This article addresses general requirements for U.S. based small businesses. Please reach out to a local attorney or tax advisor for advice specific to your location if you are based outside the U.S.
All businesses, except partnerships, must file and pay taxes on any income earned or received during the year. Businesses that are partnerships file an annual information return to report income, gains, losses, and other important tax information. Almost every state imposes a business or corporate income tax, though each state and locality has its own tax laws. Find out the business income tax requirements in your state or territory.
The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. An employee usually has income tax withheld from his or her pay. If you do not pay your tax through withholding, or do not pay enough tax that way, you might have to pay estimated tax. If you are not required to make estimated tax payments, you may pay any tax due when you file your return. For additional information refer to Publication 583.
Individuals who conduct their own business typically have to make estimated tax payments. Estimated tax is the method used to pay taxes on income that is not subject to withholding. This includes income from self-employment, interest, and dividends. You may also have to pay estimated tax if the amount of income tax being withheld from your salary, pension, or other income is not enough.
To pay your taxes, you will need to set aside money from the payments you receive from clients. You must make estimated tax payments if you expect to owe at least $1,000 in tax for the year after subtracting any tax credits. The amount you need to pay in estimated tax payments for the whole year is equal to 100% of what you owed in the previous tax year or 90% of what you expect to owe in the current tax year. If your adjusted gross income exceeds a certain threshold, substitute 110% for 100%.
But how do you predict what you’ll earn for the year when you’ve never been in business before? It’s difficult, and the IRS doesn’t expect you to do it. The Estimated Tax Worksheet on page 5 of IRS form 1040-ES, Estimated Tax for Individuals, provides a formula for calculating how much tax liability you’re likely to incur for the year based on your quarterly income. Each quarter, you’ll need to run through this worksheet to calculate how much to send in. If you’re good at doing your own taxes, you can complete this form yourself, either by hand or with tax software. If not, hand the work off to your accountant.
You’ll need to submit your estimated federal tax payments quarterly. Each period has a pay online, by phone, or by mail, refer to the section of Form 1040-ES titled "How to Pay Estimated Tax." For additional information, refer to Publication 505, Tax Withholding and Estimated Tax.
There isn’t really a separate tax on the self-employed. Self-employment tax refers to Medicare and Social Security payments. As an employee, 6.2% of your paycheck is withheld for Social Security and 1.45% is withheld for Medicare. You may also owe an additional 0.9% Medicare tax on wages in excess of $200,000 (there’s no employer match for this tax). If you earn more than $127,200 in 2017 ($128,700 in 2018), you don’t have to pay Social Security taxes on income above that cap.
Your employer is required to match those amounts. When you are self-employed, you are the employer, so you are required to match those amounts. This matching portion is what is known as self-employment tax. In total, you will pay 15.3% in Social Security and Medicare taxes on 92.35% of your net earnings (unless your net earnings are less than $400). The employer matching portion is tax deductible.
Self-employment tax is not paid quarterly but is submitted as a lump sum with your annual tax return using IRS Schedule SE, Self-Employment Tax.
If you hire even one employee for your small business, or if you structure your business as a C corporation (which makes you an employee), your tax situation becomes much more complicated. You’ll have to withhold federal and state income taxes and FICA (Social Security and Medicare) taxes on behalf of each employee. You’ll also have to pay the matching portion of Social Security and Medicare for each employee, and you’ll have to fill out additional paperwork and possibly make more frequent tax payments using IRS form 941, Employer’s Quarterly Federal Tax Return, as well as the equivalent state form. If your tax liability is high enough, you will have to make payments monthly or semiweekly instead of quarterly. The details of this system are beyond the scope of this tutorial; see IRS Publication 15 (Circular E), Employer’s Tax Guide, for more details.
Sales and Use Tax
States may impose a tax on the sale of goods and services. Check whether your business has to register to pay and/or collect sales tax in your state. Exclusions in sales tax often include food, clothing, medicine, newspapers, and utilities.
In general, you can deduct the costs of running your business in the same year that you pay them. The tax treatment is different for assets you buy that are expected to last more than one year. You generally must depreciate these assets, or spread their cost over several years.
But the IRS has a special rule known as the Section 179 deduction that is designed to allow small businesses to deduct the full cost of assets in the year they are purchased. This is also known as "expensing," because you get to deduct the cost of new assets just as you do current expenses. If you purchase a computer for business use that costs $1,000, the tax deduction will make its actual cost to you only $750. Property that is eligible for this special first-year expensing includes machinery, tools, fixtures, computers, software and vehicles used in your business. To make sure you get all the tax deductions you're entitled to, you need to maintain good records of your company's expenses. If you incur an expense that combines personal and business use, you must divide up the total cost and take the deduction only for the business use.
Each of the 50 states have different definitions of what property is taxable. Some states collect property tax from businesses in commercial real estate locations. Certain states also collect property tax for business assets, such as vehicles, computer equipment, and peripherals. The amount of tax you pay is calculated by the total value of the property or on a certain percentage of the value. Search for property tax requirements in your state.