Tax Returns for Small Businesses
Understanding the different types of businesses and their respective pros and cons can certainly be of benefit to you were considering running your own business - or even if you currently run a business. Here are a few "differences" that may assist in shedding some light on the subject.
When starting out in business – or even while in business – it is important to find the best business type “fit” for you so that you can make the most of its structure and set up.
Tax Returns for Sole Proprietors
The simple business tax return is actually not a business tax return at all. It is a Schedule C attached to the individual 1040 tax return. Unlike partnerships and corporations, there is no separate tax return filing. An LLC (Limited Liability Company) can also be a sole proprietor. If an LLC does not choose to be treated as another entity, e.g. a corporation, it will be considered a “disregarded entity” for tax purpose and a Schedule C will be attached to the 1040.
Who files a schedule C? Small businesses such as barbers, store owners, and contractors. The essence of a contractor is he is paid to deliver a product and HOW he gets the product is not the payer’s concern. Let’s take taxes as an example. If I hire an EA to work in my office, require he wear professional attire, keep regular hours, answer the phone, and follow company policy, he is an employee, not a contractor. Such an employee would be paid a wage either hourly or as a percentage of client fees, the employer would withhold taxes, and send him and the IRS a W-2 form for the year in January of the next year.
Now, suppose I hire an EA to side-check tax returns for my firm. He works from home, dresses as he pleases, works his own hours, and is not subject to my direct control, other than the fact that he deliver a properly side-checked tax return. What he delivers for me is a reviewed tax return, with any errors caught, and ideas of how to save client tax dollars. He is a contractor. I would pay him without deducting taxes, and file a form 1099 with the IRS at the end of the year. He would file a Schedule C, unless he had elected to form a corporation or partnership.
A Sole Proprietor when filling out a business tax return has many advantages over an employee. He can directly take off his income business expenses. If he drives a car in his business, business miles can be directly taken off his mileage as an expense. If he goes on a business trip, that is a deductible expense. If he operates an office out of his home, that is a deductible expense.
A Sole Proprietor who likes to keep his own books may do so. Quickbooks and other bookkeeping programs are quite good, and he can use them. If he does not like keeping his own books, he can hire a bookkeeper. Torchlight Tax also does bookkeeping. As bad bookkeeping can prevent proper tax filing, we find it needful to offer this service to our clients.
There is a third option available to a small businessman who does not want to purchase a bookkeeping program or pay a bookkeeper. Open a separate bank account for your business. Deposit all business income to that bank account. Pay all business bills by check or card from that account. Make sure you make a note if you won’t be able tell what the expense is for later. Do not pay any personal expenses from the business account. Any personal income you take from the business account is recorded. Do not pay any business expenses from your personal account. At the end of the year, you can get your gross income by totaling the deposits you made for the business. You can total the different types of expense you had by category. Bring this to your tax pro and he can work out your Schedule C and 1040 easily enough.
The Disadvantages of a Schedule C
There are certain disadvantages to filing a Schedule C. One is that it seems too easy to cheat - Add an extra $2000 dollars to your advertising expense. Take your vacation plane fares and hotel as a business expense. Claim a non-existent home office. Take your wife out to dinner and call it a client meeting. Deduct your home mortgage as office rent. Call your movie watching research. The drawback here is that (1) it is dishonest and (2) you are eventually likely to get caught. Then you face heavy fines and penalties and interest, and even possible legal action.
Another disadvantage to Schedule C is you are much more likely to get an IRS Audit. Schedule C filers are more likely to get audited by the IRS than individuals with no Schedule C or partnerships or corporations.
Another disadvantage is a Schedule C is 15.3% SELF-EMPLOYMENT TAX IN ADDITION TO INCOME TAX. Let me explain. If you are an employee, 7.65% of your pay is taken out for social security and Medicare, and the employer pays 7.65%. This is in addition to income tax. And, unlike income tax, there are no exemptions and deductions. On Schedule C 15.3% of your profit goes to Self Employment tax up to the Social Security limit.
It can be a a rude surprise, Say someone makes a $100,000 profit in their business, has a spouse, 3 kids, deductible mortgage interest, and $50,000 in church donations. They think they will owe no tax. Well, in this scenario, they may escape paying income tax, but they will owe $15,300 in self-employment tax. If they had not planned for it, it can be a shock. Much of this could have been avoided by incorporation.
This high self-employment tax can be substantially lessened for some by forming a corporation, and if you want more details on this, contact Torchlight Tax for a free consultation.
To file your Schedule C, we will need an annual total of your income and expenses (also known as a profit and loss,) in addition to the data needed for a personal tax return. If you use a vehicle in your business, we will need the vehicle make and model, when it was put in service for your business, and the total personal and business miles for the vehicle. If you do not have an annual total for income and expenses, we can work it out for you by doing your bookkeeping as a separately charged service.
Tax Returns for LLC (Limited Liability Company)
A primary advantage of a Limited Liability Company is they offer some protection to your personal assets. A lawsuit could potentially bankrupt the LLC but leave your personal assets, such as your house, untouched. This protection can be limited. I am not a lawyer and cannot practice law or give legal advice, but if you have an LLC, it might be wise to review LLC laws for your state or contact a competent tax lawyer. I have been told that in many states the protection afforded by LLC status can be voided. One of my clients was advised by her lawyer to give 1% of her LLC to her son, as having a two man LLC afforded protection a one-man LLC could not provide, as state law allowed a one man LLC be disregarded. This apparently varies from state to state.
Taxes are an interesting subject for an LLC. An LLC can be a disregarded entity as far as the IRS is concerned, and treated like a Sole Proprietor. It can also be a partnership or a corporation. If you do not know which it is, that would be a good reason to contact us or another tax professional.
If your LLC is acting as a sole proprietor, partnership, or corporation, seek data for each on filing that kind of return.
Get in Touch with Us
If you are considering using our services, contact us for a free consultation. This can be done in person, on the phone, or even a video chat. We will do our best to help you, and there is no obligation. We figure if we do our best to help people with their taxes, we will have plenty of paying clients. You can call us and see if we seem like a good fit for you. It is extremely important that we know, like and trust each other. You will be giving us all kinds of personal, financial information. You have to feel comfortable trusting us. We will be presenting your data before the IRS. We have to trust you.