unning a business is hard enough without the added pressure of filing taxes. In a perfect world, you’d be thinking about tax preparation at all times, keeping documents and records organized to help ease the burden come tax time. Indeed, practicing good “financial hygiene” throughout the year removes some of the headaches of filing business taxes.
We’ve put together this guide to help small business owners prepare their taxes. Of course, it’s always advisable to consult with your accountant or tax professional if you have a question related to tax preparation, filing, and payment.
Know which business tax return to file
Choosing the right form to file your taxes depends on how you originally set up your business from a legal standpoint.
The following are the respective IRS forms:
Gathering the necessary documents
While the complete list of documents will vary based on your business’s structure, below is a basic checklist of the documents, receipts, files, and information you need to fully understand what you owe to properly file your taxes.
Income sources include revenues from your business operations and any investment or secondary income.
- Gross receipts from the sales of products or the delivery of services
- Sales records, even when the amount hasn’t yet been paid in full by the customer. (This is for those entities who file taxes on an accrual basis; such records are considered your Accounts Receivable.)
- Returns, allowances, and refunds
- Business checking/savings account interest (1099-INT or statement)
- Other income, such as rental income, royalties, commissions, or federal/state clean energy tax credits.
Beginning in 2022, if you receive $600+ annually for goods and services using a peer-to-peer (P2P) payment platform, you will receive a 1099-K form and need to report that business income on your taxes. (You are still required to report income from P2P platforms even if you are under the $600 limit, but you will not receive a 1099-K form.)
Costs of goods sold
If you produce, purchase, or sell merchandise for your business, you’ll need to consider your inventory at the beginning and end of the year.
- The total dollar amount of the beginning inventory
- Purchases made to replenish Inventory
- The total dollar amount of the ending inventory
- Items removed for personal purposes
- Materials and supplies needed to procure, ship, transfer, store, or maintain the inventory
A wide range of costs can fall under applicable business expenses. Keep meticulous receipts and records so as not to miss any of these, as these can count towards partial or full deductions.
- Advertising or marketing expenses
- Phones, including landlines and mobile phones related to business, including connectivity and service (usually monthly plans)
- Business equipment, including computer hardware, printers, cash registers, and scanners
- Office supplies
- Transportation and travel expenses related to the business, including mileage, parking, tolls, airfare, taxis/ride hailing services, and lodging, along with incidentals related to the trip, such as meals
- Commissions and fees paid to employees, contractors, or third-parties
- Contract labor expenses
- Wages or salaries paid to employees
- Benefits paid to employees, including health insurance premiums and contributions to retirement plans
- Depreciation of assets (This usually relates to heavy equipment or fixtures needed for the business that are not regularly purchased and replaced. Some computer equipment can also fall into this category.)
- Cost and first date of acquisition of business assets
- Sales price and disposition date of any assets sold
- Documentation of prior-year depreciation
- Intangible assets, including patents or copyrights held, and their amortization
- Business insurance
- Interest expense
- Mortgage interest on any real estate owned by the business
- Interest on business loans
- Investment expense and interest
- Professional fees, including those for legal and accounting services; the annual report fees paid to your state’s Division of Corporations fall into this category as well
- Commercial lease/rent expense
- Repairs and maintenance expenses
- Home office expenses, included mortgage interest, rent paid, insurance, and utilities (If the home is used for the business, there are deductions based on the portion of the square footage of the home dedicated to the business)
You also want to make sure you’ve completed and filed all employee-related documents, including:
- Form 1099-NEC and Form 1096, for reporting non-employee income
- Form W-2 and Form W-3, for reporting employee income
- Forms 940 and 941, for reporting unemployment, Social Security, and Medicare tax withholdings
It’s also a good idea to gather any financial statements generated by the business, as taxes are line items in these. These documents include your:
Determining tax deductions and credits
Deductions are a way for businesses to reduce their tax burden. The IRS allows businesses to claim expenses as deductions if they can prove them necessary to operate and generate revenue.
The deductions listed below can be claimed by sole proprietorships, as well as C-corps and S-corps, partnerships, and LLCs, although there might be different rules for each. Consult with a tax professional to determine what exactly you can claim.
- Startup and organizational costs: Business startup costs are seen as a capital expense by the IRS since they are an investment in your business, even though the business hasn’t officially spent the money yet; instead, the funds are simply transformed into an asset. Deductions for capital expenses typically occur over several years. This is known as amortization and helps businesses accurately assess profitability year over year. For further information, consult chapters seven and eight of IRS Publication 535, which covers business expenses.
- Inventory: Some inventory-based businesses will manufacture products or purchase them for resale. These businesses can deduct the cost of their stock or the goods they sell. As noted above, you must value inventory at the beginning and end of each tax year to determine your cost of goods sold. Inventory-related expenses beyond the cost of the products or raw materials include shipping, storage, and factory overhead.
- Commercial property rent: If you rent your commercial space, you can deduct your lease or rental payments from taxes. If you run your business from your home, you can determine what portion of your home expenses are deductible; it’s usually based on the square footage of your home dedicated to your business. You can learn more through IRS Publication 587.
- Utilities: Any utilities that you use for your business are fully deductible. This includes water, electricity, trash removal, and Internet/phone service.
- Insurance: Most businesses will take out some form of business insurance, most of which is deductible. Examples of deductible insurance policies include property insurance, liability coverage, malpractice insurance, workers’ compensation, auto insurance, and business interruption insurance. Employee health and life insurance can also be deductible.
- Auto expenses: Delivery and distribution businesses can deduct all expenses related to their fleets, including fuel, parking, tolls, maintenance, insurance, and the like. However, the IRS allows some deductions if a personal vehicle is used for business purposes. The IRS standard mileage rate is currently $0.58 per mile, and you must divide and demonstrate your expenses based on actual mileage. For more information, refer to Publication 463 on travel, entertainment, gift and car expenses.
- Travel expenses: Related to auto expenses are any travel costs associated with doing business. Deductible travel expenses include airfare (and associated fees, like baggage and travel insurance), tolls, taxis/ride hailing services, and lodging.
- Payments and depreciation on business equipment or machinery: If you lease equipment or machinery for your business, you can fully deduct these expenses. This includes anything from printers and scanners to manufacturing equipment and delivery vehicles. You can also claim depreciation on equipment and machinery. However, these costs must be deducted over several years. To do this, you must claim a Section 179 deduction.
- Office supplies, equipment and furniture: Any office-related equipment, including supplies, computers, and even furniture, are expenses that can be deducted.
- Software: Business software, including any subscription-based SaaS software—including TurboTax or any tax-preparation software—can be deducted. Some of these auto-renew, so it’s important to keep records of how many seats (i.e., number of subscriptions) you’ve paid for. These types of expenses can be claimed under “Other Common Business Expenses > Other Miscellaneous Expenses” on the Schedule C tax form.
- Advertising and marketing: Any expenses related to advertising or marketing your business can be deducted. All expenses related to your website, including hosting, design, and development, are also deductible.
- Business meals and entertainment: Meals and entertainment used to entertain clients or generate new business can be deducted, but not equally across the board. Most meal costs are only deductible up to 50%, but certain types of meals, such as the catering provided for an office party, are 100% deductible.
- Loan interest: If you have a small business loan, the interest payments are usually fully tax deductible as long as the loan is used to cover business expenses. To claim this deduction, the business owner must be legally liable for the debt, and the loan must be through a traditional lender (not with a friend or family member).
- Bad debt: As another loan-related deduction, any money you lent to someone in your business without getting it back can be claimed as “bad debt.” According to the IRS, this “worthless” debt can be claimed as long as you can prove that it was related to your business. Bad business debts include loans to customers, suppliers, distributors and employees or credit sales to customers.
- Taxes: Oddly enough, the taxes you incur from just running your business are deductible. These taxes might be federal, state and local income, real estate, or sales taxes. Your employer-related taxes, such as the employer share of unemployment taxes, are also fully deductible.
- Employee salaries and benefits: Generally, the wages you pay your employees, including bonuses and commissions, are fully deductible. However, this deduction does not apply to sole proprietors, partners and LLC members because these individuals are not considered employees. You can also deduct certain employee beneﬁt programs, like education assistance, dependent care assistance, life insurance adoption assistance or qualiﬁed retirement plan accounts.
- Contract labor: Just as employee wages are tax-deductible, so are the costs associated with hiring contracted labor. You must issue form MISC-1099 to any contract worker receiving $600 or more from you in a given tax year.
- Legal and professional fees: Fees paid to third-party professionals for the delivery of professional services are tax-deductible – as long as they are”ordinary and necessary expenses directly related to operating your business”. This includes legal fees, as well as fees paid to accountants and tax professionals for tax preparation services. Additionally, any annual fees paid to your state’s Division of Corporations or a third-party representative are also deductible.
Filing business taxes
Some small business owners can self-file their taxes using tax preparation software with a direct connection to the IRS’s website for electronic submission. This option makes sense for solopreneurs without employees, cost of goods sold, or depreciating assets.
For larger businesses involving employees, inventory, or physical locations, it is better to consult with a tax professional, as multiple documents and filing requirements may be too complex and overwhelming for an individual business owner.
March 15, 2023 is the deadline for the filing of corporate tax returns (Forms 1120, 1120-A, and 1120-S) for the tax year 2022. (Note that this is not the deadline for the payment of taxes that are due to the IRS.)
This date is also the deadline to request an automatic six-month extension of time to file (Form 7004) for corporations that use the calendar year as their tax year and for filing partnership tax returns (Form 1065) or to request an automatic six-month extension of time to file (Form 7004).
Here are some other important deadlines related to the actual payment of 2022 taxes:
- Jan. 17, 2023: Deadline to pay the first-quarter estimated tax payment for the tax year 2022.
- June 15, 2023: Deadline for second-quarter estimated tax payments for the 2022 tax year.
- Sept. 15, 2023: Deadline for third-quarter estimated tax payments for the 2022 tax year.
- Dec. 15, 2023: Deadline for fourth-quarter estimated tax payments for the 2022 tax year.
Best practices for preparing yourself for tax season
To keep organized and reduce any tax-related stress, there are several best practices that small business owners can put in place.
Hire an accountant to work with you throughout the year
Instead of hiring an accountant to prepare and file your taxes only during tax season, it’s a good idea to have an accountant work with you and your bookkeeper throughout the year. An accountant can help you track income and spending and make sure that you are assembling and maintaining the right documents. Accountants can spot and address cash flow problems and work with you to monitor the health of your business. You and your bookkeeper should be using accounting software, and your accountant can assist you with how to use it properly to generate documents needed at tax time.
Maintain meticulous records
In addition to having an accountant on call when needed, best practices for tax preparation include keeping thorough and accurate records throughout the year. Without adequate record keeping, you could be leaving deductions on the table and find yourself with a higher tax responsibility. Worse, if documentation is unclear or inconsistent, you could be putting yourself and your business at risk for an audit.
Separate business from personal expenses
Many small business owners, especially solopreneurs, commingle expenses and accounts since they are the principals funding the business and accepting payments from customers. As another best practice, and not just for the sake of reporting taxes, create separate accounts for your business and personal expenses. (Novo offers free business checking accounts – apply today.)
Establish your business entity properly
Failing to classify your business entity properly could result in the unnecessary overpayment of taxes. When classifying your business, several factors must be considered, such as whether you plan to include business partners, accept investment from outsiders, or hire employees, or how closely you want your personal and business finances aligned.
The five most common business structures are:
- Sole proprietorships. Contractors, freelancers, and unincorporated businesses typically use this business structure. As a sole proprietor, you are responsible for reporting taxes to the IRS on your personal tax returns.
- Partnerships. A partnership has the same legal structure as a sole proprietorship, but it allows for two or more owners. Instead of paying income tax, a partnership must file an annual information return. Each partner must also report their share of the business’s income and losses on their personal tax return.
- C-Corporations. The IRS recognizes a C-Corporation as a separate tax-paying entity for federal income tax purposes. Profits are distributed among shareholders, and special tax deductions may also apply.
- S-Corporations. An S-Corporation shields multiple owners from liability and allows shareholders to report pass-through income on their personal tax returns. Certain institutions, such as financial companies, are ineligible for S Corporation status.
- Limited Liability Companies (LLCs). The IRS treats an LLC as a corporation, partnership, or disregarded entity (i.e., part of the LLC’s owner’s tax return) depending on elections made and the number of members it has. Given that LLC regulations vary by state, make sure to check the Secretary of State or other business gateway website in the state where you formed your LLC.
Consult with an attorney and accountant at the onset to determine how your business should be classified, with an eye to what you might owe in taxes. If you realize that you didn’t set up your business properly at the beginning, ask the attorney what the fees would be to reorganize and re-establish your business entity.
While you might have separate payroll software or a service and maintain a separate payroll account at your bank, mismanaging payroll can have a dramatic effect on taxes. This might occur, for example, when a payroll service isn’t remitting payroll taxes properly.
Frequently Asked Questions
What happens if I miss a tax deadline?
If you don't submit a tax return and/or miss making a payment due by its appropriate deadline, you'll most likely need to pay the penalty, such as an extra interest charge.
There are two main potential penalties:
- Failure-to-file penalty: This penalty for 1040 returns is 5% of the tax due per month, up to a cap of 25% overall, with additional fees piling up after 60 days.
- Failure-to-pay penalty: This penalty is 0.5% for each month, or part of a month, up to a maximum of 25%, of the amount of tax that remains unpaid from the due date of the return until the tax is paid in full.
Is hiring an accountant throughout the year worth it? I’m just starting out and I need to manage expenses.
Seasoned entrepreneurs well-versed in IRS and their state tax codes may already have their internal bookkeeping and accounting systems on auto-pilot, and might not see the need for regular accounting counsel. However, given the shifting nature of federal and state tax codes, especially as they relate to what is permitted for deductions, it is worth the investment to hire an accountant to consult on these issues.
Keep in mind that any fees you pay for professional accounting services can be deducted as a business expense for that tax year, as cited above.
How do I know what the IRS considers an expense that’s tax-deductible?
According to the IRS, just about any business expense that is considered "ordinary, necessary and reasonable" will qualify as a deduction.
Nonetheless, it can be challenging for a small business owner to easily consider an expense as ordinary, necessary, and reasonable. When in doubt, save the receipts, and consult with your accountant. Again, tax laws change, and an expense that might not have been allowed to be taken as a deduction one year can suddenly be allowed the following year.
What taxes do small businesses typically pay?
The most common taxes paid by small businesses include:
- Income tax. Income taxes usually make up the most substantial portion of taxes owed if your business made a profit during the year.
- Estimated taxes. Estimated taxes include income tax, self-employment tax, and alternative minimum tax. Salaried workers can avoid paying the estimated tax by increasing their withholding through their employer.
- Employment taxes (also called payroll taxes). These taxes include social security and medicare taxes, federal income tax withholding, and federal unemployment tax for your employees.
- Self-employment taxes. Self-employment taxes cover your social security and medicare taxes if you work for yourself.
- Excise taxes. Excise taxes vary based on various factors, such as the kind of business you operate, the equipment you use, or the products you sell.
In addition, you may also owe state and local taxes, sales tax for certain products or services, and property taxes on real estate and equipment.
Small business tax preparation can seem complicated and overwhelming. However, it needn’t be, if business owners implement and maintain strict recordkeeping processes throughout the year.
With the right tools and processes in place, including the right accounting software, business owners can stay organized and have readily available the proper documents needed to file and pay the necessary taxes due throughout the year. Of course, business owners should rely on the guidance of an accounting or tax professional when needed.
This page is for informational purposes only and is not intended to be relied upon as legal, financial, or accounting advice. Please consult your own professional if you have any questions.