with Intuit’s QuickBooks bookkeeping software programs.
1099Pro: Designed to make tax filing easier, separate versions of 1099Pro are geared for either small businesses or large corporations. You can preview on-screen reports and enter data directly onto graphic representations of IRS forms. Preprinted forms are then easy to prepare, print and file on paper or electronically. Single-user and multi-user versions are available, enabling you to enter up to 5,000 transactions.
Master Tax: Four versions of the Master Tax software programs are available to assist you in filing payroll taxes. You can import payroll data or enter it manually. A wide range of features are offered to produce reports and file federal, state and local payroll taxes.
Websites, such as Taxsites.com provide listings of the various tax related software programs. In some cases, you can try a demo version of a program to see if it fits your comfort level.
Tax planning should be done in conjunction with the guidance and expertise of your accountant. One of your first priorities will be to make an informed decision regarding the structure of your business, as discussed in Choosing Your Form of Business. That decision, with help from your accountant, will make a significant impact on your tax status and subsequent planning.
Typically, a good tax professional will consider all aspects of your current business and personal financial situation. The size and nature of the business, number of employees, along with the most recent federal, state and local tax laws, will all play a significant role in such planning.
The bottom line will be to have a plan that limits your tax bite, while not hindering your ability to have the capital or resources you need on hand to conduct business. In addition, you want to make sure that any tax loopholes you decide to slip through, as part of your tax strategy, are legal and won’t lead to a tax audit or to IRS penalties.