All businesses must pay taxes regardless of the entity type or size. For many entrepreneurs this can be a costly, and time consuming process. The four major types of taxes that effect small business are sales tax, margin tax, employment taxes, and income taxes.
In the states, a local government has the right to collect sales tax on products sold within their boundaries. It is important to remember that the state, city, and county can all collect tax. Sometimes, there are even special-district taxes for implementation of a city-related service such as a rapid-transit system.
The situation becomes more complicated by the fact that different products, and sometimes services, have different tax rates. For instance, certain grocery items receive no sales tax. However, some products are exempt from all sales tax, or exempt from state sales tax but not from local tax, and so on. One type of exemption involves holding items that are purchased to be resold later. This means retailers and wholesalers generally do not pay sales tax. Nonprofit organizations are also exempt from sales tax providing items purchased are not for personal use.
In most cases, you don’t have to collect sales tax for every location to which you deliver which is an issue for any company with an online presence. Sales tax is dependent on what is called a nexus. If you have a nexus in a state, you must collect sales tax in that state. Usually, a nexus can be thought of as a physical presence. In general, a nexus exists for you in a state if:
1. You have a store in that state.
2. You have employees working in that state.
3. You have some kind of office location or other property in that state.
4. At some point during the year, you employ someone, in some capacity, working within that state to solicit sales—such as setting up a booth at a convention.
5. You, an employee, or an agent, at some point during the year, visit a customer in that state.
Conclusively, the U.S. probably has the world’s most complicated sales-tax system. Unlike European nations, that generally have a single sales-tax rate, every order your deliver potentially has a different tax rate. It is important to contact the local Chamber of Commerce for details about collecting sales tax in a specific area. For Texas, visit http://www.window.state.tx.us/taxinfo/sales/ and click on the “Apply for a new sales tax permit” link. Here you will be able to download the form and then fax or mail your information. You will need to following to register:
1. Sole owners need a social security number.
2. Partnerships need the social security number or federal employer’s identification number for each partner.
3. Texas corporations must have their file number from the Texas Secretary of State.
4. All corporations need the social security number for each officer or director.
5. Every business must have an NAICS code
As of January 1, 2008, the Texas Legislature amended the existing franchise tax by changing the tax base, lowering the rate, and extending coverage to active businesses receiving state law liability protection. The tax applies to partnerships (general, limited and limited liability), corporations, limited liability companies, business trusts, professional associations, business associations, and joint ventures. Sole proprietorships and certain family limited partnerships are not subject to the margin tax.
The revised tax base is the taxable entity’s margin. Margin equals the smallest of three calculations:
1) total revenue minus cost of goods sold
2) total revenue minus compensation
3) total revenue times 70 percent
When calculating margin, it is important to review the exclusions from revenue which include certain flow-through funds, worker’s compensation claims, and dividends and interest from federal obligations.
The tax rate is 0.5 percent for entities primarily engaged in retail and wholesale trades as well as those businesses under Major Group 58 SIC Code (eating and drinking businesses). The rate is 1 percent for all other taxable entities. Taxable entities with $300,000 or less will owe no tax. Taxable entities with tax due of less than $1,000 will owe no tax. However, all taxable entities, including those that owe no tax, must file a return. It is important to realize that if you earned $310,000, you would not be taxed on the total amount but rather the amount over $300,000 or $10,000. A useful resource concerning franchise tax can be found at: http://www.window.state.tx.us/taxinfo/franchise/franfaq.html.
Small businesses which employ individuals to work for them are responsible for paying employment taxes. Employment taxes affect a business at the federal, state, and local level. Being aware of what employment taxes your business is responsible for is vital to avoiding potential issues with the Internal Revenue Service.
Employer ID Numbers (EIN)
An employer Identification Number is also known as a Federal Tax Identification Number, and is used to identify a business entity. Most businesses will require an EIN as it will be used on all tax documents. An EIN can be obtained by filing online through the IRS website (www.irs.gov).
Individuals who work for themselves are required to pay self-employment taxes in the form of Social Security and Medicare taxes which are similar to the Social Security and Medicare taxes withheld from most wage earners. The total self employment tax rate is 15.3%. It is composed of 12.4% Social Security and 2.9% Medicare. In an employer-employee situation, the employee pays half of these amounts and the employer makes a matching payment (see tax percentages below). The self employment taxes are doubled for the self-employed individual since they are both the employer and employee.
Federal Employment Taxes
At the federal level, businesses are responsible for paying Federal income tax withholding, Social Security and Medicare taxes, and Federal unemployment taxes (FUTA). Form W-4 is used to determine the amount of Federal withholding to deduct from each employee paycheck. The amount of federal withholding is sent by the employer directly to the Internal Revenue Service as partial payment of that individual’s tax liability for the year. Social Security and Medicare taxes relate to benefits from the Federal Insurance Contributions Act (FICA). Benefits under FICA are for old-age, survivors, disability insurance, and hospital insurance. 6.2% is withheld from each paycheck for each employee for Social Security, up to a maximum of $6,045, on a maximum income of $97,500. 1.45% is withheld from each paycheck for Medicare, with no maximum amount. The employer is responsible for matching the amount of Social Security and Medicare taxes withheld from each paycheck. The Federal unemployment taxes are the only taxes not paid by each employee through withholding. This amount is paid strictly by the employer.
Form W-2 is a wage and tax statement used to report wages, tips, and other compensation paid to an employee to the IRS. The form also includes the amount of Federal income tax withheld, Social Security and Medicare taxes withheld, and any advanced earned income tax credit payments. A copy of the W-2 must be provided to each employee by January 31st after the end of the year. Another copy must also be sent to the Social Security Administration.
Every business must pay federal income taxes. For many small businesses this can be a challenging task. There are many factors to consider when complying with federal income tax laws.
Methods of Reporting
- This is not a separate taxable entity; therefore it does not file a return.
- Instead, the proprietor includes the net profit (loss) of the business on his/her own individual tax return.
- This is not a separate taxable entity but is required to file an informational federal tax return, Form 1065.
- Each partner reports his/her share of the net income (loss) of the partnership on their personal income tax return.
Limited Liability Partnership (LLP) and Limited Liability Corporation (LLC):
- These are not separate taxable entities and they do not file tax returns.
- Each member of the LLP or LLC reports his/her share of the entities net income (loss) on their individual return.
- This is not a separate taxable entity but does file a federal tax return, Form 1120S.
- The shareholders (owners) report their share of net income (loss) on their own income tax returns.
- This type of entity is required to file its own tax return, Form 1120 and pay federal income taxes.
- The shareholders (owners) pay income taxes on the dividends or wages received from the corporation.
- This type of entity is subject to double taxation, first at the corporate level and then at the shareholder level
Calculating Federal Income Taxes
A basic formula for calculating taxable income is as follows:
|Income (broadly conceived)||$xxx,xxx|
|Less: Exclusions (income that is not subject to tax)||(xx,xxx)|
|Gross Income (income that is subject to tax)||$xxx,xxx|
The general formula for calculating tax due is as follows:
|Federal income tax on taxable income||$xx,xxx|
|Less: Tax credits||(xx,xxx)|
|Tax Owed (Refund)||$xxx|
The income tax rates used to calculate federal income tax on taxable income is dependent on three main factors: the form of organization, the current year’s tax rates, and the amount of taxable income. These rates can be found on the IRS website. The deadline to file an individual tax return is April 15, or October 15 if an extension is filed. Corporations must file their tax returns by March 15, or September 15 if an extension is filed.
The following is a list of some common business deductions that may impact your taxable income:
- Bad Debt
- Charitable Contributions
- Meals and Entertainment
- Rent or Lease Payments
- Repairs and Maintenance
- Salaries and Wages
More information regarding business deductions and their limitations can be found on the IRS website. They offer several publications detailing what business expenses are deductible and how to deduct them.
- If running a home-based business all expenses related to the residence are deductible.
Only the expenses incurred due to the business residing in the home are deductible.
- All meals and entertainment expenses incurred by the business are deductible.
Only 50% of the M&E expenses are allowed as a deduction, with a few minor exceptions.
- If conducting business in your automobile all mileage is deductible.
Only the portion of mileage relating to the business is deductible.
- Choosing the wrong filing status
The Instructions to the 2006 Forms 1040, 1040-A, and 1040-EZ provide detailed information to assist taxpayers in choosing their correct filing status.
- Failing to include or using incorrect Social Security numbers
These should be included exactly as they appear on the Social Security cards.
- Failing to use the correct forms and schedules
Be sure to read all instructions to make sure you have correctly completed all the necessary forms and schedules.
- Failing to file a return when due a refund
It is still necessary to file a return when due a refund. After three years, a taxpayer forfeits refunds if no return is filed. If I run a corporation and filed an extension my income tax return must be filed by:
- Mailing a return to the wrong address
There are different addresses, found on the Internal Revenue Services website, depending on where you reside.
Boyd, James H., et al. West Federal Taxation: Taxation of Business Entities. 2007 ed.
Ohio: Thomson South-Western, 2007.
Internal Revenue Service. 16 July 2008. <http://www.irs.gov>.
“Sales Tax.” Window on State Government. 15 July 2008.
“Tax Rates.” Federation of Tax Administrators. 15 July 2008.
“Texas Franchise Tax.” Window on State Government.15 July 2008.
“What are Sales Taxes?” Business Owners Tool Kit. 15 July 2008.
“Withholding Tax.” Investor Words.com 14 July 2008 <www.investorwords.com/5979/withholding_tax.html>.