The Tax Cuts and Jobs Act came into effect in 2018. While it offered some tax concessions, it has left many online business owners unsure of their tax liabilities and how they can reduce them.
By and large, your business structure will determine how your tax is calculated. The key is to know that you don't have to calculate it all alone. In fact, tax advisors are there to ensure that you get the very best from your money and the right advice can make a big difference. With some understanding about your small business tax, you can keep your business moving forward.
All businesses have to pay income tax on their taxable income or net profit, but it doesn’t stop here. There are other state and federal taxes for which business owners are responsible. But how does small business tax work? Read on to find out more.
What Taxes Are Applicable?
Online business owners must manage various taxes.
- Federal and state income taxes – levied on annual taxable income
- Self-employment tax – This amounts to 15.3% of your income and covers Medicare and social security. You can claim back half when you file your income tax return.
- Capital gains tax – payable on investments and the sale of assets. You will pay between 0.15% and 20% on assets you have held for more than a year. The actual rate paid will depend on your income. The more you earn, the more you’ll pay. Any asset that you have held for less than a year is business income for tax purposes and will be taxed as such.
- Payroll taxes will cost your small business 7.5% of your gross payroll. You will also have to pay into worker’s compensation and unemployment funds. Many small and online businesses hire a payroll company to manage tax liabilities. The payroll company takes responsibility for filing reports. These can get complicated, and late filing will result in penalties.
- Property tax – Depending on where you are located, you will pay between 0.18% to 1.89% of the value or the fixed property owned by your business.
- Dividend tax – If your business receives dividends on investments, these will be taxed as income. This will take the form of corporate tax or personal income tax, depending on the business entity
- Excise taxes – apply to certain industries. These are indirect taxes, so you will recover the taxes when you sell the product. Businesses that sell products like gas and alcohol are responsible for collecting the excise and paying it to the government
- Sales tax – most states levy a sales tax, and it is up to the online business owner to collect the taxes and pay them over to the state
Choosing Your Business Structure
When you set up your business, you choose the business structure that will apply. Your choice of business entity has both legal and tax implications.
Most businesses are sole proprietorships, more than 70% of which have just one owner. If your business is unincorporated and you are the only owner, it is automatically a sole proprietorship. You assume all legal and financial responsibilities. Your business income forms part of your personal income tax on your income tax return.
The new tax law allows owners to reduce their tax liability by deducting 20% of the net business income from their taxable income.
Limited Liability Companies
A limited liability company safeguards the owners’ assets in case of business failure. An LLC may have an unlimited number of members. This makes it easier for the owners to raise capital and grow the business.
For tax purposes, a limited liability company or LLC is taxed in the hands of the members and reported as personal income tax. This is known as pass-through tax treatment. As a member of an LLC, you are also liable for self-employment tax.
Single-member LLCs are automatically taxed as sole proprietorships. The ownership percentage of each member of a multiple-member LLC must be determined. Multiple-member LLCs can choose to be taxed as a C corporation rather than as a partnership. But C corporation taxation is subject to double taxation.
Many states levy an annual tax on LLCs. So, it is essential to do your homework and work out whether you can cover the state taxes with the tax advantages of pass-through profits.
In an S corporation, the owners are taxed in their personal capacity in accordance with their proportion of ownership. The S corporation combines the benefits of the traditional corporation with the tax flexibility of an LLC.
C corporations pay corporate taxes at a flat rate of 21%. The owners don’t declare the business tax on their income tax returns. The C corporation is taxed as a legal business entity. The owners pay income tax on the profit when it is paid to the shareholders.
So, the income is taxed twice, first as business income and then as personal income.
When to Pay Business Taxes
Most individual tax is settled once a year before the deadline set by the IRS. As an online business owner, you must estimate your tax liability and self-employment costs if you expect to owe $1,000 or more when you file your tax form. These amounts must be paid quarterly in advance. The IRS will deduct the estimated amounts from your total tax liability at the end of the tax year.
Business owners who fail to pay at least 90% of the owed tax will face tax penalties.
It is a good idea to open a separate account for your tax commitments. You’ll have to keep between 30% and 40% of your income in the account to ensure that you can meet all your tax commitments.
If you buy office equipment for your home business, can you deduct the full amount in that tax year? The answer surprisingly is yes. A large business would have to deduct the expense over time in the form of depreciation. As a small business owner, you are entitled to deduct the full amount in the year you bought it.
A small online business may deduct all expenses to which a large organization is entitled. Sometimes small businesses can find additional deductions. Items like health insurance premiums can help to legally reduce taxable income. There are several allowable deductions that you may have overlooked.
- Reimbursements for motor vehicle use
- Home office deduction
- Travel expenses
- Medical expenses – as a sole proprietor with individual medical insurance, you can deduct the premium from your income
- Qualified retirement contributions
What is the Small Business Tax Rate?
The Small Business Administration reports that the average tax rates of small businesses are 19.8%. A small business with one owner pays on average 13.3%, and a business with more than one owner averages 23.6%. S corporations pay on average 26.9%. Corporations pay higher taxes because they earn considerably more income.
Do I Have to Pay Taxes for My Online Business?
The short answer to this question is yes. If you make a profit, you have to pay income tax. You may also be liable for self-employment tax, local property tax, and employee payroll tax.
Can a Small Business Get a Tax Refund?
Taxpayers can only expect a refund if they have paid more than they owed. Most business owners report tax as their own income since they own pass-through companies. If the sum of their quarterly payment and the withholding tax from their wages exceeds the amount owed, they will receive a tax credit.
C corporations that overpay will also receive a tax credit for the overpaid amount.
How Much Money Can You Make Online Before Paying Taxes?
Your online business will not pay income tax unless it makes a profit. Even if you’ve made a loss, you will still have to submit a return. Regardless of your business income, you will still have to pay other taxes such as property tax and payroll tax. Self-employment taxes are due once your online business makes $400 per year.
As your online business grows, your tax returns may become progressively more complex. Tax compliance requires that you meet the deadlines for the submission of returns. Failure to make the submissions on time or errors made can result in heavy penalties.
A monthly financial statement will help you to get your online business accounts organized. This will help you to meet your tax deadlines and ensure that you claim all the relevant expenses. Why would you pay more tax than you have to? Including all expenses provides that your taxable income isn’t overstated.
A professional online bookkeeping service like Bench can help to keep your business income up to date. So, you’ll be ready when the tax season comes around.
Get Ready for Tax Season
Running an online business isn’t easy, and knowing how does small business tax work, is an important piece of the puzzle. Understanding what to expect and knowing how the different business structures affect your income tax return can help you to meet your tax obligations on time.
Getting tax advice and employing an online bookkeeping service can keep your books in order and ensure that you don’t pay more tax than you have to. So, when tax season rolls around, you’ll be ready to file.