I’ve done a lot of posts about unusual small business deductions, but I haven’t done anything about the basics. If you’re new to the small business world, that’s what you really need to know. These are some of the basic, core facts that you need to know to prepare your small business taxes.
First, if you’re just starting out, and you haven’t filed any papers like articles of incorporation, and you don’t have any partners, then you’re considered to be a sole proprietor. Your business tax return goes on a form called a Schedule C, and that’s part of your regular 1040 form. Don’t file your personal taxes and then try to file your business return later, they’re one and the same thing.
What if I’m an LLC? An LLC is a limited liability company, it’s not a corporation. Most LLC’s will file as sole proprietors unless they have filed documents to be taxed as an S or C corporation. (Then they file corporated tax form 1120S or 1120.) LLCs that have partners will file partnership returns, form 1065. This post is about sole proprietors who file Schedule C with their 1040 return.
A popular question I hear is, “How much money do I have to make to file a return?” According to the IRS, if you make over $400 of self employment income, you are required to file a federal tax return. This is very different from the minimum filing requirements of regular returns. Once you’ve made over $400, that income is subject to self employment tax and the IRS is very keen on collecting your self employment tax.
Another common question is, “How will the IRS know that I’ve made over $400?” The easiest way for the IRS to find out your income, assuming that you haven’t reported it yourself, is from forms 1099MISC. Many companies hire people as contract labor and don’t withhold payroll taxes. If you make over $600 from them, they are required by law to give you a form 1099MISC, showing how much they paid you. A copy of that form also goes to the IRS. That’s the most common way small businesses can get in trouble for underreporting their income.
Another way the IRS can find out that you’re not reporting your income is through your bank records. Let’s say for example that all of your business transactions are for cash and you never receive a 1099MISC. Although you wouldn’t get caught as quickly, let’s say you had an annual income of $20,000 from your all cash business. Your spending would be out of line with your income and could trigger an audit. A quick look at your bank statements would prove you weren’t reporting your income. If you’re serious about starting a real business, do it right and have a plan for handling your taxes. It will save you a lot of trouble in the future.
Small business income, unlike wage income, has one big disadvantage–it get’s taxed twice. First, it’s taxed at your normal tax rate and then again at the self employment tax rate (15.3%.) Let’s say you’re already in the 25% tax bracket for another job you have, your self employment income would then be taxed at 40% (the 25% plus the 15%.)
Small business income also has one big advantage–you can reduce your self employment income by any expenses you had acquiring that income. You may even have more business expenses than you have income, in that case, you can use your business losses to reduce your regular income, that lowers your overall income tax bill. Now you don’t want your business to be losing money every year (that’s not really good business practice.) But when you’re starting up, being able to deduct your losses is very helpful.
So what kinds of expenses can you deduct? The key phrase that the IRS uses is anything that is “regular and necessary” for the business. A good guideline is right on the Schedule C form. Here’s a link to it right here: Schedule C. Advertising, legal and professional fees, auto expenses, insurance, rent, repairs and maintenance, supplies, and office expenses. Meals and entertainment are deducted at 50% of what you spend (since the idea is that you’d have to eat anyway.)
If this is your first time filing taxes for your small business. I recommend getting a professional to help you. Even if you have a knack for the paperwork, it really helps to have someone else go over the possibilities of what you can deduct and make sure that the big things like depreciation (if you have that) are handled correctly. If you get started on the right track, it’s easier to stay that way.