5 Tax Considerations To Keep in Mind as a Small Business Owner
Owning your own business is synonymous with the American dream: being able to build something that will allow you to earn a living and perhaps even support your family. But having your own small business can also make your taxes more complicated.
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For example, you will have to pay taxes every quarter instead of once per year. But it isn’t all bad: Small business owners have some tax advantages that employees don’t. We’ll cover the good, the bad, and everything business owners need to know about taxes.
Make Your Estimated Tax Payments
One of the most important things to remember as a small business owner is to pay your estimated taxes, also known as quarterly tax payments. Small business owners are required to make four tax payments per year, and this includes self-employed individuals.
“IRC § 6654 states that if you expect to owe at least $1,000 of taxes when you file your return, you are required to make estimated tax payments during the year or face an underpayment of estimated tax penalty,” said Logan Allec, CPA and founder at Choice Tax Relief.
While taxes can be complicated, Allec noted that there are two ways the IRS allows you to calculate your estimated tax payments:
- Pay 90% of your actual current year liability in estimated taxes throughout the current year
- Pay 100% of your actual prior year’s tax liability in estimated taxes throughout the current year
“Whichever method you use,” Allec said, “the IRS requires that you pay in 25% of your estimated taxes for the current year by April 15 of the current year, 50% by June 15 of the current year, 75% by September 15% of the current year, and 100% by January 15 of next year.”
Don’t Rush Into Forming an S Corp
Business owners sometimes rush into forming S corporations as soon as they reach certain levels of income because it may allow them to save on payroll tax. But forming an S corporation isn’t necessarily the right move for everyone, Allec said.
“For example, the payroll tax savings generated by making the S corporation election has been diminished somewhat as a result of the qualified business income (QBI) deduction under IRC § 199 created as part of the 2017 Tax Cuts & Jobs Act.” This act was passed during the Trump administration.
“Assuming you qualify for the deduction in full,” Allec said, “reporting your business income on Schedule C of your tax return — which you would do if you did not elect for your business to be taxed as a corporation for income tax purposes — would generally mean that you could deduct 20% of your net business income as a QBI deduction.”
This deduction sounds enticing, but it may not reduce your tax liability as much as you expect, according to Allec. “With an S corporation, however, you only get the 20% deduction on the amount of business income passed through to you on your K-1 from your S corporation — you do not get the deduction on the wages you pay yourself from your S corporation.”
Take Your Home Office Deduction
If you have a small business and work from home at least part of the time, you can qualify for a home office deduction. Generally, the space must be used for business purposes and nothing else. You can deduct an entire room you use as an office, or you can deduct just a desk you exclusively use for work in your bedroom. You also can deduct a portion of your home expenses (rent or mortgage interest, insurance, property taxes, utilities, etc.).
However, some people have been hesitant to take their home office deduction.
“Many small business owners are under the impression that taking the home office deduction is an automatic red flag for an IRS audit,” Allec said. “With so many people working from home, this is simply no longer the case.”
You Can Claim Paid Sick Leave
The pandemic caused millions of people to call out sick when they otherwise would not have, resulting in huge losses in productivity. For example, an early 2021 UN report stated that the pandemic contributed to a 4.4% global GDP loss. Business owners have had to bear the brunt of some of that loss in terms of lost productivity.
However, U.S. federal legislation helped with that loss somewhat, said Liam Hunt, analyst at SophisticatedInvestor.com. “The Families First Coronavirus Response Act (FFCRA) mandated that many small and medium-sized businesses provide paid sick leave and family leave for employees who were impacted by COVID-19 until [December 31, 2022],” Hunt said.
He said the bill offered a generous tax credit to business owners. “If you paid for your employees’ sick leave until this date for reasons pertaining to COVID-19, you can claim 100% of the costs incurred as tax credits. You can also claim the employer’s portion of the FICA payroll taxes garnered by sick-leave expenses.”
But You Can’t Deduct Everything
One mistake small business owners are known to sometimes make is being too fast and loose with claiming expenses. This can be problematic, especially if you are audited.
“In order for a business to deduct an expense, it must be reasonable and ordinary,” said Morris Armstrong, founder of Morris Armstrong EA LLC. “That is not always black and white because a lease payment of a Maserati may be much higher than a Corolla, but the Maserati may be required in your market.”
In general, the expense should not only be for something you use for your business, but it should also be ordinary and necessary. If it isn’t, you could get into trouble with the IRS.
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