Sorting out your business vs. personal taxes is a task you can't put off if you're self-employed. Filing your returns correctly and on time can help you avoid getting penalized by the IRS. Whether you've recently started a business or you're just considering self-employment, these tips can help you better understand what's involved in filing business and personal taxes.
Business vs. personal taxes
Your tax rate for business or personal income is determined by whether your business is a pass-through entity or a corporation.
If you have a pass-through entity, the business income is passed through to you personally; you pay taxes on it at your personal income tax rate. Pass-through entities include sole proprietorships, general partnerships, limited liability companies and S corporations.
Say you're a freelance writer and you run your business as a sole proprietorship. Because the IRS treats your business income and personal income as the same thing, you'd file your taxes using Form 1040. Any income you make from your business would be subject to personal income tax rates. For the 2019 tax filing season, personal income tax rates range from 10% to 37%. Your tax bracket depends on how much money you make.
If you run a C corporation, you pay corporate tax rates instead. The Tax Cuts and Jobs Act of 2017 reduced the corporate tax rate from 35% to 21%, meaning no matter how much income your business generates, you'll pay a flat 21% tax rate Opens in new window. C corporations are also required to pay taxes on dividends or distributions from the business. Qualified dividends associated with a stock you own for more than 60 days are taxed at between 0% and 20% Opens in new window, based on income. Nonqualified dividends from stocks you've owned for fewer than 60 days are taxed at your ordinary income tax rate.
Which forms should you use?
The forms you'll use to report your business income depend on how your business is structured. Opens in new window
If you operate your business as a ...
- Sole proprietorship: Report business income on Form 1040 and report business expenses on the Schedule C form.
- C corporation: File Form 1040 for personal income tax and Form 1120 for your business income.
- Partnership: Use Form 1065 to file your business return and include information from Schedule K-1 to report business income on Form 1040.
- S corporation: Use Form 1120-S to file your business return and Form 1040 for personal income tax.
- Limited liability company: File as a sole proprietor and report business income on Form 1040. Alternatively, use Form 1120 or Form 1065 if you'd rather be treated as a corporation or partnership for tax purposes.
Employment and estimated taxes
As a business owner, you're responsible for paying employment taxes and estimated taxes.
Employment taxes Opens in new window include Social Security tax, Medicare tax and federal and state unemployment tax. For 2019, the Social Security tax rate is 12.4% on wages paid up to $132,900. If your business has employees, you pay half of this amount; the other half comes out of your employees' wages. If you're self-employed, you're responsible for paying the full amount of self-employment tax. Similarly, the Medicare tax rate is 2.9% of wages paid to employees, split between you and your workers. If you're self-employed, you pay the full amount of the tax yourself.
The federal unemployment tax rate is 6% of the first $7,000 paid to each employee Opens in new window. You may be eligible for a tax credit if you also pay state unemployment tax. Each state determines how much businesses pay for unemployment taxes. Sole proprietors, general partners and members of LLCs treated as a partnership don't pay unemployment tax.
Businesses must pay estimated taxes four times a year if they expect to owe at least $1,000 in tax liability Opens in new window. The amount you pay is based on your tax filing status and business income. These payments are applied toward any taxes you owe when you file your income tax return for the year.
Deductions and record keeping
Deductions reduce your taxable income for the year. The more deductions you have, the lower your tax bill is.
When filing personal taxes, you might deduct things like student loan interest, mortgage interest or charitable donations. With business taxes, there's a whole host of things you can deduct Opens in new window, including:
- Office supplies
- Business equipment
- Business loan interest
- Marketing and advertising expenses
- Bank fees
- Health insurance premiums (if you're self-employed)
- Business use of your home or car
- Rental expenses for business property
- Employee pay
- Taxes and insurance
There are a couple of rules you need to follow when deducting business expenses. First, the expense has to be ordinary, meaning it's common and accepted in your trade or line of business. Second, it has to be necessary, meaning that it's helpful and appropriate for your business.
The Tax Cuts and Jobs Act introduced a 20% pass-through deduction Opens in new window, allowing pass-through entities to deduct 20% of qualified business income. The deduction is capped based on income. For the 2019 tax season, you may be eligible if you make $160,700 or less Opens in new window as a single filer and $321,400 or less as a joint filer.
Any time you're deducting expenses, whether business or personal, the most important thing is to keep good records. For example, if you're deducting charitable donations on a personal return, you should have receipts and bank statements showing how much you donated, the organization you donated to and when the donation was made. For business expenses, such as travel or office supplies, you can use receipts and bank statements to back up your deduction.
Personal income taxes for both federal and state filings are due in April each year, but business taxes follow a separate calendar. Opens in new window
Here are the deadlines for different tax forms for the 2019 tax filing season:
- March 16, 2020: Deadline for filing Form 1065 for partnerships and Form 1120-S for S corporations
- April 15, 2020: Deadline for filing Form 1040 for sole proprietorships and Form 1120 for C corporations
- September 15, 2020: Deadline for filing tax extensions for partnerships and S corporations
- October 15, 2020: Deadline for filing tax extensions for sole proprietorships and C corporations
Estimated tax payments are due four times a year, in January, April, June and September. You make the first payment for the current tax year in April and the fourth quarter payment the following January. It's important to get these payments in on time since the IRS can penalize you for paying estimated taxes late or for underpaying them.