It's that time of year again: tax time. Preparing your taxes may seem like an annoying task that distracts you from running your business, but filing an accurate return can reduce the risk of paying fees and penalties down the road.
What you need to complete this task is a checklist, which you'll find below.
This discussion explains what you need to know about your business tax return and the impact on your personal taxes. Follow the checklist to file an accurate tax return on time.
Business Taxation Basics
The first item on your tax preparation checklist is to understand how your business is taxed.
Many taxpayers don't clearly understand how their share of business profits is taxed, and how the tax affects their personal tax liability. There are many ways you can structure your company, and that causes confusion for taxpayers.
The best way to understand the differences is to consider C corporations (C Corps) vs. all other business structures:
- C Corporation: C Corps are subject to double taxation. The C Corp files a tax return and pays taxes on net income (profit). The owners can retain after-tax earnings for use in the business, or pay shareholders a cash dividend. If a dividend is paid, the dividend income is added to other sources of income on the shareholder's personal tax return.
- Pass-through entities: Most other business structures pass the company profits and losses directly to the owners. Sole proprietorships, partnerships, S Corporations, and many other businesses are referred to as pass-through entities. Assume, for example, that your share of a partnership's profit is $10,000. The partnership files a tax return, and issues you a Schedule K-1, which reports the $10,000 in income, and the $10,000 is added to your other income sources on your personal tax return. The partnership tax return documents the partners, the percentages of ownership, and the partnership's profit- but no taxes are calculated on the partnership tax return.
There are some exceptions, but generally, a business faces double taxation as a C Corp, or the company is a pass-through entity.
The tax forms and schedules you must complete are based on your business tax structure. As a result, it's important to understand how your firm is taxed.
Personal Return Components
Next, you need to know how your business profits impact your personal tax return (Form 1040). As explained above, income from your business can flow into your personal return in several ways, but there are three methods that are the most common:
- Dividends: If you are a shareholder in a corporation and receive dividends, the dividend income is posted to Form 1040.
- Partnership income: Partners that earn income through a partnership receive a Schedule K-1, which reports the income earned. Partnership income is posted to Form 1040.
- Self-employed owners: If you're self-employed, profits and losses from your business are reported on Schedule C of Form 1040
If you or your spouse receives a Form W-2 for wages earned as an employee, the W-2 income is added to your business-related income on Form 1040.
Once you understand how your business is taxed, and the impact on your personal tax return, consider these additional tax issues:
Your Tax Prep Checklist
Follow these steps to file an accurate tax return that includes the proper amount of business income and tax deductions:
Gather Your Records
Start the tax preparation process by gathering your records and producing your year-end balance sheet and income statement reports. Ideally, you should use accounting software, which allows you to generate the financial statements automatically.
Many of the line items in your tax return are based on the income statement, including your total income and business expenses.
In addition to your financial reports, you may need to access receipts for some large expenses. Have this information on hand, as you start preparing your taxes. If you use a tax accountant, you'll need to provide these records to the tax preparer.
Review Your Statements
To ensure that your income statement expenses are correct, take one last look at your bank statements and credit card statements. This time investment can pay off if you happen to notice a deductible expense that was not properly coded in your accounting transactions.
You'll want to review check amounts and debits in your bank statement and the spending in your credit card statements. Scan the statements and look for larger dollar amounts, and confirm that each amount is posted as an expense in the income statement.
Make any necessary corrections and generate a new income statement before you prepare your taxes.
Use a Tax Accountant
The tax laws change frequently, and you should discuss your return with an accountant, who can apply current tax laws to your business results. Even if you prepare your own tax return, you can benefit from this type of discussion.
Assume, for example, that the tax accountant tells you that current tax law allows you to fully depreciate certain types of machinery and equipment in the year of purchase. You bought a $3,000 machine, and you posted the machine as an asset on your books.
Depreciation expense is the expense incurred as you use an asset to produce revenue each year, and your tax depreciation expense may be different from the expense posted to your accounting records. In this case, you can depreciate the entire $3,000 machine for tax purposes, while your accounting records post depreciation expense over five years or more.
Discussing your financial results with an accountant can help you take advantage of all allowable tax deductions, and reduce your tax bill.
Remember Estimated Tax Payments
Most business owners are required to make estimated tax payments during the year. When you finish your tax return and compute the tax liability, verify that you deducted the estimated tax payments for the year. This step reduces that risk of paying more taxes than you currently owe.
Make the effort to file your return electronically, because you'll receive confirmation that the return was filed before the tax deadline. Electronic filing also ensures that your entire tax return gets transmitted, and the IRS will process a tax refund faster if you use this method.
Fortunately, tax software allows you to file your return electronically.
Extending Your Filing Date vs. Payments
If your tax situation is more complex than normal- or if you are missing tax documents- you may request an extension. If the extension is approved, you can file your tax return after the normal deadline.
Keep in mind, however, that your tax liability is still due on original tax due date. If you don't make payment on that due date, you may be assessed interest and penalties.
Your particular tax return due date will vary, depending on your business structure.
Plan in Advance
Use this checklist to gather your records, identify your tax deductions, and file your return.
However, the best way to address all of these issues is to plan for your tax liability in advance. Review your tax return for the prior year, so that you understand how your tax liability was calculated. If something unusual happens during the year, such as the sale of an asset for a gain, document the transaction so that you can locate it at tax time.
Finally, consider hiring a CPA who can help you estimate your tax liability, keep your records organized, and prepare your business tax return.