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Understanding the Operation of Taxation in Your Business
 
 
Understanding the Operation of Taxation in Your Business

Taxation is a very complex part in any business operation. Do not be alarmed though, it is a necessary part of business ownership and taxes are a part of life. There are appropriate ways to manage taxation and comply with government regulations. Your tax rules will be based on the structure of your company and a number of factors that are driven by law. Many entrepreneurs successfully manage their taxes by themselves and on their own. As the structure and complexity of your business increases you may want to acquire the services of a certified public accountant. As an entrepreneur you must register to pay taxes. You obtain the necessary licenses and permits and notify the IRS. As you register your business many local and state registration entities provide the appropriate forms and filing requirements. These entities often provide periodic updates and inquiries with your business to ensure you have the appropriate forms and the tax filing requirements to comply with Federal and state laws. These are the basic taxes you should be aware of as an entrepreneur depending on the structure of business you have:

  • Property taxes

  • Sales and use taxes

  • Franchise taxes

  • Estimated federal and state individual income taxes

  • Estimated federal and state corporate income taxes

  • Corporate income tax

When registering to pay your taxes, you want to complete the appropriate tax application with you state department of revenue. They will guide you on the appropriate taxes your business will be liable for and provide advice if you're purchasing an existing business. If you are purchasing an existing business file for or request a "Certificate of No Tax Due". Depending on your state requirements this document will release you from any liability for any existing sales taxes or revenue withholding liability. Many of these forms can be completed on-line or in person.

Employer identification number (EIN)

Every business requires an employer identification number with the exception of a sole proprietorship. This is required even if you do not have employees. You must apply for an EIN using the Form SS-4, Application for Employer Identification Number (EIN). An EIN is a nine-digit number (for example, 12-3456789) assigned to employers, sole proprietors, corporations, partnerships, estates, trusts, certain individuals, and other entities for tax filing and reporting purposes.

We will now discuss some of the required taxes you will encounter as a business entrepreneur. These may be your responsibility at either the Federal, state, county, or local level.

Estimated income tax

Small business owners must estimate the amount of money their business has made and pay taxes on these estimates. Estimated income tax is required for every form of business. You are responsible for paying these taxes on a quarterly basis. If you have underpaid these taxes during the year then you are required to pay penalties at the end of the year. These calculations of the estimated income tax should be included in your monthly cash flow projections. These taxes are due each quarter on these timeframes"

\For the period of: Pay estimated income tax by:​

January 1 through March 31​ April 15​

April 1 through May 31 June 15​

June 1 through August 31 September 15​

September 1 through December 31​ January 15 (of the following year)​

Individual federal income taxes

Sole proprietorships, partners, or shareholders in an S corporation are considered self-employed for tax purposes. In these structures you do not have an employer to deduct federal income tax from your wages. Therefore you must make quarterly payments to your quarterly estimated federal income tax. This income is required to be reported even though it technically may not be distributed to you. You are required to report this on Form 1040-ES, "Estimated Tax for Individuals on a quarterly basis". Then you will file a Form 1040 Department of the Treasury - Internal Revenue Service "US Individual Income Tax Return" at the end of the year with a schedule C form "Profit or Loss from Business" .As a self-employed individual you are responsible for the full amount of contribution for self-employment tax which is your contribution to social security and Medicare. This also is required on a quarterly basis and included in your estimated tax payment.

State income tax

Quarterly payments are also required for individual state income tax as an estimated tax declaration for individuals. As an entrepreneur you are responsible for these taxes and keeping up to date on taxation requirements. Local department of revenue and small business administration offices are able to assist you in keeping up to date in the new requirements. You are required to have a withholding identification number from the state department of revenue and report these taxes monthly, quarterly, or annually based on your state requirements. States require that you complete an annual reconciliation report of income tax form.

Corporate income tax

Corporations are also required to pay income taxes at the state level. This is paid on the "estimated tax declaration for corporations". They too are required on a quarterly basis just as other taxes. They are required on the Form 1120 Department of the Treasury Internal Revenue Service "Estimated Tax for Corporations" period. Some corporations function under the fiscal year, in that case taxes are due on the 15th day of the fourth month.

Franchise taxes

Franchise taxes are based on a corporation's assets. Some of the franchise aspects may cover multiple states and the IRS has a calculation to compute that tax. S corporations are also required to file a report.

Sales taxes

Sales taxes are required for all merchandise that is sold within a state. You are required to pay state sales taxes to the state in which you operate a retail business or provide services. This is required under the retail sales license which authorizes you to collect sales tax. You are not required to collect sales tax on goods distributed for resale provided you have a resale certificate for the good to purchase. You may also be responsible for local taxes for the city in which you operate. Check with your local city requirements.

Vendors use tax

Depending on the state, some out-of-state business owners, which are located in another state are required to collect and submit a vendor use tax for the state in which they do business.

Interested in learning more? Why not take an online class in Business Law for Entrepreneurs?

Consumers use tax

If you are a wholesaler located in one state who sells goods in another state you may be required to register for consumer use tax. You collect this tax if you live in one state and purchase goods from an out of state source. Taxes are collected for the state of residence at the time of purchase and you must remit and pay this consumer use tax. Maintain your gross receipts throughout the year to justify the taxes you pay and the deductions you may take on gross sales throughout the year.

Property taxes

Property taxes are assessed against your business to pay for improvements around your community. These taxes are assessed by your county tax assessor and are paid on an annual basis. All individuals and business entities that own property must file a property inventory with the county tax assessor at the beginning of the year which includes the estimated value of your property.

We will now discuss the tax responsibilities discussed under the business structures. Each of these has separate responsibilities for individuals and as a collective entity.

Sole Proprietorship

A sole proprietor is someone who owns an unincorporated business by themselves with no other owners. So if you are the sole member of a limited liability company (LLC) you are not a sole proprietor if you chose to structure the company as an LLC as a corporation. In the sole proprietorship the profits and losses of the year are calculated and they are entered on the annual tax return of the owner. The financial results of the business are calculated, and the profit or loss appears on the tax return of the sole owner. If there is a profit loss, it results of the business act as a sort of tax shelter on the owner's return by offsetting an equal amount of other taxable income.

If you are a sole proprietor you may be required to file a combination of any of these: Income Tax, Self-employment tax, Estimated tax, Social security and Medicare taxes and income tax withholding, Federal unemployment (FUTA) tax, and filing information returns for payments to nonemployees

Partnership

A partnership is the relationship that exists between two or more persons who conduct business. Each of the partners contributes their money, time, property, labor and skills, and shares in the profits and losses of the business. A partnership is required to file an annual information return to report the income, deductions, gains, losses, from its operations, but it does not pay income tax.

Instead of paying taxes, the business "passes through" any profits or losses to its partners and each partner includes their share of the partnership's income or loss on their tax return.

In a partnership both partners are responsible for reporting the annual return of income and these employment taxes: Social security and Medicare taxes and income tax withholding, Federal unemployment (FUTA) tax, and depositing employment taxes.

The limited partnership is taxed exactly the same way as the partnership, with profit and loss allocated among all partners, both general and limited, according to the limited partnership agreement.

The individual partners are responsible for their Income Tax, Self-employment tax, and Estimated tax.

Corporation

In corporation taxing the corporation's stock is sold to perspective shareholders in exchange for money or property. Corporations use the same tax deductions as a sole proprietorship to determine their taxable income. A C corporation is a separate tax paying entity that conducts its business, determines its income or loss, pays its taxes, and distributes any profit to shareholders. The corporation's profit is taxed to the corporation and then taxed to the shareholders as it is distributed as a dividend.

If your business is in the form of a C corporation you are responsible for: Income Tax, Estimated tax, Employment taxes of Social security and Medicare taxes and income tax withholding and Federal unemployment (FUTA) tax.

S Corporation

S corporations as you recall are limited to 100 shareholders and can only have one class of stock. In an S Corporation taxes are passed to the shareholders for the corporation's income and losses. This flow through type of income is claimed on personal tax returns and gives the S corporation the benefit of avoiding double taxation on corporate income.

If your business is in the form of an S corporation you are responsible for: Income Tax, Estimated tax, and Employment taxes of Social security and Medicare taxes and income tax withholding, Federal unemployment (FUTA) tax, and depositing employment taxes.

Shareholders are responsible for filing Income Tax and Estimated tax.

Limited Liability Company (LLC)

The limited liability company consists of members. For taxation purposes the limited liability company is part of the owner's tax return. If you have at least two members you are categorized as a partnership for tax purposes.

Limited liability companies afford the limited liability and pass-through tax treatment of the S corporation while avoiding the S corporation's restrictive eligibility requirements. Limited liability companies can then make use of creative allocations of profit, loss, and control what would constitute prohibited multiple classes of stock in an S corporation.

Withholding taxes

As an employer you will be responsible for withholding Federal income tax from your employees' wages. You are also responsible for contributing to unemployment funds, Medicare, and Social Security. If you are ever in doubt contact the IRS for the requirements for withholding taxes.

Federal unemployment taxes (FUTA)

As an employer you are also required to contribute to Federal unemployment tax. Unemployment benefits are paid from state unemployment taxes and unemployment insurance. The cost of administering unemployment programs is paid from the Federal unemployment taxes (FUTA) funds. As an employer you are required to pay 6.2% on the first $7000 of each employee's annual pay. This number may vary somewhat because you receive a credit for the state unemployment taxes you pay. Each employer is required to pay Federal unemployment taxes if you employ one or more employees for at least one day in each of 20 calendar weeks. Federal unemployment taxes are reported annually on the IRS form 940 "Employer's Annual Federal Unemployment (FUTA) Tax Return". These taxes are due by January 31 in every calendar year.

State unemployment taxes

As a business owner you are required for state unemployment taxes. These taxes may vary depending on the state but these are the general requirements to determine if you must pay state taxes:

  • You pay $1000 or more to a worker in your private home

  • You employ one or more people at least one day during 20 different weeks of the year

  • You pay cash wages of $20,000 or more in the calendar quarter

  • Your payroll totals $1500 in any calendar quarter

Remember although the tax is on your employees' wages you are not allowed to deduct the tax from their wages. This tax is your responsibility not theirs. The only exception is the sole proprietor. They are not required to pay unemployment taxes because they are not considered an actual employee of the business.

You are required to display a poster indicating an unemployment insurance "Notice to Workers" and you must provide any employee who you must terminate in your workplace a copy of information that describes unemployment benefits.

The tax experience rating

Businesses are given a tax experience rating which is a method for determining the contribution rate of employers based on the state unemployment code and their rate of unemployment. The state unemployment tax rate is based on the amount of unemployment benefits that you pay out as a percent of your total wages. The tax experience rating is designed to ensure that a business owner has sufficient funds to cover future unemployment payments. Your tax experience rating is based on the number of benefit claims you experience over time. If you have had a number of employees claim unemployment benefits you may experience a higher tax expense rating. If you have had few employees claiming unemployment benefits you will have a lower experience rating. As a new business you're assigned the standard rate. Your experience with employee benefit claims will determine whether your rate increases or decreases. Obviously there is an incentive to be an employer of choice.

Social Security and Medicare taxes aka FICA

The Federal Insurance Contribution Act requires all employers pay Social Security taxes to the government to provide for survivor, old age, and disability benefits as well as Medicare Insurance payments. As an entrepreneur you are required for collecting these payments. The payments are made in in equal amounts by the employee and employer. The rate averages 6.2% for Social Security and the Medicare rate averages 1 to 1.5%. This rate increases on an annual basis so beware for planning purposes.

New hire reporting

Under the New-Hire Act of 1997 and Federal Welfare Reform Act of 1996 employers are required to report newly hired employees. This was designed to expedite child support collections. Employers have 20 days from the initial hiring date to report the name, address, and social security number of each new hire employee and you must include your Federal employer identification number. You are required to report this to the state.

Here are some additional tax tips to make tax responsibilities easier for the entrepreneur:

  • Always file your taxes and make payments in a timely manner

  • Always use your business structures legal name

  • Never allow the use of assets for personal purposes and keep business and personal expenses separate

  • Always use adequate record keeping and bookkeeping methods or software

  • Seek advice if the tax law becomes too cumbersome or confusing

  • Take advantage of any tax credits such as energy efficiency or healthcare

  • Take appropriate deductions for property especially property use in manufacturing or production of goods

  • Utilize the Small Business Jobs Act Tax provisions

  • Avoid common IRS audit traps such as classifying employees as independent contractors, large sum miscellaneous deductions, or home office deductions.

  • Keep current on all of your financial tracking and receipt entry

  • Remember you may be able to deduct educational expenses for your employees to improve their skills

  • Do not overlook potential deductions for business losses or trips required for conducting business

  • Remember to keep your tax documents for at least seven years

  • Claim any charitable contributions your business has made remember, this adds to the goodwill of your community

Summary Reminders and Takeaways

As you set up your business obtain your city sales or local business occupation license. You will then apply for the Federal employer identification number and contact your local state department of revenue and the Internal Revenue Service to determine how and when to pay your Federal and state estimated taxes.

If you operate as a corporation you will determine your corporate income tax and any franchise tax obligations. Remember to find out your city or county property tax obligations and include these costs into your monthly cash flow statements. Last but not least contact city and county governments to see if your business is required to pay any community level sales tax.

There are entities which help entrepreneurs with tax regulation and payment requirements. Seek out experts in these areas, such as a small business administration for advice. Be sure to make your quarterly payments, and if you are ever in doubt, seek the professional assistance of an accountant or tax representative to ensure your compliance with taxation regulation. Being a business owner is a rewarding experience and is easy if you maintain tax compliance. Always pay your taxes on time and as required and keep your documentation for all business costs and expenses organized. Always educate yourself on the new requirements of business ownership including taxes.

 
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