As a business owner, you have federal, state, and local tax requirements. Each state and locality has its own tax laws. Common types of business taxes include the following:
All businesses, except partnerships, must file an annual federal income tax return. Partnerships file an information return. Almost every state levies a business or corporate income tax, though each state and locality has its own tax laws. Your tax requirement depends on the legal structure of your business:
When beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file. The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure.
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it "passes through" any profits or losses to its partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return.
Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions.
In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.
The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.
S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
To qualify for S corporation status, the corporation must meet the following requirements:
Limited Liability Company (LLC)
A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, and you should check with your state if you are interested in starting a Limited Liability Company.
Owners of an LLC are called members. Most states do not restrict ownership, and so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner.
A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state’s requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.
Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”). Specifically, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation. And an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation.
Effective Date of Election
An LLC that does not want to accept its default federal tax classification, or that wishes to change its classification, uses Form 8832, Entity Classification Election, to elect how it will be classified for federal tax purposes. Generally, an election specifying an LLC’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed. An LLC may be eligible for late election relief in certain circumstances. See Form 8832 General Instructions for more information.
The federal government requires businesses to pay employment taxes, such as:
All states require businesses to pay state workers’ compensation insurance and unemployment insurance taxes. These states/territories also require a business to pay for temporary disability insurance:
Sales and Use Tax
States may impose a tax on the sale of goods and services. Rates may vary by county. As a business owner, you may have to:
Exclusions and Exemptions
Exclusions in sales tax often include food, clothing, medicine, newspapers, and utilities. Since food is a necessity, some states do not tax food. In addition, certain groups are often exempt from paying sales tax. Charitable, religious, and educational groups are often excused from paying sales tax under certain conditions.
Many states also have a use tax. Rates may vary by county. Similar to a sales tax, a use tax is imposed for the storage, use, or purchase of personal property that is not covered by the sales tax. Typically, this applies to lease and rental transactions, or to major items purchased outside of the state, such as automobiles.
Depending on the state, you may have to register to pay and/or collect use tax.
Each of the 50 states have different definitions of what property is taxable.
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. If you do not pay enough through withholding or estimated tax payments, you may be charged a penalty.
How to Pay Estimated TaxIf you are filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, you generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return.