If you recently started a small business, or your looking to do so, tax is an important subject that you simply can’t ignore. You must know how to register your small business for tax, or whether tax registration is even necessary in for your business.
A lot of small business owners feel intimidated by tax rules, so much so that it might deter some people from starting a business altogether. The idea of an already unstable income combined with uncertainty on how to fulfil tax obligations is a major sore point.
Don’t let the fear of tax get in your way of achieving something great. Tax can seem daunting, but it doesn’t have to be. There are a few simple ways in which you can make sure that your business is paying tax the right way. One of the first ways to start, is to register your business for tax in a way that suits your industry.
Does My Small Business Need to Pay Tax?
Paying tax won’t be an issue if your business doesn’t need to, so asking the question of whether you need to pay tax is a logical place to start. Unfortunately, no profitable small business is normally small enough to qualify for tax exemption.
Very few people expect a child running a lemonade stand to pay tax on their earnings. Realistically, these earnings are too small to amount to anything significant. Similarly, if someone bakes cookies and sells them from home, it may be more of a hobby than a serious business venture, and this is likely to reflect in the earnings.
You’ll know if your small business is more of a hobby than anything else. If you’re a hobbyist, chances you’ll end up spending all your earnings to support your hobby, meaning you won’t truly have a profit, so you’re not running a business, as all your earnings go back into your hobby rather than to contribute to your personal expenses.
It should be noted that the gap for earning without being liable to pay taxes is very narrow. Even if you’re working alone without any employees as a sole proprietorship, your earnings are be taxable. This is especially true if you’re a freelancer, contractor or any other kind of service provider and you earn most of your income through your business.
If your earnings are substantial enough that you can buy groceries, pay rent or afford to cover any of your personal expenses with your business earnings, you should consider yourself to be a small business owner, which means your business is tax liable.
Different Ways to Register Your Small Business for Tax
How you pay small business tax will depend on how you registered your business with the IRS. If you’re still in the process of starting your business, here are the different ways you can register:
- Sole proprietorship: This is the simplest business structure. It’s easy to start, seeing as you don’t need any formal registration to run your business as a sole proprietor. As a sole proprietor, you’ll be entitled to all of your business earnings, with no legal distinction between yourself and your business. The benefit of running a sole proprietorship is that it’s simple and easy, the disadvantage is that you’ll also be liable for any debt incurred by your business, meaning your personal assets are at risk.
- Partnership: Where two or more persons decided to start a business venture together, a business is considered to be a partnership. Depending on how a partnership is registered, business partners (like sole proprietors) can be responsible for all business losses, placing their personal assets at risk. This is known as a general partnership.
- Limited liability company (LLC): Registering an LLC is a good option for many different business owners. The main benefit of an LLC is that the business owners or any shareholders aren’t liable for business debts or legal fees incurred, protecting personal assets. Additionally, business owners have the choice whether their LLC company should be taxed as a personal proprietor, partnership, S-corporation or C-corporation.
- Corporation: Corporations are owned by stockholders and require a set structure. Corporations can fall in either one of two categories – S or C-corporations. It’s unlikely that you’ll register your new small business as a corporation, seeing as stockholders are required to elect a board of directors for a corporation. Although some small business owners register as the sole stockholder and appoint themselves as the a single-person board of directors, this business model doesn’t lend itself well to most small businesses that are just starting out.
As mentioned above, there are different ways in which you can register an LLC for tax. While registering an LLC to be taxed as a sole proprietorship or partnership won’t change the tax rules that your business falls under, there are two unique corporate tax regimes for LLC companies. Here’s some more information about registering your business as an S or C-corporation.
- S-corporation: With the S-corporation model, the business entity pays no income tax. Instead, the tax liability of the business tax is distributed to the S shareholders on a personal income tax level. To qualify as an S-corporation, a business must be a domestic corporation (i.e. not foreign) and have no more than 100 shareholders. Additionally, an S-corporation may only have 1 class of shares. Certain businesses, such as financial corporations, are ineligible to be registered as S-corporations.
- C-corporation: Unlike an S-corporation, C-corporations are taxed independently of their business owners. With a C-corporation, there’s no limit with regards to how many shareholders a company may have. Furthermore, rules regarding foreign shareholders are more relaxed. Because of this, most major corporate companies are taxed as C-corporations
For most new businesses, sole proprietorship is the most popular choice. It’s easy and doesn’t require any upfront investment in terms of registering your business. Once your business expands, however, registering it as an LLC to be taxed as sole proprietorship can be a good way to protect your personal assets.
Tax Rates for Different Small Businesses
Your taxable income will differ depending on how your business is registered for tax. Here are the business tax rates:
- Sole proprietorships pay a 13.3% tax rate
- Partnerships pay a 23.6% tax rate
- S-Corporation pay a 26.9% tax rate
- C-corporations pay a 17.5% tax rate
Keep in mind that for these tax rates to apply, your business must fall within the guidelines of a small business in your industry. For new businesses, this usually isn’t a problem. Most freelancers, contractors or even healthcare professionals with a healthcare practice quite easily fall into the specifications set for small businesses. Similarly, small building contract firms, plumbers or other service providers are usually eligible to qualify for small business tax rates.
Different Kinds of Small Business Taxes
Although it can be tempting to register your business as a sole proprietorship simply to take advantage of the 13.3% tax rate, there are other taxes that small business owners must pay, which can complicate your choice.
Depending on your business model, there are different kinds of tax you might have to pay such as:
- Income tax
- Employment/Payroll tax
- Self-employment tax
- Excise tax
- Sales tax
- Property tax
While all businesses are required to pay some form income tax, you won’t be liable to employment tax if you have no employees, not would you need to pay excise tax if you don’t sell eligible products such as cigarettes or liquor.
If you register your business as a sole proprietorship, you’ll usually have to pay self-employment tax. Self-employment tax covers tax expenses that are normally at least partially covered by your employer, such as Social Security and Medicare. You are liable to pay self-employment taxes if you’re self-employed and your net earnings in the past year were at least $400.
How to Pay Small Business Tax for the first time?
Whether you’re starting a new business, or you already have a young startup and you need to pay tax for the first time, consulting an accountant is the best way to help you stay on track with your tax obligations.
Although owning a sole proprietorship can simplify your taxes, there are various reasons why getting an accountant is still the best choice, especially when you’re just starting out.
Firstly, you may choose to register your business under a different tax regime than sole proprietorship, which can complicate your taxes. Even if you register as a partnership, tax rules can become daunting.
Secondly, your first year or two of business will be a busy time. You’ll need to learn a lot about your industry to succeed. You’re unlikely to have enough time to learn enough about filing your small business tax correctly, which could place you at risk for penalties for late payments and other mistakes.
Most importantly, consulting an accountant is a great way to get professional, trustworthy advice on how you should register your business for tax, giving you a head start on your small business tax.