How to prepare for Tax Day as a small business owner
Editorial staff, J.P. Morgan Wealth Management
- It’s important to keep detailed and organized records of the money coming in and out of your business to help calculate and substantiate your tax obligations.
- While your specific tax situation is likely to be as unique as your business itself, in general, many of the nuts and bolts of your taxes depend heavily on the type of business entity you’re operating.
- An accountant or tax professional can guide you through the specific requirements for your business and help you respond to any changes in tax regulations.
Business owners are bound to encounter plenty of challenges along the path to success – whether it’s attracting top employees, minimizing costs or determining the best way to grow. But no matter what type of business you run, filing taxes can be one of the more daunting tasks you face during the year.
Fulfilling your tax obligations in a way that’s efficient and beneficial for your business might seem like an uphill battle. Luckily, some careful planning and preparation can help make the climb more manageable.
Speaking with a tax professional who can help you determine the best strategy for your business can help you remain compliant and successful, and you should consult a tax professional before making decisions about how to structure and strategize for your business. For now, here are some general tips to help your business get ready to tackle tax season.
Gathering your tax documents
Your tax situation is likely to be as unique as your business itself. But there are some common documents that you’ll want to have on hand to help tax season go more smoothly.
First and foremost, it’s important to maintain a detailed log of the money coming in and out of your business. You may decide to use an accounting software platform to streamline your bookkeeping.
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Even if you have an electronic system in place, items like sales slips, bills, invoices, receipts and canceled checks are generally key supporting documents for calculating and validating your tax filings. You’ll want to organize these records and keep them in a safe place.
Here are some specific kinds of documents that you should keep tabs on.
- Gross receipts: The total income coming into your business will be a big factor in determining your tax picture. Evidence of your inflows might include cash register tapes, records of cash and credit sales, receipt books, invoices and 1099-MISC forms.
- Purchases: You’ll also need records of any items you buy and resell to your customers, including the materials or parts you use to produce finished products. You should keep track of documents showing, amongst other things, the amount you paid, the payee and a description of what you bought.
- Expenses: These are other costs you pay to run your business – and may range from office supplies to utilities and rent payments (just to name a few). Supporting documents may include checks, receipts, credit card statements and invoices.
- Travel, transportation, entertainment and gifts: If you’re taking any tax deductions for these items, you’ll generally need a “paper trail” to substantiate your business-related purchases.
- Assets: The property (including machinery, furniture and other things) you own and use to run your business provides its own set of recordkeeping challenges. You’ll generally need detailed records – such as purchase and sales invoices, real estate closing statements and proof of payment, etc. – to calculate things like annual depreciation and gains or losses if you sell these assets.
- Employment taxes: If you have employees, there are specific records you’ll need to keep for employment tax purposes. Amongst other important things, you’ll generally need to keep track of your payroll records, including documents showing wages, benefits and withholding.
Tailoring your taxes to your business structure
Recordkeeping may have a lot of similarities across the business landscape, but some of the nuts and bolts of your taxes may depend heavily on the type of business entity you’re running.
Let’s look at a few common business entities and some of their basic tax features:
- Sole proprietorship: As a sole proprietor, you own and operate your unincorporated business as an individual (or, possibly, as a married couple). There’s generally no legal distinction between the business owner and the business. Come tax time, you generally report your business income and losses on your personal U.S. federal income tax return (using Schedule C). (Bear in mind that there may be other applicable taxes and tax filing requirements as well, such as with respect to earnings from self-employment).
- Limited Liability Company (LLC): This type of entity may provide some flexibility in determining the tax treatment of your business. As a default, the IRS generally treats domestic LLCs with two or more members as a partnership for U.S. federal income tax purposes, meaning income and losses of the LLC are “passed through” to the owners (who each report their share on their personal U.S. federal income tax return). When there’s only one member, the domestic LLC is generally treated by default as an entity that is disregarded as separate from its owner for U.S. federal income tax purposes (similarly to a sole proprietorship). Alternatively, the LLC can generally choose to be treated as a corporation for U.S. federal income tax purposes. An eligible LLC can generally change its classification by filing an election using IRS Form 8832 (but be aware of the timing and effective date requirements that may apply as well as the tax implications of making a change). Different tax treatments and considerations may apply depending on the context (including, for example, for state and local tax purposes).
- Limited partnership (LP): A limited partnership generally includes a general partner that is responsible for managing the business activities of the partnership and one or more limited partners that have a financial interest but not control over the management of the business. The general partner generally has unlimited liability for the obligations of the partnership, while the limited partner(s) have limited liability. For U.S. federal income tax purposes, the partnership files an annual information return using IRS Form 1065, and each partner receives Schedule K-1 reflecting their share of the LP’s income and losses (and other items such as certain credits and deductions) to report on their individual U.S. federal income return. Again, different tax treatments and considerations may apply depending on the context (including, for example, for state and local tax purposes).
- C Corporation: Unlike some of the other entity types discussed here, an entity treated as a C Corporation is a tax-paying entity itself rather than a pass-through entity. This means that income of the C corporation may be subject to double taxation – the company is required to pay U.S. federal income taxes at the entity level, and shareholders are also subject to U.S. federal income taxes on the income when it is distributed as dividends. However, C Corporations may offer certain other benefits, including limited liability for shareholders and potential advantages when it comes to setting up certain employee stock ownership plans. This type of company is generally required to file a U.S. federal income tax return using IRS Form 1120 annually. As always, keep in mind that C Corporations may also be subject to state and local taxes and filing requirements.
- S Corporation: Operating this type of entity generally allows shareholders the benefit of a single level of taxation afforded to a pass-through entity for U.S. federal income tax purposes, while retaining some of the benefits of incorporation – provided it meets certain requirements. Be aware that the tax rules applicable to S Corporations are complicated and the requirements can be challenging to meet and maintain. S Corporations generally file their annual U.S. federal income tax return using IRS Form 1120-S, and, much like partnerships, they provide Schedule K-1 to shareholders to enable the shareholders to report the relevant amounts on their individual returns. Don’t forget about other potential tax considerations, such as state and local requirements, too.
If you are interested in learning more about other business entities and whether a different structure could make sense for your business, you can learn more here. You should consider talking to your tax advisor before making important transactions or decisions about structuring.
The bottom line
There are lots of moving parts involved in running a business, and staying on top of your taxes can be among the most formidable and time-consuming tasks for a business owner. However, try not to be overwhelmed – keeping the necessary records and adapting your tax plan to your business structure can help you navigate tax season.
Well in advance of any deadlines, it can be indispensable to work with an accountant or tax professional who can guide you through the specific requirements for your business and help you respond to any changes in tax laws, rules or regulations. Now might be the perfect time to grab those IRS forms, organize your invoices and receipts and consult with an expert so that you can tackle Tax Day like a pro.
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Editorial staff, J.P. Morgan Wealth Management
