How to File Business Taxes

Learning how to file business taxes is something that all business owners have to tackle eventually.

In this article, we’ll cover some key definitions, explain what the IRS looks for from different types of business, show you the forms that need completing, and list the backups you’ll need to include. We’ll also point you to handy software tools that can simplify submission.

Key Takeaways

  • Before you can file business taxes, you have to know what IRS business category you fall into for tax purposes
  • Federal income taxes get most of the attention, but states and counties levy income taxes of their own. You have to think about tax filing at different levels of government.
  • Regular, accurate record-keeping can take the pain out of tax filings and ensure you get the deductions, credits, and refunds you’re due.
  • A good tax filing software package can make the whole thing painless.

Understanding Business Tax Requirements

The type of business you operate determines the taxes you have to pay. Freelancers, for example, have a shorter list of taxes to pay than big companies with lots of employees do. The way taxes are declared also differs from one business category to the next.

Here are the basic tax types:

Income tax: a percentage of the business’s income depending on its structure and location. Jurisdiction is important. Forty-three US states levy their own tax on corporate income on top of what’s paid to the federal government.

Payroll tax: businesses with employees must pay payroll taxes. These include levies for Social Security and Medicare. Employees pay part of these as deductions from their wages, which employers have to match.

  • Social Security payments come to 6.2% of the employee’s paycheck. With the employers matching half, the total comes to 12.4%.
  • Medicare levies a total tax of 2.9% of the employee’s paycheck. That means employer and employee each pay 1.45%.
  • Businesses with employees also pay federal unemployment tax for each one — 6% of the first $7,000 they earn each year.

Self-employment tax: Sole proprietorships still have to pay into Social Security (12.4%) and Medicare (2.9%), or 15.3% of the business’s annual income.

Capital gains tax: If your business has an investment that’s grown in value or if you’ve sold off any assets in the last year, you may need to declare capital gains for taxation. The rate is a percentage of the increase in the asset’s value, typically 15% but it could run as high as 28%, depending on the type of asset and how long you owned it.

Property tax: If your business owns real estate, the county where the land or buildings are located may levy a property tax. These vary by county and are based on the assessed value of the property.

Dividend tax: Publicly traded corporations must pay a tax on any dividend paid out to shareholders. The dividend payment is treated as a source of taxable income by the IRS. Rates range from 0% to 20%, subject to how long the investment was held and the shareholder’s taxable income.

The Different Business Tax Structures Explained

Sole Proprietorship

Freelancers, consultants, and independent contractors typically have a lighter paperwork burden at tax time compared to other business structures. However, there are specific guidelines that these ‘sole proprietors’ have to abide by.

In a sole proprietorship, the business is owned by one person, and that person is legally bound to the business. In practical terms, that means the sole proprietor keeps all the income; but they’re also personally liable for all the debts.

In fact, the IRS treats sole proprietorship as a ‘pass-through entity‘. Instead of being subject to corporate income taxes, any profits or losses are reported on the owner’s personal tax return. In taxation terms, this has pros and cons

  • For more information on sole proprietorship and its tax implications, visit the IRS resource page for sole proprietorships.

Partnership

Like a sole proprietorship, a partnership is legally connected to its owners. It’s another kind of ‘pass-through’ entity where all of the profits and losses ‘pass through’ the business to the partners. They, in turn, declare their share of the partnership’s profits or losses on their personal tax returns.

Each partner’s portion of profits and losses is usually laid out in a formal partnership agreement. Because they are part-own a pass-through business entity, partners can sometimes take advantage of a 20% tax deduction provided for in the 2018 US Tax Cuts and Jobs Act.

As they are self-employed, partners are required to calculate and set aside income taxes, with each partner required to pay taxes quarterly (in January, April, July, and October) on their share of the partnership’s yearly profits.

The IRS also expects each partner to pay income taxes on their agreed share of the business’s profits. The agency assumes each partner has received their respective distributive shares every year. Practically speaking, this means the tax man doesn’t look at how much money/income you withdrew from the business. Your tax bill is calculated based on your share of the partnership’s profits.

  • For more information on partnerships and their tax implications, visit the IRS resource page.

Limited Liability Company (LLC)

A limited liability company (LLC) is a business structure that blends the liability cover a corporation receives with the pass-through taxation that sole proprietorships and partnerships benefit from.

One advantage of an LLC is the flexibility it offers in terms of management and ownership structure. Another is the liability limitation, which is important for small businesses that carry more risk than a normal sole proprietorship or partnership.

An LLC can have one owner or many. The owners of an LLC are referred to as members. LLC members normally manage the business as a group — unless they opt for a ‘manager management’ model.

The thing that distinguishes LLCs from partnerships is their limited liability status, meaning LLC owners are shielded against personal liability in the event of a lawsuit or bankruptcy.

Where it resembles sole proprietorships and partnerships is in its pass-through status. Despite limited liability, the LLC is attached to its owners for tax purposes.

Income from the business passes through to the LLC members, who report their respective cuts of profits or losses when they submit their personal income tax returns.

An LLC with one owner is treated much like a sole proprietorship by the IRS. The LLC itself doesn’t pay taxes or need to file a tax return.

  • For more information on limited liability companies and their tax requirements, visit the IRS LLC resource page.

Corporation

A corporation is distinguished from other business types in that it must pay income taxes on its profits. Sole proprietorships, partnerships, and limited liability companies (LLCs) do not have their business profits taxed directly. In those businesses, profits pass through to the owners, who declare income or losses individually on their personal tax returns.

Because corporations are standalone legal entities, they’re taxed on any profits that aren’t deductible as business expenses. Generally speaking, taxable profits refer to monies set aside to cover the corporation’s operating expenses or finance its expansion, as well as those distributed amongst the owners via dividends.

To cut the amount of profit subject to taxation, a corporation can deduct business expenses from the total. The only stipulation is that the expenses have to be incurred in pursuit of revenues or profit.

These can include operating costs, start-up costs for a new venture, product development, and advertising. A corporation can also deduct the salaries and bonuses paid to staff, along with the cost of employee medical and retirement benefits.

If the corporation’s owners are also employees, they pay income taxes on their salaries and bonuses, just as any regular employee would.

  • For more information on corporations and their tax requirements, visit the IRS’ dedicated corporate tax resource page.

Federal and State Tax Obligations

The primary distinction between state and federal taxes is that federal taxes are used to fund the activities of the federal government, and state taxes fund the governments in each state.

American businesses file their federal taxes through the IRS. The 44 US states that collect state business taxes have their own separate taxation authorities. In New York, the Department of Taxation and Finance collects business taxes in the state. In California, it’s the Franchise Tax Board.

How business taxes are calculated differs between the two levels of government. For example:

  • US Corporations pay a 21 percent rate of federal income tax.
  • 44 US states also levy a corporate income tax, with marginal rates that range from 2.5% to 11.5%

Importance of Accurate Record-Keeping

Taxation is unavoidable, and so is the record-keeping that supports it. Business tax filings require records, receipts, bank statements, and other backups — especially when you’re claiming tax deductions or credits.

The IRS won’t rubber stamp anything, and in fact, the agency stipulates that businesses retain some types of tax records at all times. Businesses are required to keep records of employment tax documents, for example, for at least four years after filing.

In the event of a challenge or discrepancy noted by state or IRS tax assessors, the burden of proof is on the business. Without proper documentation to draw on, you may not be able to substantiate your claims.

Gathering Necessary Documentation for Business Taxes

Keeping your business tax records up to date ahead of the March or April deadline eliminates the need for a last-minute scramble to find everything and organize it into a coherent package.

To make life easier at tax time, here’s what small business owners should keep track of:

  • Business expenses: Maintain a record of all business costs and keep any receipts in an associated file
  • Sales records: Track all the revenue the business has brought in
  • Profits and losses: Maintain a profit and loss (P&L) statement that tracks your earnings and losses
  • Wages: Keep stringent records of the salaries paid to employees

When it comes time to complete your business tax filing, you’ll use these to prove how much business income was generated and how much was spent on business expenses.

Business Income Documentation

  • Sales records: These can include everything from new client contracts to cash register tapes
  • Invoices and receipts: The bills you send customers and the proof that payment has been made
  • Bank statements: The monthly statements for your business banking account will contain the deposit information for sales made via cash, debit card, credit card, and online

Deductible Expenses

  • Employee salaries and benefits: You need detailed records of what you’ve paid employees and contractors, along with the cost of medical or other employment-related benefits you’ve funded
  • Office supplies and equipment: This is a big category covering everything from office computers to machines used in manufacturing and the toner used in photocopiers.
  • Travel and entertainment expenses: If you have employees who fly cross-country to see clients or need to meet customers over meals and drinks, you need to keep all receipts along with a record of who met with whom.

How to Choose the Right Business Tax Form

Selecting the appropriate form to file your business taxes depends on how your business is structured — but it’s not quite as easy as it sounds. Though there are only four main types of business for tax purposes, there is some overlap in the definitions.

Many freelancers and solopreneurs register as a sole proprietorship. That allows them to report their business income and outgoings by attaching a Schedule C to their individual income tax returns.

If you run your business as an LLC — and you’re the only LLC member — the IRS will also treat you as a sole proprietorship and expect you to submit a Schedule C. Multi-member LLCs are considered partnerships and must file a Form 1065.

If you’ve structured your business as a corporation, or treat your LLC like one, the IRS will expect you to file a separate corporate tax return: Form 1120 for C-Corporations or Form 1120S for S-Corporations.

Here is a list of the forms the different business types need to prepare:

  • Schedule C (for sole proprietors): The IRS Schedule C form is filed along with the standard Form 1040 for individual tax returns. It’s for self-employed individuals, sole proprietors of a business, or a limited liability company (LLC) with a single member. It’s used to detail activities around income generation and use of profits.
  • Form 1065 (for partnerships): In a partnership business structure, the IRS uses Form 1065 to work out whether the partners are reporting their income accurately. Each partner also needs to attach a Schedule K-1, which details their respective share of the business’s profits and losses. Partners then need to report those profits and losses on their personal tax returns (Form 1040) with a Schedule E form attached.
  • Form 1120 (for C corporations): Corporations pay tax directly on profits and must file an IRS Form 1120 corporate tax return. If a corporation expects to pay taxes in a given year, it must estimate the amount due for the 12-month period and make quarterly payments to the IRS.
  • Form 1120S (for S corporations): While a traditional C corporation submits its taxes using IRS Form 1120, an S corporation uses Form 1120S. What’s the difference? A C corporation pays corporate tax rates and has no restrictions on ownership. An S corporation is a pass-through entity that reports its profits and pays taxes via the owners’ individual tax returns.

What to Consider When Choosing a Business Tax Form

  • Business structure: are you filing as a sole proprietorship, a partnership, an LLC, or a corporation?
  • Tax year: While individuals have to file taxes for the Jan-Dec calendar year, businesses can choose to file for a fiscal year, which is any period of 12 consecutive months. Once you define a fiscal year for your business, however, you can’t change it.

Calculating Business Taxes

Even if you pay an accountant to handle your taxes, knowing the range of tax choices is important if you’re going to run your business in an informed way. Understanding how taxes are calculated will make it easier to identify potential tax traps — and opportunities for tax savings.

These are the major factors that determine the size of your tax bill.

  • Gross income determination: Gross income is the total amount of revenue earned minus business expenses like operating costs and interest payments.
  • Deductible expenses: Any expenses that are ordinary and necessary to conduct your business are generally deductible. Ordinary means that an expense is normal and accepted in your sector. Necessary means it’s appropriate to the task and supports a practical business objective.
  • Tax credits and deductions: Tax credits are applied against the amount of tax you’re due to pay, reducing your tax bill dollar-for-dollar. Tax deductions, on the other hand, are applied against your total income to reduce how much is subject to taxes.
  • Depreciation: Depreciation is an accounting method that spreads the cost of an asset over its expected useful life so its value is tracked against your business’s profitability. Instead of recording the full price of an asset as soon as it’s purchased, businesses record depreciation as a periodic expense in the profit and loss statement.
  • Self-employment tax: This refers to Social Security and Medicare taxes paid by freelancers and independent contractors who work for themselves. Wage earners have Social Security and Medicare taxes withheld from their paychecks.

Filing Your Business Taxes Using Software

Filing taxes can be overwhelming if you’re navigating on your own. Intuitive software with reports and organized data can ease the burden when tax season is in full swing. Tax solutions let you handle the filing process yourself online.

These services take you through it step by step and ensure every box is ticked before you hit send. You save on fees and the back-and-forth of working with an accountant. They’re ideal if your tax situation is fairly simple and straightforward.

Check out our guide to the best business tax software.

Benefits of Business Tax Software

  • It’s convenient: Tax software is one of the most user-friendly SaaS categories in tech — and by far the most convenient way to file taxes. You can use it at the office or home, start the process, save your work, and then log in again the next day to pick up where you left off.
  • It’s easy to use: Tax solutions walk you through the filing process step-by-step. No preparation or prior knowledge is required. The software will ask questions about your tax situation before helping you complete the correct forms and suggesting tax deductions and credits you might qualify for
  • It’s accurate: Tax software removes the guesswork from filing because you don’t have to worry about getting the calculations wrong. The solution does the math for you and guides you through each field on the submission forms.
  • You’ll get any refund faster: Using an online tax solution, e-files your return directly into the IRS’s own systems. That’s much faster than sending paper documents in the mail and lets you select how you want to receive a refund. Direct deposit is typically one of the options. Most will offer notifications so you can keep track of processing, payments due, or refunds due.

For a list of top tax software solutions, visit Techopedia’s Best Tax Software page.

Conclusion

Filing your federal income tax return is part of the price of doing business. Important to get it right, but don’t forget there are state and local business taxes too. State revenue bodies will levy income taxes of their own, plus property taxes, sales taxes, and more, depending on the kind of business you operate — and where.

Want more great time-saving tips to help run your business more effectively? Check out Techopedia’s small business guides and tutorials.

FAQs

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Mark De Wolf

Mark is a freelance tech journalist covering software, cybersecurity, and SaaS. His work has appeared in Dow Jones, The Telegraph, SC Magazine, Strategy, InfoWorld, Redshift, and The Startup. He graduated from the Ryerson University School of Journalism with honors where he studied under senior reporters from The New York Times, BBC, and Toronto Star, and paid his way through uni as a jobbing advertising copywriter. In addition, Mark has been an external communications advisor for tech startups and scale-ups, supporting them from launch to successful exit. Success stories include SignRequest (acquired by Box), Zeigo (acquired by Schneider Electric), Prevero (acquired…