As a small business owner, you have a lot of responsibilities, particularly when it comes to Uncle Sam.
You have the major responsibility of declaring the income and expenses of that business and paying taxes on the profit, and if you hire employees, you have to withhold taxes on their pay and pay your company’s share of employment taxes.
The structure of your small business dictates your tax obligations, here’s a look at what to expect under each formation:
If your business is set up as a sole proprietorship, you will declare your income and expenses on Schedule C of Form 1040. It’s a simple form to complete, but it is wise to consult with a tax professional to ensure that you are declaring income properly and taking every eligible deduction. If you have no employees, you needn’t apply for a federal ID number and can use your Social Security number to identify your business.
Because you are a sole proprietor, you will not give yourself a pay check. Simply take draws from the business whenever you need money. If the business is profitable, you may be required to make estimated tax payments. Those draws that you take do not have taxes withheld from them and you must do that on your own or get help from a tax professional.
Use IRS Form 1040-ES to make your estimated tax payments, and write your Social Security number and ‘Form 1040-ES’ and the current tax year on the memo line of the check. You want to make sure you are getting credit for paying current year liabilities. If you owe for prior years, pay those in a separate check with the tax year indicated on the memo line.
When you make an estimated tax payment, you must include your contribution to your social security and Medicare accounts. This is called self-employment tax which is levied at 15.3% of your Schedule C profit and reported on Schedule SE Form 1040.
A partnership pays no income tax and income and expenses are reported on Form 1065. The profit is passed through to the partners according to their partnership percentages on Schedule K-1. These numbers are transferred to your individual income tax return where you pay your share of taxes on your share of the profit. The profit is also subject to self-employment tax. To fulfill your tax liability, you should make quarterly estimated tax payments.
Sub S Corporation
This type of corporate structure is very similar to the partnership in that the S Corp pays no income tax at the federal level. Your state, however, may require a minimum tax to be paid. Your share of the corporate profits will be declared on Schedule K-1 where it flows through to your individual income tax return
You are not required to pay self-employment tax on the profit. However, as an employee of the corporation, you should receive most of your pay through payroll. The corporation must withhold employment taxes and pay the employer’s share of your Social Security and Medicare taxes. You may take distributions of the profit from the corporation. You may still be required to make estimated tax payments to accommodate the profit that you will declare.
This legal entity is truly a separate structure and is self-contained. The corporation must pay estimated taxes if profitable, and you can do this through Eftps.com. Declare the corporation’s income and expenses on Form 1120.
As an employee, you must take payroll checks. Any dividend distributions that you receive will be subject to not only at the individual level but also at the corporate level. You’ve heard of the term “double taxation.” Well, this is what they’re talking about. The corporation is required to issue Form 1099-DIV if it distributes $10 or more in dividends to a shareholder.
Limited Liability Company (LLC)
For federal tax purposes, there is no designated tax return for an LLC. You must elect to be treated as an S Corp, C Corp, partnership or sole proprietor. Once you make the election, you must abide by the rules of that entity structure.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.