Tax basics for small businesses

January 16, 2024 | 8 minute readEn español

As you launch your business, you’ll likely develop plans for hiring, marketing and making your first sale. But taxes, often overlooked by new entrepreneurs, are equally important to consider. By not immediately tending to them, you can potentially get yourself in trouble. Plan for business taxes from day one to ensure accuracy and reduce the risk of tax penalties down the line.


How business and personal taxes differ

Your business structure will impact your taxes, including how and when you file your returns. If you own a very small business, you’re most likely operating under a sole proprietorship or limited liability company (LLC). If this is your first tax year as an entrepreneur, note that paying taxes on business income and paying taxes on employment income differ in several key ways.


Quarterly estimated taxes

If you expect to owe $1,000 or more when your tax return is filed, you generally will have to make estimated tax payments quarterly. For more information on who must make quarterly estimated tax payments, see the IRS Estimated Taxes guide. You will need to pay estimated tax to the federal government and possibly one or more states and/or localities, depending on where you live and where the business operates. If you operate your business as a C corporation, or an LLC taxed as a C corporation, you also will generally need to file a corporate tax return annually and pay estimated corporate taxes quarterly. Separate annual informational tax returns are required for partnerships, LLCs taxed as partnerships and S corporations.


Waiting to pay business taxes until your tax filing deadline could result in being required to pay a large penalty. Penalties are generally assessed based on the estimated tax you should have paid each quarter and the length of delay in payment. You also may be required to pay interest.


Calculating business taxes

When paying quarterly estimated taxes, you generally pay both the tax on income you made plus the self-employment tax, which includes Social Security and Medicare taxes. For information on the current self-employment tax rate, see the IRS Self-Employment Tax guide. For purposes of self-employment tax in your own business, you often are both the employer and employee. 


Keep in mind that you’ll also need to set aside money to pay quarterly estimated taxes on any income you receive as an independent contractor or self-employed professional that generally gets reported on Form 1099-NEC at the end of the year. This is sometimes referred to as 1099 income.


W-2 income

If you run payroll in your business, the income that comes through each paycheck is often referred to as W-2 income. As an employer, you must deduct the appropriate taxes from each employee’s paycheck and send them to the government. Major payroll providers will help you determine how much to take out, automatically deduct it from your business bank account and send it to federal and state tax authorities on your behalf. However, you ultimately are responsible for paying the correct amount, so it is a good idea to have your accountant at least spot-check to make sure your payroll deductions are what they should be. Changes to tax laws and your employees’ incomes may require you to update the amounts you are deducting.


Strategies to keep taxes in order

Separate business from personal accounts

If you set up your accounts and record keeping ahead of tax time, it lets you focus more on running your business and less on what can be an onerous task.


If you are a sole proprietor, start by separating your business and personal finances to keep an accurate tally. Using a personal checking or savings account for business can lead to higher taxes because it’s easy to forget to deduct every deductible expense. Similarly, deducting expenses paid out of your business’s finances to make personal purchases is improper and can leave you vulnerable to owing the government money in taxes, interest and penalties if you ever are audited. 


You also might consider applying for a dedicated business credit card. It’s easier to track expenses if you make them on one or two business cards that have been set aside for your business needs. Some business credit cards offer extensive reports on your business spending, which can be helpful in categorizing expenses for tax purposes. As a bonus, many business cards also offer business-centric rewards categories and other benefits — and, used responsibly, a business credit card can help you establish positive credit history for your business.


Track sales tax

Businesses that must charge sales tax often find it beneficial to invest in appropriate software to help keep track of it — given that they must comply with the laws of each state and locality they serve. These business owners might also seek help from an accountant to make sure they are managing the tax software properly. Regardless, make sure to maintain detailed transaction and customer records, track the states and localities where your business has customers, and reconcile your books frequently so you catch any errors early that could affect the amount you owe in taxes


Know what is (and isn’t) tax deductible

Many business owners pay more tax than they need to because they aren’t aware of the deductions businesses may be entitled to. These are often quite different from personal tax deductions. The IRS publishes a guide called Business Expenses that is worth consulting periodically to make sure you know which expenses are tax deductible. If the end of the year is approaching and you brought in more profits than usual, timing the payment of larger deductible expenses during that year may help you reduce your tax bill for that year if you are a cash basis taxpayer. Just make sure you discuss any potential deductions with your accountant to ensure you are properly timing your deductions.


Simplify tracking of business expenses

It’s easy for paper receipts tucked away in a drawer or folder to get lost or torn. Using simple technology can make keeping track of your expenses more convenient. So in addition to accounting software, it could be helpful to use a mileage-tracking app on your mobile phone to capture every trip you take for business in your personal vehicle, or a travel-specific app to record all travel-related expenses, such as hotel stays and airline tickets. This way, you can make the most of the tax deductions available for business travel expenses. Similarly, using an app that allows you to scan your business receipts and upload them to your accounting software or digital storage will help you keep track of on-the-go expenses. Some apps allow you to view a tally of all your expenses for the year and what your current profits are when expenses are subtracted.


Read more: Cash flow management basics for small businesses


Budget for tax payments throughout the year

Saving for taxes monthly will ensure you have ample cash on hand when it’s time to make estimated tax payments each quarter. This strategy may be especially helpful when you’re first getting started and when business income is sporadic or varies seasonally. It’s common for smaller companies and sole proprietorships to save for taxes in a separate business bank account to ensure funds aren’t accidentally allocated for another purpose.


Open a tax-advantaged retirement account

One tried-and-true way to reduce your personal federal taxable income this year is to open a tax-advantaged retirement account — a traditional IRA, SIMPLE IRA, SEP IRA, Individual 401(k) or other retirement account — for which your contributions up to specific limits generally will be tax-deductible for the current year. (Eligibility for these types of plans depends on your specific circumstances. For more information, see Retirement Plans for Small Business.) Maxing out your deductible contributions and even opening a second type of account in accordance with IRS rules can help you reduce your federal taxable income.


Consider opening a health savings account (HSA)

Another way to potentially reduce your tax bill is to open an HSA, a type of account generally available to people who are enrolled in a qualifying high-deductible health plan. As an individual business owner, you can open one with a bank or credit union that offers HSA accounts, provided you meet certain eligibility requirements. An HSA is designed for your current and future health needs, and when you put money into the HSA, you can claim a tax deduction. Plus, you can withdraw funds federal income tax-free — provided you use them to pay for qualified medical expenses. Like retirement accounts, an HSA has contribution limits, and if you are 55 and older at any time during the calendar year, you can save even more money in an HSA with catch-up contributions.


Small-business tax glossary

Includes income reported on Form 1099-NEC that independent contractors or self-employed individuals receive from customers and clients in a year

The taxes certain entities and individuals, including businesses, pay each quarter, generally based on an estimate of the taxable income for the year

Non-deductible fine levied in certain circumstances, including on taxpayers who have underpaid quarterly estimated taxes or have not paid them on time

Social Security and Medicare taxes generally levied on individuals that are self-employed or an independent contractor

The wages, tips and other income employees receive in a year is reported on Form W-2. An individual may receive multiple Forms W-2 if that individual has multiple employers or changes jobs

Important Disclosures and Information

Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.


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