Tax season is in full swing and it’s possible you may have even landed on this blog post because you google searched something about small business taxes! Well, you have come to the right place because we love to talk about small business taxes and today we are here to answer 10 frequently asked questions. We recently asked our social media audiences to submit some of their burning questions and these were the best and most common questions we received. If you’d rather watch/listen to our Facebook Live that we did recently where our very own CPA answered these questions, scroll to the bottom and you can easily watch the video where we dive into the details even more.
Q: How long should I wait for 1099’s and what do we do if we don’t receive one that we are expecting?
A: Employers have until January 31st to issue 1099s so you need to wait until at least that date. You can kindly ask for an update and if you still have not received one by the 31st, maybe try to ask one last time. If you still don’t receive one, you’ll still want to be sure to report that income you received on your taxes. This is why it’s important even as a freelancer to keep your own bookkeeping records so you can feel confident with the amount you are reporting as income on your taxes.
Q: I’ve heard you pay less in taxes if you are an S-Corp, is that true and if so when is the best time to become one?
A: It depends. S corporations are a pass-through entity meaning shareholders pay tax on their share of the business income at a personal level rather than at the business level.
If you are the sole owner of your business, you have the option to structure your business as a single member LLC and report your business activity directly on our personal tax return on a Schedule C. You do incur self-employment tax at a rate of 15.3% on top of your income tax rate by using this structure. Structuring your business as an s corp would reduce your tax liability in this case since you would no longer be subject to self-employment tax, however there are many other factors that need to be weighed to see if this is the best option for you, such as the increased cost of payroll due to the requirement that s corp owners take payroll and the increased bookkeeping and tax cost from having to file a separate tax return.
You should also keep in mind that some states tax corporations heavily. So what may benefit you at the federal level may not necessarily benefit you at the state level.
Q: Can my business deduct money that I donated to charity?
A: All charitable contributions made by the business can be deducted for book purposes. However, depending on the type of entity your business is, charitable contributions may not be deductible by the business for income tax purposes. All entity types, except for c corporations, require that charitable contributions made by the business flow through to the shareholder and the shareholder can deduct them on their personal income tax return if they itemize. C corporations are the only entity type that allows businesses to take a deduction on their income tax return for charitable contributions.
Q: Am I taxed on the inventory that I didn’t sell and still have in stock at the end of the year?
A: Inventory is a component of cost of goods sold. The higher your ending inventory at the end of the year, the lower your cost of goods sold expenses are. So while you are not assessed tax on your inventory directly, ending inventory does affect your expenses. You would also want to check with your state as many states do assess a personal property tax on inventory and other tangible assets.
Q: What should I do if I haven’t made any estimated tax payments for last year and I don’t have money saved up to pay what I might owe? Can I file an extension to give me more time?
A: An extension is only an extension for time to file your tax return, it is not an extension to pay. Paying past the original due date of the tax return, even if you have filed an extension, will cause interest and penalties to accrue on your tax due. It is best to pay as much as you can by the due date of the return, even if it is not the full amount due. You can request an installment plan with the IRS or apply for a personal loan through a financial institution to cover the tax due, but depending on the amount of tax owed, either of those options may end up costing you more in interest than if you had just paid late. Ultimately, you should seek advice from a CPA that knows specifics about your current tax situation as the solution that is best for you will vary greatly depending on your personal financial situation.
Q: Is it true that claiming home office deductions is a red flag to the IRS and I will probably get audited?
A: The IRS has very strict rules when it comes to home office deductions. Taking the home office deduction in itself is not a red flag, the red flags arise when taxpayers try to push the limits of this deduction. The biggest way to avoid an audit in this area is to make sure you have a separate room designated as a home office that you do not use for any other activities. It cannot be a shared space, such as working from your kitchen table. This is why most people get audited. You must list the square footage of your home office in comparison to the total square footage of your home as a whole. If you have to provide an estimate, be reasonable. Anything over 50% is unreasonable and definitely a red flag. As long as you truly have a dedicated home office in a separate space, taking this deduction is not anything to worry about.
Q: My business has claimed a loss on the last 3 years’ tax returns. Is the IRS going to tell me it is a hobby instead of a business?
A: Possibly. The IRS considers an activity to be a business if it has shown a profit in the last 3 of the 5 years. If it does not, the IRS may review or audit your business to determine if it should be recategorized as a hobby. There are a total of 9 factors that the IRS looks at to determine if the activity is a business or a hobby. The IRS does make these determinations on a case-by-case basis so I would certainly suggest consulting with a CPA.
Q: Are there any big tax changes in 2019 that I should know about before I file my business taxes?
A: As you know, the Tax Cuts and Jobs Act of 2017 brought about some big changes. If you filed a tax return in 2018, your 2019 tax return will be very similar. The two biggest ways businesses get a tax break from this tax reform is through depreciation and the QBI deduction. You can now deduct up to $1,000,000 through section 179 on capital purchases. First-year bonus depreciation is allowed at 100%. For example, let’s say you purchased equipment for $1,250,000 in 2019. Now you can immediately expense $1,000,000 of that in 2019 rather than depreciating it over multiple years. The first-year bonus depreciation deduction then allows you to expense the remaining $250,000 in 2019 as well. The QBI deduction allows businesses to deduct up to 20% of their qualified business income. Without taking any limitations into account, an s corporation with a net income of $100,000 would get a $20,000 deduction. The deduction flows through to the shareholder’s personal tax return just as the income does. The QBI deduction is eligible for all business types except c corporations. Certain industries may be subject to taxable income limitations that reduce or eliminate the QBI deduction.
Q: Do I need to file tax returns in the states my employees live in?
A: Payroll almost always triggers nexus, meaning you now have a connection to another state and potentially additional filing requirements. If you have employees in a state that perform services or sell products and you have sales in that state, you probably have an income tax filing requirement. Having employees that perform administrative duties only usually does not create an income tax filing requirement. Every state has different filing requirements so you may have a filing requirement and not even know it.
Q: How do I know how much to pay in estimated taxes?
A: It depends. Do you just want to avoid the underpayment penalty or do you want to reduce your tax liability so that when you file your income tax return you owe as little as possible?
If you want to avoid the underpayment penalty, you will need to pay in 100% of the tax from the prior year or 80% of the tax for the current year, whichever is smaller. You will usually avoid the penalty altogether if you owe less than $1,000 in tax after deducting withholdings and credits.
If you want to know how much you should be paying in estimated tax payments throughout the year so that you owe as little as possible with the filing of your tax return, then you need to engage in tax planning services.