Understanding Business Basics: Accounting A 5-Part Mini Series

How Taxes Work

Taxes can be a headache for a business owner due to the complexity and amount of paperwork required to file with multiple government agencies. Unlike regular W-2 employees that file taxes once a year, business owners are required to fulfill their tax obligations on a monthly, quarterly, and annual basis, depending on their business type and revenue. Here are the different tax obligations you must fulfill throughout the year as a business owner:

As a business owner:

  • Federal Income Tax: Business owners must make estimated quarterly payments, then reconciled and filed annually.
  • State/Local Income Tax: Varies by state and your local municipality
  • Self Employment Tax: Full amount of the FICA taxes (Social Security and Medicare taxes).

If you have employees (employment taxes):

  • Employee Federal Income Tax: A portion of an employees salary must be withheld by the business owner.
  • Employee State & Local Income Tax: Varies by state and your local municipality.
  • FICA Taxes: Paid by both employer and employee, amount withheld by the employer.
  • FUTA: Federal unemployment tax filed annually but must make quarterly deposits.
  • SUTA: State unemployment tax filed and paid quarterly, reconciled at year-end.
  • Worker’s Compensation: Is a form of insurance required by law in every state except Texas.

If you are selling goods:

  • Sales Tax: Varies by state and the amount of revenue/transactions your business makes.
  • Excise Tax: Imposed on specific goods or activities, such as alcohol, tobacco, gasoline, and firearms.

As you can see, taxes alone require a considerable effort and consume a lot of your time as a business owner. To make matters more complicated, different states have different tax laws. So, if you have employees from another state, you would be responsible for complying with the laws in that state as well as your home state.

Tax Deductions & Credits
    There are several tax deductions and credits available to businesses that can help reduce their tax liability. Though it’s important to note that tax laws and regulations can change, and specific eligibility requirements may vary.

  • Qualified Business Income (QBI): This deduction allows pass-through business entities, such as Sole proprietorships, Partnerships, S-corporations, and LLCs to deduct up to 20% percent of their qualified business income on their taxes.
  • Section 179 Deduction: This deduction allows businesses to deduct the full cost of qualifying property, such as equipment and machinery, in the year of purchase, up to a specified limit.
  • Startup Costs: New businesses can deduct certain startup costs, such as market research, advertising, legal and accounting fees, and organizational expenses incurred before the business starts generating revenue.
  • Depreciation: Businesses can deduct the cost of certain assets used in their operations over time through depreciation. This includes vehicles, machinery, equipment, computers, and other tangible property.
  • Business Expenses: Businesses can deduct various ordinary and necessary expenses related to their operations, such as salaries and wages, rent, utilities, supplies, advertising, insurance premiums, professional fees, and travel expenses.
  • Home Office Deduction: If you have a dedicated space in your home used exclusively for business purposes, you may be eligible to claim a deduction for your home office expenses, including a portion of your rent/mortgage, utilities, and maintenance costs.
  • Research and Development (R&D) Tax Credit: The R&D tax credit is available to businesses that engage in qualified research activities aimed at developing new products, processes, or technologies. It provides a credit based on a percentage of qualified research expenses.
  • Work Opportunity Tax Credit (WOTC): This credit is available to businesses that hire employees from certain targeted groups, such as veterans, long-term unemployed individuals, or individuals receiving government assistance. The credit amount varies based on the employee’s qualifications.
  • Small Business Health Care Tax Credit: Eligible small businesses that provide health insurance coverage to their employees may qualify for a tax credit to help offset a portion of the premium costs.
Why it’s important

As a business owner, paying taxes has several benefits, including:

  • Avoiding audits and investigations: Failing to pay your taxes or under reporting your income can lead to audits, investigations, and legal action by the government. By paying your taxes in full and on time, you can avoid the stress and costs associated with these processes.
  • Qualifying for loans and other financial products: Lenders and other financial institutions often look at a business’s tax history when evaluating its creditworthiness. By consistently paying your taxes, you can demonstrate financial stability and increase your chances of qualifying for loans and other financial products.
  • Meeting legal obligations: As a business owner, you have a legal obligation to pay taxes on your income, profits, and property. By paying your taxes on time and in full, you can avoid legal penalties and other consequences.
  • Accessing government services: By paying taxes, you contribute to the funding of public goods and services, such as roads, public safety, and education. As a result, you and your business can benefit from the use of these services and the infrastructure they provide.
  • Building trust and credibility: Paying your taxes demonstrates your commitment to being a responsible and law-abiding member of society. This can help to build trust and credibility with your customers, suppliers, and other stakeholders.