How to Prepare Your Small Business for Tax Season
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As the calendar year ends and business tax season looms, entrepreneurs must start gathering documents and calculating their income, expenses and deductions to determine how much the IRS expects them to pay in taxes by the April deadline.
A small business tax preparation checklist could help ease the process. Whether you’re getting ready for your first business tax season or you’re an experienced veteran, continue reading to brush up on what you need to prepare.
When is business tax season?
Personal tax returns are due in April every year, and springtime is often thought of as tax season, especially for pass-through entities, which we’ll discuss in greater detail, below. But business owners may need to pay taxes throughout the year.
Because business owners don’t have an employer who withholds tax from their earnings, they typically make quarterly estimated tax payments.
|Payment||Payment period||Due date|
|1st payment||Jan. 1-March 31||April 15, 2019|
|2nd payment||April 1-May 31||June 17, 2019|
|3rd payment||June 1-Aug. 31||Sept. 16, 2019|
|4th payment||Sept. 1-Dec. 31||Jan. 15, 2020|
Self-employed owners of sole proprietorships, partnerships or S corporations have to make quarterly estimated payments if they expect to owe more than $1,000 when their personal return is due. Corporations must make estimated payments if they expect to owe more than $500 in income tax.
Despite making quarterly payments, you could owe an additional amount when you file your personal tax return in the spring. For instance, you may need to pay more business income tax if your estimates were off.
Employment taxes are also due each month if you have employees. Employment tax includes Social Security and Medicare contributions that you must withhold from both your employees’ and your own paychecks. As a business owner, you’d owe federal unemployment tax as well.
State and local taxes. In addition to federal taxes, you would need to pay state and local taxes depending on the nature of your business. Your state taxes could include income, employment and sales taxes.
Small business tax preparation checklist
Consider starting your tax preparation or meeting with a tax advisor before year’s end to get ahead of tax season, said Linda Farinola, founder of New Jersey-based Princeton Financial Group. As you prepare, here’s a checklist of steps you could follow.
1. Determine if your business is a pass-through entity.
Your business entity would determine how the IRS would tax your earnings. Some businesses are considered pass-through entities, which means business profits are passed through to the owner’s personal income and taxed at the personal income tax rate.
Pass-through entities include:
- Sole proprietorships
- Limited liability companies
- S corporations
The Tax Cuts and Jobs Act created a deduction for pass-through businesses that went into effect in 2018. Eligible business owners can deduct 20% of qualified business income.
If you operate a C corporation, you would need to pay corporate taxes and wouldn’t be eligible for the deduction. However, the Tax Cuts and Jobs Act lowered the corporate tax rate to 21% as well.
Your business entity also determines which tax forms you need to file. Sole proprietorships and LLCs with one owner should file a Schedule C form to report business income and expenses, while corporations use Form 1120 to report taxable income. Business owners in a partnership report their income on Schedule K-1 and must file Form 1065.
2. Gather the necessary documents.
Your tax forms would likely require business information such as income, cost of goods sold and expenses. To find this information, you’ll need to gather financial documents and statements breaking down your income and spending.
Locate the following documents:
- Last year’s tax return, if applicable
- Bank account and credit statements and reconciliations
- Business formation documents
- Profit and loss statement
- Year-over-year comparative balance sheet
- List of fixed asset purchases
- Loan documents
- Capital contributed to or distributed from the business
- Personal information for business owners, including addresses and Social Security numbers, noting any change in ownership
- Payroll reports
Be prepared to calculate how much you’ve spent on business expenses like inventory, advertising, travel and supplies, as well as any costs related to your office space. You may also need to have your gross receipts from sales or services handy, in addition to information about any income you earned outside your business during the year.
3. Find out what forms you need to send.
As an employer, you need to send W-2 forms to each employee on your payroll before Jan. 31, so they can complete their personal taxes. If you hire contractors, you would have to send them a 1099-MISC form each year. Both forms summarize how much you paid your employees or contractors throughout the year for their work.
If you hire another business to complete contract work, you’d need to send a 1099 form to that business as well. Although, you would only send 1099 forms to sole proprietorships and partnerships, not corporations.
4. Make timely decisions.
Before the end of the year, you may want to make large business purchases that you could deduct on your upcoming tax returns. “They might want to make some of the purchases to deduct and reduce their income and their profit,” said Todd Youngdahl, managing partner at Washington Wealth Advisors.
Several federal tax credits available in 2019 are scheduled to expire next year. You may want to take advantage of tax credits that benefit your company before they’re gone. Applicable tax breaks could include:
- Work opportunity tax credit: Incentive to hire employees who fall into certain groups, such as qualified veterans or ex-felons.
- Paid family and medical leave tax credit: Employers that are not legally required to provide two weeks of paid leave but do so anyway could qualify for a tax credit.
- Electric vehicle tax credit: Up to $7,500 tax credit for purchasing an electric-powered four-wheel vehicle.
5. Hire help, if you need it.
To help you prepare for business tax season, you could hire a certified financial planner or tax advisor. You could also work with an enrolled agent who has IRS certification to handle tax matters for all taxpayers.
Consider seeking professional guidance to make sure you’re making the correct amount of estimated tax payments throughout the year to avoid owing a large amount in the spring, plus a possible fine. An advisor can also help you avoid making mistakes, like writing off expenses that aren’t actually deductible.
Pass-through businesses looking to get the 20% deduction may benefit from professional guidance, Farinola said. It could be tricky to determine what portion of your income could qualify for the deduction.
“That is not an easy calculation,” she said. “It’s definitely worthwhile to talk to somebody.”
If tax help is beyond your business budget, many tax preparation software programs are designed for small business owners filing on their own, such as Intuit’s TurboTax Business and H&R Block Premium and Business software.
Steps to take next tax year
If you followed all of the steps and still had a hard time making quarterly payments or locating all of the necessary paperwork, this is a good time to get organized before a new calendar year begins.
Consider opening a separate bank account to set aside money for quarterly taxes, Youngdahl said. “The strategy there is so they’re not having to come up with some large amount of money four times a year,” he said.
Better track business expenses. You should also be diligent about keeping track of business expenses you expect to deduct. Separating your personal and business spending would make it easier to isolate business expenses during the year, Youngdahl said.
Setting up a retirement account before year-end could also reduce your income tax. Without an employer to form or contribute to a retirement account, business owners are responsible for starting and contributing to a retirement account, such as a self-employed 401(k) or Simplified Employee Pension IRA.
A tax advisor or accountant could assist you with creating a strategy for your business, though some experienced business owners may feel comfortable managing tax preparation on their own.
“It depends on where they are in the lifeline of their business,” Youngdahl said.