Personal Business Taxes

Millions of individuals and couples own small businesses. I love it! It’s one of the greatest things about the country we live in. Unfortunately, I have noticed that most of these small business owners don’t fully understand how they’re taxed on their business profits. I have titled this post “personal” business because I want to focus on the businesses run by a single person or a married couple. These are mostly organized as sole proprietorships or single member LLCs. Ultimately, there are three big things you need to focus on to make sure your business taxes are in order: how the IRS sees your business, the types of taxes applied, and quarterly taxes.

How does the IRS see your business?

The IRS considers you and your business as one in the same. Everything your business does is tracked on Schedule C (Profit and Loss from Business Activity) and attached to your personal tax return. Since the IRS views your business as ‘you’, all bank accounts are treated as one. Essentially, it doesn’t matter if you use your business or personal card to pay for something, you are still allowed to take deductions if you paid for an actual business expense with your personal accounts. Most people separate business accounts in order to track income and expenses throughout the year.

What taxes are applied to small businesses?

Your business income is calculated and taxed at 15.3% (self-employment tax for Social Security and Medicare). The income/loss is then added or subtracted from your gross income on the front page of your tax return. This results in your income being taxed at your personal rate as well. You can deduct half of the self-employment taxes paid if you had business income. I stress the self-employment tax topic because most people don’t realize they pay that additional tax on top of the personal tax rate. That is why I suggest setting aside 25% of your net income to pay taxes.

How do you prepare for quarterly taxes?

Don’t forget about quarterly taxes! Everyone must pay estimated taxes. Most people have them come out of each paycheck - small business owners are different and are generally required to pay them quarterly. If you work a regular job along with a side business, you may be able to increase your paycheck withholding to cover your estimated taxes. It is important to make estimated payments so that you can avoid penalties when you file your tax return.

Now that you know what you need and the working parts that apply to small business taxes, find a way to DOCUMENT EVERYTHING. Business miles, expenses, and meals all need to be tracked. I always tell clients to save everything you have just in case. There are a variety of expense trackers you can use that allow you to attach receipts, or it can be as simple as throwing all your receipts in a shoebox and hand it over to your accountant at the end of the year. In the event of an IRS audit, you will need to provide support for any expenses you took for the business.

Good luck with your business endeavors! You probably spend so much time building up your business, but don’t forget to spend some time on taxes. I hear stories about people having to shut down their business because they have to pay 5 years’ worth of back taxes. Don’t let that happen to you!

And as always, if you’re feeling a little lost or unsure of what to do next with your personal or business finances, contact me!

Mike Zeiter, CPA/PFS

Tax Deductions

I get this request all the time. “Hey Mike, I need to find more tax deductions so I don’t have to pay as much.” Depending on the person (and my mood), my  response is usually a sarcastic, “You can give half of your income to charity.” Obviously, people generally don’t want to give away half their income just to save on taxes. They are looking for deductions that allow them to reduce their taxes AND keep their money. I am going to simplify the tax code for now and just look at two different types of deductions. The first group are deductions that give you a benefit in the current year and allow you to keep your money. The second group of deductions give you a tax benefit, but you lose the money.

Keep your money and save on taxes - Traditional Individual Retirement Account (IRA), Employee Retirement Plan (401k, 403b, etc.), and Health Savings Accounts.

These are your first choices when looking to save more on taxes. Retirement plan contributions will grow in your account and you will pay tax on them in the future, but hopefully at a lower tax rate. Money that you put into a health savings account can be used for medical expenses in the future and you never pay tax on it.

Spend money to save on taxes – Mortgage interest, property taxes, charitable contributions, business expenses, etc.

This group essentially covers all other tax deductions. The amount you save from these is equal to the expense times your tax rate. These deductions are items that you need to make sure you include on your tax return if you incur them, but don’t create them for the sole purpose of reducing your taxes.

Here's why...

Example: You pay $5,000 in mortgage interest this year and your family makes $100,000 which puts you in the 25% tax bracket. You will receive a tax benefit of 25% of the $5,000 which is $1,250.

Would you trade me $5,000 for $1,250? Probably not. That’s why you shouldn’t do things just to get a tax deduction. It doesn’t mean that you are better off financially. However, some people would rather give $10,000 to a charity of their choice than $2,500 to the federal government. To each his own.

Remember to always think about the true savings when it comes to taxes. Don’t let a deduction tempt you into spending more money than you need to. And next time you hear Joe Cool in the break room talking about how he doesn’t want to pay off his mortgage early because of the tax benefits, you can explain the true financial cost of that decision.

-Mike Zeiter, CPA/PFS

P.S. – I have overly simplified this to discuss the general calculations. The tax rules are much more complicated so please consult with a professional about your specific options around tax planning.