IRS Advice for Small Business Week
On the occasion of National Small Business Week this week, the IRS has some tips for anyone launching their own enterprise.
Big Decisions for Small Businesses
For starters, the website IRS.gov has free resources available, such as an online center to assist the self-employed with tax filing. The agency also has pages such as “Hobby or Business?” and the US Small Business Administration has a guide on “Ten Steps to Start Your Own Business.”
Step 5 is choosing a structure for the business, which ultimately has tax implications. The form of business determines which income tax return form must be filed:
- Sole proprietorship—When someone owns an unincorporated business by themselves.
- Partnerships—The relationship between two or more people to do trade or business.
- Corporations—In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation’s capital stock.
- S Corporations—Corporations that elect to pass corporate income, losses, deductions, and credits to shareholders for federal tax purposes.
- Limited liability companies (LLC)—The IRS treats an LLC as either a corporation, partnership, or as part of the owner’s tax return (e.g. sole proprietorship) depending on elections made by the LLC and its number of members. LLCs are subject to different regulations depending on state statutes.
Step 8 is acquiring a tax ID or employer identification number. The form of business being operated determines what taxes must be paid and how to pay them:
- Income tax—All businesses except partnerships must file an annual income tax return. Partnerships file an information return.
- Self-employment tax—Individuals who work for themselves pay Social Security and Medicare tax to contribute to coverage under the Social Security system.
- Employment tax—When small businesses have employees, the business has certain employment tax responsibilities that it must pay and forms it must file.
- Excise tax—Levied on various goods, services, and activities, such taxes may be imposed on the manufacturer, retailer, or consumer, depending on the specific tax.
The IRS notes that business owners generally must pay taxes on income, including self-employment tax, by making regular payments of estimated tax during the year.
Small businesses must figure their taxable income based on a tax year, the accounting period for reporting annual income and expenses:
- Calendar year—twelve consecutive months beginning January 1 and ending December 31.
- Fiscal year—twelve consecutive months ending on the last day of any month except December. A 52–53-week tax year is a fiscal tax year that varies from 52 to 53 weeks but does not have to end on the last day of a month.
Furthermore, the IRS advises that maintaining adequate records helps small businesses monitor their progress, prepare financial statements, identify sources of income, keep track of deductible expenses, keep track of their basis in property, prepare their tax returns and support items reported on their tax returns. Taxpayers should maintain their records for at least three years.
Looking ahead to filing 2022 taxes in 2023, the IRS points to some potential benefits.
With a growing number of business owners now working from home, many may qualify for the home office deduction, also known as the deduction for business use of a home.
Usually, a business owner must use a room or other portion of the home exclusively for business on a regular basis. Exceptions to the exclusive-use standard apply to home-based daycare facilities and to portions of the home used for business storage, where the home is the only fixed location for that business.
Those eligible can figure the deduction using either the regular method or the simplified method.
To choose the regular method, fill out and attach Form 8829, Expenses for Business Use of Your Home. In general, this form divides the expenses of operating the home between personal and business use. Direct business expenses are fully deductible. On the other hand, the business portion of indirect expenses—such as real estate taxes, mortgage interest, rent, casualty losses, utilities, insurance, depreciation, maintenance, and repairs—is figured on this form, based on the percentage of the home used for business.
Alternatively, instead of filling out Form 8829, business owners can choose the simplified method, based on a six-line worksheet found in the instructions to Schedule C, the tax form for sole proprietors. This method has a prescribed rate of $5 per square foot for business use of the home. The maximum deduction is $1,500, based on business use of at least 300 square feet.
For 2021 and 2022 only, businesses can generally deduct the full cost of business-related food and beverages purchased from a restaurant. Otherwise, the limit is usually 50 percent of the cost of the meal.
To qualify for the higher limit, the business owner or an employee must be present when food or beverages are provided. Moreover, the expense cannot be “lavish or extravagant.” For this purpose, grocery stores, convenience stores and other businesses that primarily sell pre-packaged goods not for immediate consumption, do not qualify as restaurants.
“National Small Business Week is a time to honor and celebrate America’s entrepreneurs and innovative startups. This year’s theme, ‘Building a Better American Through Entrepreneurship,’ celebrates the resiliency and tenacity of America’s entrepreneurs,” says Isabella Casillas Guzman, administrator of the US Small Business Administration. “I look forward to recognizing our small business giants and their tremendous impact on our economy and communities across the nation.”