November 6, 2024 | 8 minute read
When a business launches, the owner will likely develop plans for hiring, marketing and making their first sale. But taxes, often overlooked by new entrepreneurs, are equally important to consider. Entrepreneurs should plan for business taxes from day one to maintain accurate records and reduce the risk of tax penalties down the line.
A business’s structure will impact its taxes, including how and when returns are filed. Owners of very small businesses often operate under a sole proprietorship or limited liability company (LLC). First-year entrepreneurs should note that paying taxes on business income and paying taxes on employment income differ in several key ways.
Those who expect to owe $1,000 or more when they file a tax return generally will have to make estimated tax payments quarterly. For more information on who must make quarterly estimated tax payments, see the IRS guide on estimated taxes. Business owners will need to pay estimated tax to the federal government and possibly one or more states and/or localities, depending on where they live and where the business operates. Those who operate their businesses as a C corporation, or as an LLC taxed as a C corporation, 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.
Owners who wait to pay business taxes until their tax filing deadline could be required to pay a large penalty. Penalties are generally assessed based on the estimated tax that should have been paid each quarter and the length of delay in payment. Business owners also may be required to pay interest.
When paying quarterly estimated taxes, business owners generally pay both the tax on income they made plus the self-employment tax, if applicable, which includes Social Security and Medicare taxes. For information on the current self-employment tax rate, see the IRS guide on self-employment tax. For purposes of self-employment tax, business owners often are both the employer and employee.
Keep in mind that business owners may also need to set aside money to pay quarterly estimated taxes on any income they 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.
For businesses with employees, the income that comes through each paycheck is often referred to as W-2 income. Employers must withhold the appropriate taxes from each employee’s paycheck and remit them to the government. At the end of each year, employers must file a Form W-2 for each employee to report their income and the amount of taxes withheld. Major payroll providers will help business owners determine how much to withhold, automatically deduct the taxes from their business bank account and remit the taxes to federal and state tax authorities on their behalf. However, business owners ultimately are responsible for paying the correct amount of taxes, so it might be a good idea to have an accountant at least spot-check to make sure any payroll deductions are what they should be. Changes to tax laws and employees’ incomes may require business owners to update the amounts they are deducting.
Setting up accounts and record keeping ahead of tax time lets business owners focus more on running their businesses and less on what can be an onerous task.
Sole proprietors can start by separating their business and personal finances to keep an accurate tally. Using a personal checking or savings account for business may lead to higher taxes if the business owner forgets to deduct every deductible expense. Similarly, deducting expenses paid out of a business’s finances to make personal purchases is improper and can leave a business owner vulnerable to owing the government money in taxes, interest and penalties if they are ever audited.
Business owners also might consider applying for a dedicated business credit card. It might be easier to track expenses made on one or two business cards that have been set aside for business needs. Some business credit cards offer extensive reports on 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 an entrepreneur establish a positive credit history for their business.
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, business owners should make sure to maintain detailed transaction and customer records, track the states and localities where their business has customers, and reconcile their books frequently so they catch any errors early that could affect the amount they owe in taxes.
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 to business expense resources that business owners can consult periodically to make sure they know which expenses may be tax deductible. Business owners should discuss any potential deductions with their accountant to ensure they are properly timing their deductions.
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 expenses more convenient. So in addition to accounting software, it could be helpful for business owners to use a mileage-tracking app on their mobile phone to capture every trip they take for business in their personal vehicle, or a travel-specific app to record all travel-related expenses, such as hotel stays and airline tickets. This way, they can keep track of business travel expenses that may qualify as tax deductions. Similarly, if business owners use an app that allows them to scan their business receipts and upload them to their accounting software or digital storage, it might be easier for them to keep track of on-the-go expenses. Some apps allow users to view a tally of all their expenses for the year and what their current profits are when expenses are subtracted.
Read more: Cash flow management basics for small businesses
Saving for taxes monthly can help ensure that business owners have ample cash on hand when it’s time to make estimated tax payments each quarter. This strategy may be especially helpful when an entrepreneur is first getting started or 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.
Business owners may be able to reduce their personal federal taxable income by opening a tax-advantaged retirement account — a traditional IRA, SIMPLE IRA, SEP IRA, one-participant 401(k) or other retirement account — for which their contributions up to specified annual IRS limits generally will be excluded from their taxable income for the relevant year. Eligibility for these types of retirement plans depends on a business owner’s specific circumstances. (For more information, see Retirement Plans for Small Business.) Maxing out tax-deductible contributions and even opening a second type of retirement account in accordance with IRS rules can help business owners reduce their federal taxable income.
Another way for a business owner to potentially reduce their 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. Individual business owners can open an HSA with a bank or credit union that offers HSA accounts, provided they meet certain eligibility requirements. An HSA is designed to pay for current and future health needs, and the money contributed to an HSA is tax deductible. Plus, business owners can withdraw funds federal income tax-free — provided they use the funds to pay for qualified medical expenses. Similar to retirement accounts, an HSA has an annual contribution limit that is established by the IRS, and if a business owner is 55 or older by the end of their tax year, they will qualify for a higher annual contribution limit and can save even more money in an HSA.
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.
Bank of America, Merrill, their affiliates and advisors do not provide legal, tax or accounting advice. Consult your own legal and/or tax advisors before making any financial decisions. Any informational materials provided are for your discussion or review purposes only. The content on the Center for Business Empowerment (including, without limitations, third party and any Bank of America content) is provided “as is” and carries no express or implied warranties, or promise or guaranty of success. Bank of America does not warrant or guarantee the accuracy, reliability, completeness, usefulness, non-infringement of intellectual property rights, or quality of any content, regardless of who originates that content, and disclaims the same to the extent allowable by law. All third party trademarks, service marks, trade names and logos referenced in this material are the property of their respective owners. Bank of America does not deliver and is not responsible for the products, services or performance of any third party.
Not all materials on the Center for Business Empowerment will be available in Spanish.
Certain links may direct you away from Bank of America to unaffiliated sites. Bank of America has not been involved in the preparation of the content supplied at unaffiliated sites and does not guarantee or assume any responsibility for their content. When you visit these sites, you are agreeing to all of their terms of use, including their privacy and security policies.
Credit cards, credit lines and loans are subject to credit approval and creditworthiness. Some restrictions may apply.
Merrill Lynch, Pierce, Fenner & Smith Incorporated (also referred to as “MLPF&S" or “Merrill") makes available certain investment products sponsored, managed, distributed or provided by companies that are affiliates of Bank of America Corporation (“BofA Corp."). MLPF&S is a registered broker-dealer, registered investment adviser, Member SIPC, and a wholly owned subsidiary of BofA Corp.
Banking products are provided by Bank of America, N.A., and affiliated banks, Members FDIC, and wholly owned subsidiaries of BofA Corp.
“Bank of America” and “BofA Securities” are the marketing names used by the Global Banking and Global Markets division of Bank of America Corporation. Lending, derivatives, other commercial banking activities, and trading in certain financial instruments are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Trading in securities and financial instruments, and strategic advisory, and other investment banking activities, are performed globally by investment banking affiliates of Bank of America Corporation (“Investment Banking Affiliates”), including, in the United States, BofA Securities, Inc., which is a registered broker-dealer and Member of SIPC, and, in other jurisdictions, by locally registered entities. BofA Securities, Inc. is a registered futures commission merchant with the CFTC and a member of the NFA.
