Module 7: Tax Planning
Your tax obligations
As a business owner, you need to understand your tax obligations. As you build and manage your business, you will want to establish sound business accounting practices, establish your tax year, prepare your taxes and ensure that your tax bills are accurate and up to date. Proper tax planning will also help you plan ahead, manage and save your money and pay your taxes on time.
When small business owners think of taxes, they typically think of federal taxes. But there are other taxes you may be responsible for, including sales tax and business and occupation taxes (B&O tax). If you have employees, you may also be responsible for covering unemployment insurance, worker’s compensation and county and city taxes.
Washington State does not have a corporate tax per se, so you only need to worry about federal income taxes, which are based on your net profit, not your gross income. You arrive at your net profit by subtracting your business expenses from income. Business expenses are ordinary and necessary expenses to operate your business (advertising, utilities, leases, travel, etc.).
Sole proprietorships, partnerships, limited liability companies and S-corporations report any net profit on the owners’ personal income tax forms.
If you are in business for yourself (including a part-time business) or carry on a trade or business as a sole proprietor, you are considered by the IRS to be self-employed. As such, you may have to pay a self-employment tax, which covers your Social Security and Medicare premiums. In 2022, the self-employment tax rate is 15.3% of net earnings. This includes a 12.4% tax for Social Security and 2.9% for Medicare. Note: Self-employment tax is not income tax. It is a separate tax that covers employee health and retirement benefits the federal government offers.
If you have employees, you need to pay employment taxes. These taxes can include withholdings for:
- Federal income taxes based on an employee’s wages.
- Withholdings to cover part of Social Security and Medicare (FICA) taxes from an employee’s wages plus the employer matching amount.
- Federal and state unemployment insurance (FUTA).
- State disability program premiums
Business & Occupation Tax (B&O)
In place of a corporate income tax, Washington uses a B&O tax on a company’s gross receipts. It is measured on the value of products, gross proceeds of sale or the gross income of the business. There are different rates for different types of businesses, and some classifications allow your company to claim credits that are deducted from the gross. The gross is then multiplied by the tax rate for that type of business. These taxes are paid quarterly or annually, based on your business structure.
These are taxes levied on the sale of specific goods and services. Alcohol, fuel and tobacco are good examples of products with an excise tax. For example, you may pay an excise tax on the total cost of a vehicle or on a gallon of gasoline. If you sell a piece of real estate, there may be an excise tax due on the sale.
Washington’s retail sales tax is composed of the state rate (6.5%) plus the local sales tax rate charged by a county or city. Local sales tax rates vary by the physical location of your company. Your business is liable for sales tax, even if it was not collected. Businesses may purchase goods for resale without paying sales tax on the transaction, but they must provide a reseller permit to the seller. When the products are resold, the business then pays the sales tax.
Some local jurisdictions have additional taxes, either on real estate or personal property. Most cities and counties also require you to have a license to do business so that sales taxes can be properly calculated and collected. You’ll want to contact your local tax office to determine specific requirements.
Your business structure impacts your income tax payments and the forms you use to file your taxes. For example, sole proprietorships, partnerships, limited liability companies and S-corporations are not taxed separately on business profits. Instead, any profits are passed through the business to its owners, who report business income and losses on their personal tax returns.
Tax Identification Number: You must have a taxpayer identification number (TIN) so the IRS can process your returns. The TIN is either your Social Security Number (SSN) or an Employer Identification Number (EIN). An EIN is issued by the IRS to sole proprietors, partnerships and corporations. You need to have an EIN if you have employees, have a qualified retirement plan, operate your business as a partnership or corporation or file returns for employment taxes. You can apply for an EIN online or via telephone.
Here is a quick breakdown of the types of businesses and the forms used to report taxes to the Internal Revenue Service (IRS).
- Sole Proprietorship
Form Used: Profit and Loss From Business, Sole Proprietor, Schedule C or C-EZ, Form 1040
You list your income and expenses on this form to determine your net profit. Your net profit is then recorded on your personal tax return (Form 1040).
Form Used: S. Return of Partnership Income, Form 1065
A partnership must file an annual information return to report income, deductions, gains and losses. The partnership must also furnish copies of Schedule K-1 (Form 1065) to the business partners. Partnership profits or losses are passed through to each business partner, and each partner includes their share of the income or loss on their personal tax return.
- Limited Liability Company (LLC)
Form Used: None
The federal government does not recognize an LLC as a classification for federal tax purposes. An LLC entity must file a corporation, partnership or sole proprietorship tax return.
- S-Corporation (S-Corp)
Form Used: Income Tax Return for an S-corporation Form 1120S
S-corporations pass corporate income and losses on the owner’s personal tax returns.
- C-Corporation (C-Corp)
Form Used: US Corporation Income Tax Return 1120
The vast majority of small businesses are not C-Corps. A C-Corporation is taxed as a separate entity under the tax laws. Income earned by a corporation is taxed at the corporate level, and the corporation must file Form 1120 each year to report this income.