This content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Nobody genuinely enjoys doing taxes, whether it’s as an individual or on behalf of a business. But small business owners, especially, dread tax season. There are some good reasons for this — for starters, it’s not a fun process — but for the most part, small business owners make business taxes much more complicated than they have to be.
Are you making some of these common mistakes with business taxes?
The basics of business taxes
This guide isn’t meant to educate you on business taxes from start to finish, but for the purposes of our discussion, it’s important to give you some tax tips.
Businesses are responsible for paying and withholding taxes. Sometimes, you’ll be responsible for paying taxes on the money you make. You’ll also be responsible for withholding and paying taxes on behalf of your employees.
There are five general types of business taxes you should be aware of:
Nearly all businesses must file an annual income tax return (partnerships must file an information return). There are different standards and procedures for this, depending on how your business is structured.
Your business may be responsible for paying taxes throughout the year in the form of “estimated tax” payments. Each quarter, you’ll make a contribution to the year-end taxes you project you’ll owe, including the income tax and the self-employment tax (if applicable).
Self-employment taxes apply to self-employed people (i.e., entrepreneurs) to cover Medicare and Social Security. There are some special rules and exceptions here, but most self-employed people will owe this tax.
Employers have specific employment-related tax obligations. For example, you’ll be responsible for withholding income taxes and withholding and contributing payments for Social Security and Medicare taxes.
Some businesses will have to pay special taxes on products they sell or manufacture — alcohol and gasoline are two examples.
At the end of the year, you’ll file a tax return for your business and provide documentation to the government to make sure you’ve paid taxes properly and provide any additional payments that are owed.
Note that in addition to filing taxes on a federal level, you’ll also have to pay taxes on state and local levels — and if you do business in multiple areas, you may have to file multiple tax returns.
The 3 most difficult elements of tax season
What makes tax season difficult for business owners? These are the top three challenges they face:
1. Record keeping and reporting
Most business owners start to face challenges because of poor recordkeeping and reporting. The meatiest part of “doing your taxes” is simply filling out forms. You’ll note the expenses you’ve paid, the money you’ve made, and dozens of other details and calculations. But if you’ve kept sloppy records throughout the year or if you don’t know the answers to these questions, you’re going to have a hard time filling out the forms accurately.
2. Meeting deadlines
Tax deadlines can feel tight, especially if you’re also juggling all your business operations while navigating the world of business taxes. If you’re caught off guard, or if you have trouble getting the paperwork together, you might have to scramble to meet a deadline — or face the consequences of missing one.
3. Using the correct forms
The IRS has hundreds of forms, they’re not labeled intuitively, and the instructions are often written in a clunky and disorganized fashion. It’s a pain to figure out which forms you need and how to use them.
9 mistakes small business owners make when filing business taxes
Many small business owners make some combination of the following mistakes when filing business taxes:
1. Missing deadlines
The most common mistake is the simplest to understand and the easiest to avoid: missing deadlines. Some combination of procrastination, inattention, disorganization and/or apathy ultimately leads to business owners missing important deadlines.
2. Keeping inaccurate or inconsistent payroll records
If you keep sloppy records, or if you don’t know where to find certain information, you’re going to have a hard time filling out and submitting the requisite forms.
3. Selecting the wrong business entity
Is your business a sole proprietorship? Or is it an LLC? You should know the answer to this question and know the differences between these business entities.
Every year, there are at least some business owners who file a return based on the wrong structure.
Taxes do tend to be more complicated for corporations and LLCs than they are for sole proprietorships and partnerships, but don’t let that intimidate you.
4. Confusing business and personal expenses
You have a client who’s also a good friend. You take him out to dinner for chit chat and laughs, and you happen to talk about business for a few minutes during this interaction. Does that technically count as a business expense since he’s a client of yours?
This is ambiguous territory. But the majority of your expenses will be very clearly business related or not business related. Delineate these categories and you’ll have a much easier time accurately reporting your expenses.
5. Deducting startup expenses incorrectly
Your business’s startup costs are (mostly) deductible, but the rules are somewhat difficult to understand.
According to Intuit QuickBooks, “The IRS allows you to deduct $5,000 in business startup costs and $5,000 in organizational costs, but only if your total startup costs are $50,000 or less. If your startup costs in either area exceed $50,000, the amount of your allowable deduction will be reduced by the overage. And if your startup costs are more than $55,000, the deduction is eliminated.”
Additionally, you can deduct startup expenses over several years. It’s easy to get things wrong here.
6. Categorizing staff members incorrectly
Modern businesses often work with a mix of full-time employees, part-time employees and independent contractors, all of whom have different tax implications. Categorizing your staff members incorrectly or accounting for them inappropriately could result in complexity (and possibly penalties) later on.
7. Glossing over small expenses
There are tons of little expenses accrued by your business, from petty cash expenditures to magazine subscriptions. If you don’t account for these when tallying up your expenses and deductions, you could end up paying more in business taxes than required.
8. Ignoring deduction limits
Not all deductions are treated equally. For example, talk to your tax professional about .
If you try to deduct too much, you’ll run into major issues.
9. Neglecting some tax expenses
Businesses have many different types of taxes to consider, such as property taxes, payroll taxes, local taxes, excise taxes and self-employment taxes.
Yes, it’s a lot to keep track of, but each tax is important.
5 ways you’re overcomplicating things
As we’ve seen, there are some elements of business taxes that are truly complex. But many business owners end up exaggerating these complexities and overestimating how difficult doing business taxes truly is.
Why are you making business taxes overly complicated?
Chances are, you’re getting tripped up by one or more of the following tendencies:
1. You assume this is unfamiliar territory
Are you one of those people who “just isn’t good with numbers”? Do you believe yourself to be bad with money? If so, you may instantly underestimate your ability to handle taxes.
You don’t have to be a math genius or a personal finance guru to handle business taxes, so don’t sell yourself short.
2. You’re learning from the wrong sources
The IRS isn’t known for its approachability or clarity. In fact, many online sources are notoriously bad at communicating how taxes work. If you read an article that doesn’t make sense, don’t blame yourself and don’t blame the complexity of taxes. Just move on to an article that phrases things in different, easier-to-understand terms (or hire an expert).
3. You’re lost in the “big picture”
Businesses have many tax obligations and a cluster of responsibilities come tax season. If you try to contemplate and plan for all of them at once, you’re going to feel overwhelmed. Instead, try to focus on one step at a time and one form at a time. No individual step in the business tax world is unconquerable.
4. You’ve heard horror stories
We’ve all heard about businesses that have made mistakes and faced massive penalties but these are often exaggerated.
If you plan ahead, you shouldn’t miss any deadlines, and if you miss a filing or payment deadline, the penalties are pretty reasonable.
As long as you’re not committing tax fraud, there’s no reason to add extra anxiety to an already-stressful responsibility.
5. You have too many other responsibilities
Many business owners who worry excessively about business taxes are simply distracted by other responsibilities. Running a business and taking care of a family is a lot of work, so, of course, the temporary addition of business tax planning seems like an obtrusive and unnecessarily complicated burden.
4 ways small business owners can make tax season easier
How do you make business taxes easier?
There are some important strategies you can use to make tax season much less complicated for your business:
1. Start early
The best thing you can do is start early. The deadline problem disappears if you start working on your taxes a few weeks, or ideally, a few months ahead of when you would normally start.
You’ll have much more time to gather records, check your numbers, find the right forms and assemble everything for delivery.
You’ll also be less stressed — and you won’t be as weighed down by other priorities and responsibilities.
2. Hire the right people
The right team can make a huge difference in how you prepare your taxes.
Hiring a professional accountant, or for larger businesses, an entire team of bookkeepers and accountants, can spare you the headache of trying to solve all your financial challenges on your own.
If you’re committed to doing the work yourself or if you can’t afford an accountant, make sure the people you work with — including contractors, vendors and clients — are open and transparent with their recordkeeping.
3. Keep consistent, accurate records
Accurate and consistent recordkeeping will make business taxes a breeze. The trouble is, you have to stay organized throughout the year.
Certain types of software, like Microsoft 365, can make it much easier to store your records in one place (and keep them properly organized so you can always find what you’re looking for). Just make sure you track all your financial information consistently, and back up your records in the cloud for security reasons.
4. Stick to a schedule
When tax season starts getting nearer, set a schedule for yourself. For example, if you know the deadline to send out W-2s is January 31, make it a point to send them by the 24th at the latest. Use mini-deadlines leading up to the 24th to keep yourself on track for that long-term goal. This will also force you to break each responsibility down into smaller, more easily digestible steps.
Business taxes don’t have to be taxing
There are some challenging elements of business taxes, but in reality, business taxes are simpler and more accessible than we make them out to be.
If you take your time, start early, hire the right people and prioritize keeping accurate, organized records, you’ll find yourself completing your tax obligations in record time — with minimal stress.
IRS Form SS-4 Instructions: What It Is and How to Find Yours
What is IRS Form SS-4?
IRS Form SS-4, Application for Employer Identification Number, is an IRS form businesses use to apply for an employer identification number (EIN). Business lenders may require an IRS Form SS-4 notice to verify a business’s EIN when evaluating a loan application.
Applying for a small business loan can be overwhelming, but there are a few things you can do in advance to make the business loan application process go smoothly. Along with filing your most recent year’s business income tax return (and any past due tax returns, too), you’ll also want to locate and make copies of the documents your lender is likely to request. Among these documents is your IRS Form SS-4. Lenders often ask for the IRS Form SS-4 notice you receive after filing the form, not the form itself.
Here’s everything you need to know about IRS Form SS-4, why it’s important to your lenders, and how to obtain yours.
What is IRS Form SS-4?
IRS Form SS-4, “Application for Employer Identification Number,” is the form businesses use to apply for an employer identification number (EIN). A business’s EIN is its business tax ID number for use when filing small business taxes.
What is an EIN and why apply for it?
An employer identification number, aka an EIN, is a unique, nine-digit number that many types of businesses need for tax purposes.
If a business has employees, it needs an EIN to pay and file payroll taxes. And certain types of business entities need an EIN to file a business income tax return.
Sole proprietorships and single-person LLCs with no employees are the only types of business entities that are exempt from this requirement.
All U.S.-based businesses have the option of getting an EIN.
There are lots of benefits to having an EIN. For example, with an EIN, you can streamline your bookkeeping processes by separating your personal and business finances, open a business bank account, establish business credit, and even speed up your business loan application.
How to use IRS Form SS-4
You can get the IRS Form SS-4 on the IRS website. The form is only one page long.
Expect to provide information like:
Your business’s legal name and address
Name of applicant and their SSN, ITIN, or EIN
Type of entity
Reason for applying for an EIN
Date your business started
Highest number of expected employees in the next year
Principal business activity
Principal type of products or services sold or rendered
Also, note that business owners themselves don’t need to apply for their business’s EIN—you can delegate that task to any responsible party, which the IRS defines as the individual or entity that “controls, manages, or directs the applicant entity and the disposition of its funds and assets.”
You can apply via mail, fax, or phone (phone for international applicants only).
Why lenders ask for a copy of the IRS Form SS-4
Lenders need to verify EINs, which is why they often request a business’s IRS Form SS-4. However, when a lender asks for your IRS Form SS-4, it’s not asking for a copy of your EIN application; it wants the notice the IRS sends out once it assigns your EIN. (Because IRS Form SS-4 is referenced on this notice, the notice itself is often referred to as Form SS-4.)
Why you need IRS Form SS-4 to verify your EIN
Lenders can’t just use a tax return to verify an EIN. Clerical errors and typos happen. It’s possible that your tax preparer entered your EIN incorrectly, and the IRS hasn’t notified you of the error yet. This is a common error for returns filed on paper rather than electronically. It can take the IRS months—sometimes even longer—to identify the error and notify you of it.
The SS-4 allows lenders to go straight to the source of the information, which can speed up the underwriting process.
What if you don’t have an SS-4 notice?
If you’re a sole proprietor or an LLC with no employees, you might not have an EIN (these are the only two types of business entities that aren’t required to get an EIN for tax purposes). In that case, the loan will be in your name, and your lender will use your social security number in lieu of an EIN.
But for all other kinds of business entities, the business is a separate and distinct legal entity from the individual. Even if you provide a personal guarantee for a loan, you’ll still need to complete the loan application in the corporation’s name, using the corporation’s EIN instead of your Social Security number. That requires an SS-4.
How to get an IRS Form SS-4 notice: Instructions
Look on your hard drive or cloud-based filing system. If you applied for your EIN online, you received an IRS Form SS-4 notice — along with your EIN — immediately as a PDF.
U.S.-based banks require a copy of the IRS Form SS-4 notice in order to open a business bank account. Your banker may be able to get you a copy.
Your accountant might have completed your EIN application form for you and may have a copy.
Call the IRS Business and Specialty Tax Line at (800) 829-4933. After providing your EIN and identifying information about your business, the IRS sends a copy of your EIN assignment letter by mail or by fax. For security purposes, the letter will be sent to the address or fax number the IRS has on file for your business.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.
IRS Form 8832: Instructions and FAQs for Business Owners
What is IRS Form 8832?
IRS Form 8832, “Entity Classification Election,” is a form business owners use to tell the IRS how to classify a business for federal tax purposes. Businesses that don’t fill out Form 8832 will receive a default tax classification, which could affect how much tax they pay.
Changing a tax election status using Form 8832 may save a business thousands of dollars per year in taxes. In addition, filling out Form 8832 allows a business to change its tax status so that the business reports its income and expenses on its own tax return, rather than the owners reporting business income and expenses on their individual income tax returns.
Here are instructions on how to fill out IRS Form 8832, as well as FAQs to figure out whether your business is eligible to complete IRS Form 8832.
Who should file Form 8832?
Only eligible businesses, including U.S.-based partnerships, U.S.-based limited liability companies (LLCs), and certain foreign entities can file IRS Form 8832 to elect to be taxed as a C-corporation, a partnership or a sole proprietorship.
Limited liability corporations (LLCs) typically file IRS Form 8832 in order to be taxed as C-corporations. Normally, a single-person LLC is taxed as a disregarded entity, and a multimember LLC is taxed as a partnership.
Single-member and multimember LLCs can fill out Form 8832 if they’d like to be taxed as a C-corporation, a partnership or a sole proprietorship. Without filling out this form, single-member LLCs are taxed as sole proprietorships by default, and multimember LLCs will be taxed as partnerships.
Although you can use IRS Form 8832 to change your tax classification to a C-corp, you will need to file a separate document, IRS Form 2553, if you want to be taxed as an S-corporation.
What happens if I don’t file Form 8832?
Businesses that don’t fill out Form 8832 receive a default tax classification from the IRS, which could affect how much tax they pay. If you’re happy with your default tax status, there’s no need to file IRS Form 8832. This form is only for businesses that want to change their tax status.
Heads up: If you want to be taxed as a corporation, you need to file articles of incorporation with your secretary of state first and then file IRS Form 8832.
Information to have before filling out IRS Form 8832
Business phone number
- Employer identification number (EIN), which is a tax ID for businesses.
If the business has only one owner, indicate the name of the owner in question 4 along with the owner’s Social Security number or “identifying” number.
IRS Form 8832 instructions: A step-by-step guide
Here’s an overview of the IRS Form 8832 instructions so you know exactly how to change your tax status.
Step 1: Provide basic business information
You can find IRS Form 8832 on the IRS website The first page of the form has information about where to mail your tax forms. Page two is where the actual form begins. Filling the form out by hand can easily lead to errors, so it’s a good idea to file the tax form electronically.
This section asks for simple information about your business, including your business name, address, and EIN. If you don’t have an EIN you can apply for an employer identification number online. If have an EIN but can’t remember what it is, look for the EIN confirmation letter the IRS sent you when you applied for the EIN. You can also find this number on old tax returns or on business permits and licenses.
If you’ve changed your business address after filing form SS-4 or your most recent returns check “Address change.” If you forgot to file the form but want the change to apply to previous tax years, check the “Late classification relief…” box.
Step 2: Complete part 1, election information
Part 1 of IRS Form 8832 asks a series of questions regarding your tax status election. You may not need to answer every question.
Line 1 asks whether you’re changing your tax status for the first time (a) or if it is a subsequent change (b). If this isn’t the first time you’re changing your business’s tax status, complete lines 2a and 2b regarding the timeline of your last election. The IRS typically limits how frequently you can change your classification to once per 60-month period. However, if your last election was made when your business was first formed and went into effect on the date of formation, the 60-month limit doesn’t apply.
If you selected option “a” in line 1, then go to line 3, which asks whether your business has more than one owner. Different boxes have different tax status options. If you’re the sole owner, you can be taxed as a disregarded entity or a C-corporation. These businesses move on to line 4, where youl enter the owner’s name and identifying number (either a Social Security number, EIN, or ITIN).
If your business has more than one owner, you can be classified as a partnership or C-corporation. After designating that your business has multiple owners, you’ll move to line 5 and fill out the name and EIN of any parent corporations.
On line 6, choose your desired tax status. Line 7 is only for foreign entities, which will provide the foreign country of organization. On line 8 you provide the month, day, and year that you would like your new tax status to take effect. Keep in mind, you can’t provide a date that is more than 75 days prior to the date on which you file; the date can also be no more than 12 months after the date you file. If you don’t provide a date on line 8, the IRS will use the day on which you filed.
Finally, on lines 9 and 10, provide the name and title of someone the IRS may contact for additional information, as well as their phone number.
Step 3: Complete part 2, late election relief
Part 2 is only for those filing their entity classification election past the deadline. If you don’t file within the time frames mentioned above, you can seek late election relief.
To be eligible for late election relief, you need to fulfill all of the following circumstances:
You failed to obtain your requested classification because you hadn’t filed Form 8832 on time.
You haven’t yet filed your taxes because the tax deadline hasn’t yet passed, or you’ve filed your taxes on time.
You can provide a reasonable cause explaining why you couldn’t file Form 8832 on time.
You’re still within a window of three years and 75 days from your requested effective date.
If these apply to you, explain your circumstances and your reasonable cause in the field in Part 2, line 11. You’ll also have to sign here.
Step 4: Mail IRS Form 8832
Once you have the form fully completed and signed, mail it to the appropriate office. The address depends on where your business is, and it appears on the first page of Form 8832 PDF.
Acceptable proof of filing is either a certified or registered mail receipt from the United States Postal Service; Form 8832 with an accepted stamp; the form with a stamped IRS received date, or an IRS letter that says it accepted the form.
Taxpayers in Connecticut, Delaware, Washington D.C., Georgia, Illinois, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Vermont, Virginia, West Virginia, and Wisconsin will mail their form to:
Department of the Treasury
Internal Revenue Service Center
Kansas City, MO 64999
Taxpayers in Alabama, Alaska, Arizona, Arkansas, California, Colorado, Florida, Hawaii, Idaho, Iowa, Kansas, Louisiana, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, Oregon, South Dakota, Tennessee, Texas, Utah, Washington, and Wyoming will mail their form to:
Department of the Treasury
Internal Revenue Service Center
Ogden, UT 84201
Step 5: Keep an eye on the mail
The IRS will accept or deny your Form 8832 filing request within 60 days. The acceptance or denial letter will go to the address you listed when completing your form.
If 60 days go by and you don’t hear anything, call the IRS at 1-800-829-0115 or send a letter to the service center to check on the status of the form.
When should you file form 8832?
There’s no “deadline” to file Form 8832 — you can file it either right when you start your business or at any point during your business’s lifetime.
However, the filing date is important. The tax status for the business is effective either:
Up to 75 days before filing the form.
Up to one year after filing the form.
If no date is entered on the form, the filing date is the effective day.
Select the proper date for your tax classification to begin so you can be taxed effectively. Ask your accountant for advice on the right effective date — there may be strategies for your type of business in terms of a better effective date.
What to know if you’re already in business
You can fill out Form 8832 at any point in a business’s lifetime. Partnerships and LLCs especially might benefit from filing this form if they haven’t already, or if they previously filed as a corporation.
You can only change your tax status every five years, with a few exceptions.
If you’ve changed your tax classification less than five years ago, but you’d like to file Form 8832, ask your accountant if your business suits one of those exceptions.
You might wonder if the same rules apply to affiliates. Part I, line 5 asks whether your business is owned by one or more parent affiliated (or parent) companies that file a consolidated tax return. If so, provide the name of the parent company and its EIN number. This is to ensure that affiliated companies are taxed properly.
Certain entities formed outside of the United States (or in certain U.S. territories) can fill out IRS Form 8832. Consult the list on the form’s seventh page for a list of those countries.
IRS Form 8832 FAQs
These FAQs address common questions about IRS Form 8832. Of course, the IRS or your accountant are also great resources.
What if I don’t have an employer identification number?
If you don’t have an EIN yet, you can easily apply for an employer identification number for free through the IRS’ website. You will need an EIN to file IRS Form 8832, but there are also additional benefits of getting an EIN.
Do I need to change my employer identification number if I change my tax classification?
No. You generally do not need to change your EIN if you switch your tax treatment.
Who can sign my entity’s Form 8832?
The signature is required in Part 1, line 9. In this section you provide the name, title, and phone number of the person the IRS should contact with questions about your form.
A business owner, manager, or officer of the business should sign Form 8832. If the election is going to be active before the date you filed the form, it also needs to be signed by anyone who was an owner during the active period but is no longer an owner.
Is this the last time I have to handle Form 8832?
No. You should also attach a copy of the form to your federal income tax return for that year.
How long will this take me to fill out?
The IRS estimates that it takes just 17 minutes to fill out this form, and as you can see from our form instructions, there aren’t too many questions to address.
Can I use IRS Form 8832 to elect to be taxed as an S-corporation?
No. Businesses that want to be taxed as S-corporations need to fill out IRS Form 2553.
Can partners within a corporation be taxed differently than other partners within the same corporation?
No. All partners within a corporation must be taxed according to the same classification.
How should I classify my business?
There are pros and cons to every type of business entity; each type comes with their own legal and financial implications, as well as their own procedures for setting up. Your safest bet is to consult with your tax advisor before undergoing any elections.
How do I know if I should change my current classification?
There are a few reasons to change your current tax classification:
You have a multimember LLC that is taxed as a partnership but you would now like to be taxed as a C-corporation.
You have a multimember LLC that is taxed as a C-corporation but you want to go back to default partnership treatment.
A single-member LLC adds more members and the business will be taxed as a partnership unless the business files Form 8832 to change its classification.
As always, consult a qualified tax advisor if you’re unsure whether to change your tax classification. That person can guide you through the ins and outs of this form — and whether changing your tax status is the right move for your business in the first place.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.
Sole Proprietorship Taxes: Everything You Need to Know
This article has been reviewed by tax expert Erica Gellerman, CPA.
Sole proprietorships are subject to pass-through taxation, meaning the business owner reports income or loss from their business on their personal tax return, but the business itself is not taxed separately.
A sole proprietor will submit a Schedule C with their personal 1040 tax return on an annual basis.
They will also be responsible for filing Schedule SE with these returns and paying self-employment taxes on a quarterly basis.
Sole proprietorship taxation is different from other business entities, like corporations, because the business itself is not taxed separately from the business owner. Instead, you report and pay your sole proprietorship taxes as part of your personal tax return.
To explain, the IRS calls this type of taxation “pass-through taxation” because the tax liability belongs to the owner of the business, “passing through” to the business owner’s personal tax return. This means that you’ll complete a separate form for your sole proprietorship taxes, Schedule C, which you file with your personal income tax form, Form 1040.
Sole proprietorship taxation has a few implications that are important to note. First, “pass-through taxation” means that the net income from your business will increase your personal taxable income—meaning your business income could push you into a higher tax bracket. Second, with sole proprietorship taxation, the income taxes that you pay are not business expenses. Some business owners post income tax payments on their profit and loss statement as expenses; however, this is incorrect if you’re a sole proprietor—these payments are actually distributions of equity and should not be posted as expenses.
Although you should not post these tax payments as expenses, this does not mean your business cannot fund your tax payments. In fact, you should set aside a percentage of your business’s income to cover the sole proprietorship taxes due on the profit in your business. You should remember, however, that when you take money out of your business to pay your taxes, it will come out as an owner’s draw and not an expense.
Sole proprietorship taxes for LLCs
Moreover, it’s important to note that even if your business is an LLC, you may still be filing taxes as a sole proprietor. Since an LLC is a legal status granted at the state level, and not a federal tax status, single-member LLCs are subject to sole proprietorship taxation. If your LLC has two members, you’ll be classified as a partnership for tax purposes; however, either single- or multi-member LLCs can elect to file their taxes as a corporation by completing IRS Form 8832.
With this in mind, if your business is an LLC and you’re unsure of what your tax status is, you’ll want to consult with your business accountant or attorney, especially if this individual helped you form your LLC.
Determining your income tax liability
As we mentioned, as a pass-through entity, you’ll pay income taxes on your sole proprietorship as part of your personal tax returns, using Form 1040 Schedule C. In order to file this return, you’ll need to determine your sole proprietorship’s taxable income.
Fortunately, you do not pay taxes on the full amount of your sole proprietorship’s income. Instead, you’ll only pay sole proprietorship taxes on the profit of your business. Essentially, this means you’ll be taxed on all profits — total income minus expenses — regardless of how much money you withdraw from the business. Therefore, your sole proprietorship’s taxable income will be close to the “net income” or “net profit” number at the bottom of your profit and loss statement, but with a few adjustments.
Like any business, you’ll be able to deduct business expenses on your return; however, you’ll want to ensure that you’re managing your bookkeeping correctly to report your taxable income and any deductions accurately. A common mistake that sole proprietors make, for example, is recording cash activity — owner’s draws, cash infusions from loans or investments, payments on long-term debt — as expenses or income on their profit and loss statement when these activities do not impact taxable income. These incorrectly recorded transactions will skew your profit calculation and can result in you paying too much or too little on your sole proprietorship taxes.
Additionally, it’s important to note that although you can deduct your business expenses, not all of them correctly reported on your profit and loss statement are 100% deductible. For example, business meals are only 50% deductible — and starting with the 2018 tax year, entertainment expenses are not deductible at all. Therefore, even though these expenses may appear on your profit and loss statement, you’ll want to remember that they may not have a 100% impact on your taxable business income.
Sole proprietorship taxes: Special deductions
On the other hand, although there is some cash activity in your business that does not impact the taxable income for your sole proprietorship, there is also some non-cash activity that can reduce your taxable income — but these activities might not appear on your profit and loss statement.
When it comes to your sole proprietorship taxes, therefore, you’ll want to keep these special and sometimes overlooked business tax deductions in mind, as they can make a huge impact on your tax liability.
Health insurance deduction
Many sole proprietors don’t realize they can deduct health insurance premiums for themselves and their families without itemizing their tax returns. If you are a sole proprietor, your health insurance premiums are an “above the line” deduction, meaning you can deduct it before you arrive at your adjusted gross income. You’ll want to note, however, that this only applies to the premium for months when you (or your spouse or other family members) are not covered by a group insurance plan.
Although the business mileage deduction isn’t limited to sole proprietorships, sole proprietors often tend to overlook this deduction, thinking it’s insignificant. However, if you use your car for business purposes, at 57.5 cents per mile (in 2020), this deduction can make a sizable impact on your tax liability. In order to receive this deduction, though, you’ll need to keep thorough mileage records, but luckily, there are a number of available business apps that can help facilitate this process.
Home office deduction
Many sole proprietors hesitate to claim the home office deduction because they’ve heard this deduction is a red flag and makes their return more susceptible to audit. If you run a home-based business, however, you are entitled to this deduction, and it can have a significant effect on your tax liability. With this deduction, though, you should keep in mind that you can only deduct expenses for the percentage of your home you use for your business. Additionally, your home office space must be used exclusively for business, so if your “office” is a corner of your kitchen table, you can’t take this deduction.
When you’re an employee, your employer pays 50% of your social security and Medicare taxes and the other 50% is withheld from your paycheck. As a sole proprietor, on the other hand, you’re responsible for 100% of these taxes. These taxes are referred to as self-employment taxes and currently, the self-employment tax rate is 15.3% of your net self-employment income. This being said, 50% of your self-employment taxes are deductible. These specific sole proprietorship taxes are reported on a special form, Schedule SE, which we’ll discuss in greater detail below.
If you want to make sure you maximize your sole proprietorship tax deductions, we recommend working with an accounting pro. Users of the accounting software Bench can be paired with a professional bookkeeper who can handle all their tax filing needs.
How to file your sole proprietorship tax returns
Keeping in mind everything we’ve explored thus far, let’s dive into the details regarding the different forms you’ll need to file to fulfill your obligations for sole proprietorship taxes. At this point, it’s important to note that although we’ve been first and foremost discussing your business’s income tax liability, you may be responsible for additional taxes — such as payroll, property, sales and excise taxes. In this regard, the IRS provides a reference list of taxes that sole proprietorships may be liable for, as well as the respective forms you would need to complete for each tax.
Sole proprietorship taxation: Income and self-employed taxes
As we explained, as a sole proprietor you’ll report and pay income tax on your business’s profit—and you’ll do so by filing additional forms with your personal return, Form 1040. This being said, most sole proprietors only need to file two forms with their individual return. Let’s take an in-depth look at each of these forms.
First, Schedule C is used to report the profit and loss of your business. You’ll also use this form to report your business mileage.
Overall, Schedule C is a relatively easy form to follow—broken up into five sections asking about your income, expenses, cost of goods sold, information on your vehicle, and other expenses. When completing this form, you’ll be able to refer to the IRS instructions for guidance and pull most of the information you’ll need from your financial statements and, if applicable, your mileage tracking app.
This being said, however, there are a few questions that warrant upfront explanation:
Accounting method: In the first section of Schedule C, you’ll be asked about your business’s accounting method. Most sole proprietors file their taxes on a cash basis, even if they keep their books on an accrual basis. Unless your accountant tells you differently, you’ll want to choose cash basis for your tax return—by doing so, you’re ensuring that you’re only paying taxes on the income you’ve actually received.
Material participation: If you’re actively involved in your business’s operations, then you will answer “yes” to this question. If you are an investor, or if the income from your business is passive in nature, consult with your accountant about how to proceed with your tax return.
1099 requirements: If you paid one or more independent contractors at least $600 by check, cash, electronic funds transfer, or wire transfer during the course of the year, you must file 1099s for them. If you paid your contractors by credit card or a service such as PayPal, the merchant processor is responsible for filing the 1099s.
Ultimately, you’ll use the information from your Schedule C to complete your personal 1040 tax form and the sole proprietorship tax rate you’ll pay on your business’s income will be equal to your personal income tax rate.
As we mentioned earlier, as a sole proprietor, you’re responsible for self-employment taxes—the social security and Medicare taxes that an employer normally takes out of an employee’s pay. In order to calculate the self-employment taxes you owe, you’ll complete Schedule C first, and then fill out Schedule SE. Currently, the self-employment tax rate is 15.3%, but once again, you’ll be able to deduct half of this amount on your 1040 form.
It’s important to note, however, that although you’ll file Form 1040, Schedule C, and Schedule SE on an annual basis, you’re responsible for paying self-employment taxes on a quarterly basis. Therefore, in order to calculate these payments, known as estimated taxes, you’ll complete Form 1040-ES and pay the respective amounts quarterly, based on the IRS due dates.
On top of your sole proprietorship taxation requirements for income and self-employment, you may also be liable for other types of taxes depending on the specific nature of your business:
Employment taxes: If your sole proprietorship has employees, you’ll be responsible for employment taxes, also commonly referred to as payroll taxes. This requirement involves withholding tax from your employees’ paychecks for income taxes, FICA (Social Security and Medicare) taxes and unemployment taxes, as well as reporting these taxes and paying your respective responsibility as an employer. To report and pay these taxes, you’ll complete Forms 940 and 941. Additionally, you’ll also be required to report an employee’s wages and tax withholdings annually by filing Form W-2 (you’ll file 1099s instead if you’re reporting payments to independent contractors).
Property taxes: If your sole proprietorship owns real estate, land, or any business property, you may be required to pay property taxes. The business property tax that you’re required to pay will depend specifically on your location and the rules as defined by your local tax authority.
Sales and excise taxes: At the state level, your sole proprietorship will need to pay sales taxes on the products and taxable services that you sell. Like business property taxes, sales taxes will vary based on your location and product or service, so you’ll want to consult your state tax agency for the relevant requirements. Similarly, with excise taxes, you’ll only be required to pay these taxes if you sell certain products, like alcohol or tobacco. If you need to pay excise taxes, however, you’ll need to do so at the federal, state and local levels—meaning the cost and schedule will once again depend on your business’s location.
When to file sole proprietorship taxes
Ultimately, the returns for your sole proprietorship taxes will depend on the specific tax. Along these lines, it’s important to remember that some tax returns, like Form 1040 and the accompanying Schedule C, must be filed annually, whereas others, like Form 941 for payroll taxes, must be filed quarterly.
This being said, in order to file your general income taxes for your sole proprietorship, you must complete the required forms on the same schedule as your personal tax returns. Therefore, you must file by April 15 unless you file an extension, which will give you until October 15 to file.
However, you’ll also want to keep in mind that, as we discussed earlier, the IRS requires you to pay this tax liability throughout the year—meaning you must complete Schedule SE to determine your estimated tax payments and pay the respective amounts on a quarterly basis.
Although there are different deadlines to adhere to, you’ll want to be sure to keep track of your tax responsibilities, pay your estimated taxes and file on time. If you don’t pay your estimated taxes and wait until you file your annual return, the IRS may charge you a penalty for failure to pay on time. Similarly, you may face a penalty for any IRS business form that you don’t file completely by the deadline.
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