Filing Business and Personal Tax Returns
In This Chapter
- Reporting business income on your business income tax return
- Business tax information that flows to your individual income tax return
- State income taxes for business
- Forms to help you file your personal taxes
- Personal federal and state returns
- When to seek professional assistance
As a business owner, your personal income tax return has some new complications. You might look back fondly on the days before you had a business of completing Form 1040EZ or the simplified Form 1040A, but the rewards of business ownership often outweigh the additional complexities at tax time.
In this chapter, we offer an overview of what to expect when April 15 rolls around each year. As we discussed in Chapter 2, your choice of business structure has a significant impact on your income tax return. Here, we cover federal returns for the various business types, including due dates and extensions. Then we review state business returns, and finish the chapter with information about completing your personal federal and state returns, including incorporating the relevant information from the business returns.
Every business is required to file an annual tax return with the Internal Revenue Service (IRS). One of the most important reasons to utilize accounting software is to document the amounts you’ll report on your business tax return.
Most businesses must file a separate income tax return to both their state government and the federal government, but there’s one exception to the rule. This section covers the ins and outs of federal tax returns for various types of business structures.
BOTTOM LINE
An ownership stake in a business means your annual tax return is at least a few pages longer, as you’ll need to account for your share of the profit or loss of the business in some fashion on your personal tax return, as you’ll see later in this chapter.
Sole Proprietorship
As described in Chapter 2, a sole proprietorship is the most basic form of a business. In short, you are the business, so you report the activities of your business on your personal income tax return instead of on a business tax return.
The primary form you’ll use for reporting your business income and expense is the IRS form known as Schedule C, Profit or Loss from Business. As you’ll see later in this chapter when we discuss personal returns in more detail, Schedule C is part of what’s known as the long version of Form 1040.
In short, this 2-page document requests the following types of information:
- Accounting method: cash, accrual, or other
- Income: total sales from your profit and loss report less cost of goods sold
- Expenses: a summary of the expenses section of your profit and loss report
- Inventory: a summary of the net activity of your inventory activities during the calendar year
- Vehicle information: questions about whether you used a personal vehicle in your business
- Other expenses: documentation of other expenses that don’t fit into one of the categories provided in the Expenses section
If you run your business out of your home, you might be able to deduct a portion of your household expenses on your tax return. Starting with the 2013 tax year, the IRS enacted a streamlined home office deduction of $5 per square foot up to a maximum of $1,500. So if that spare bedroom you use as your office measures 10 feet by 15 feet (150 square feet), you can take a deduction of $750 ($5 × 150 square feet). Or you can file Form 8829, Expenses for Business Use of Your Home, to allocate portions of your personal expenses to your business.
Partnerships
As noted in Chapter 2, a partnership is a business typically owned by two or more individuals. Partnerships are required to file Form 1065, U.S. Return of Partnership Income, to report their financial activity for the year.
This return documents the overall income and expenses for the partnership itself as well as the allocation of partnership profit or loss for each of the partners themselves on associated copies of Form K-1. As we’ll discuss later in this chapter, Schedule K-1 holds the income or loss information you transfer to your personal income tax return. The partnership pays no income tax itself, but must file an income tax return nonetheless.
S Corporations
From an income tax standpoint, S corporations share some characteristics with partnerships. The corporation itself pays no income tax, and each owner’s share of income or loss is reported on Schedule K-1. Each S corporation is required to file Form 1120S, U.S. Income Tax Return for an S Corporation.
C Corporations
As you’ve seen, the income or loss from partnerships and S corporations is taxed on each owner’s personal tax return at their individual income tax rate.
C corporations, on the other hand, are taxed separately, meaning that the corporation itself pays its tax liability directly to the U.S. Treasury. C corporations file Form 1120, U.S. Corporation Income Tax Return.
The taxation of C corporations doesn’t stop at the corporate level. Earnings of the corporation are shared with stakeholders through stock dividends, and the stakeholders (these can be individuals or other corporations) are taxed again on the same earnings, thus the confusion often referred to as ”double taxation.”
Like partnerships and S corporations, limited liability companies (LLCs) generally pay no income tax directly. However, this depends on the tax treatment the LLC elects with the IRS, from one of these choices:
Schedule C treatment: Single owner LLCs do not file separate tax returns for their business. Instead, the owner reports the income or loss of the LLC on his or her Form 1040, Schedule C, and pays tax at the individual income tax rates.
Partnership treatment: The LLC files Form 1065 annually and pays no income tax directly. Income (or loss) flows through to the partners to be reported on their individual income tax returns. This is the default status for LLCs with multiple owners.
S corporation treatment: The LLC files Form 1120S annually and pays no income tax directly. Income (or loss) flows through to the shareholders to be reported on their individual income tax returns.
C corporation treatment: Corporate income tax rates for income below $75,000 are less than personal income tax rates. Corporations pay a tax of 15 percent of their first $50,000 in income and 25 percent of any additional amounts up to $75,000. Conversely, the 15 and 25 percent tax rates start at lower thresholds for personal taxpayers. Thus, in some cases, a LLC might opt to file Form 1120 as if it were a C corporation to take advantage of these lower tax rates. In this situation, the LLC pays its tax liability directly instead of passing the income or loss through to the owners.
As you can see, limited liability companies are a hybrid of other corporate structures in more ways than one. Unlike the other business entity structures, where there’s only one tax form to choose from, in case of an LLC, you can have a variety of tax return options. Be sure to only file a single return that best suits your business needs.
Due Dates
Tax returns for S corporations and partnerships are due on March 15 each year unless your business requests an alternate tax year by filing Form 1128, Application to Adopt, Change, or Retain a Tax Year.
C corporations using a calendar year are due on April 15 or, if using a fiscal year, the fifteenth day of the fourth month after year-end. Recent law changes provide special due date rules for C corporations that use a June 30 year-end. Your tax preparer can provide the phase-in rules for a June 30 fiscal year company.
Sole proprietorships get an extra month. Schedule C must be filed as part of the business owner’s personal Form 1040 on April 15 of each year.
Partnership returns are due on the fifteenth day of the fourth month following the last day of the partnership’s year.
Tax Return Extensions
Business owners often need more time to file personal and business tax returns. Partnerships, corporations, and limited liability companies all use Form 7004 to request an automatic extension.
Partnerships and LLCs that opt to file as a partnership get an automatic 5-month extension, while corporations get 6 months. This means all these business entities have until September 15 to file tax returns if they’ve filed for an automatic extension.
Sole proprietorships and personal tax return filers can request an automatic 6-month extension by filing Form 4868. This form extends the due date of the various versions of Form 1040 to October 15 of a given year.
RED FLAG
Keep these two caveats in mind should you choose to extend a tax return. First, the IRS and your state expect you to have paid your full tax liability for the year by the statutory due date of your return. This means you may need to submit an estimated tax payment with your request for an extension. Second, procrastinating until the end of your 6-month extension means you’re almost perpetually stuck in a mode where you’re preparing a tax return. When you can, file tax returns as scheduled. Otherwise, there’s no real downside to extending when circumstances warrant asking for more time.
Estimated Tax Payments
No matter what structure you choose for your business, you likely will be required to pay some manner of estimated tax payments throughout the year. This includes you personally if you have an ownership stake in a sole proprietorship, partnership, S corporation, or an LLC that files its taxes as either a partnership or S corporation.
The IRS expects you to forecast your taxable income on a quarterly basis and submit a portion of your estimated tax liability. Form 1040-ES looks simple enough on the surface, but what we don’t have room to show are the three worksheet pages you’ll use to derive the amount you enter into the Dollars and Cents fields. You don’t send the Form 1040-ES worksheet pages to the IRS, only the payment coupon if you mail a check. You’ll likely find it easiest to pay online, as we discuss later in this chapter.
Be sure to keep the worksheet as documentation for the IRS, but also as a lead-in to paying estimated taxes to your state. You’re off the hook here if your state doesn’t have an income tax. Georgia waives the requirement to file estimated taxes if the tax return is filed by March 1 (instead of April 15), and your state might have a similar option. Most states tend to follow federal tax payment deadlines, but check your specific requirements so you don’t incur unexpected penalties. Many states offer online payment options, but these are separate from any federal tax payment options.
Depending on your income level, you might be required to conform to the safe harbor rules established by the IRS. For tax year 2014, if your taxable income was $150,000 or more (or $75,000 for married filing separate returns), you are expected to pay estimated payments amounting to the smaller of 90 percent of your current tax year liability, or 110 percent of the previous year’s actual tax liability. You’ll receive a refund for overpayments if your actual tax liability falls below your estimated payments, but if you’re subject to the safe harbor regulation and do not comply, the IRS will assess an underpayment penalty.
Estimated tax payments are due in four installments throughout the year, as shown in the next table. As with all the tax due dates we mention in this book, if an estimated tax date falls on a weekend or holiday, the deadline is extended to the next business day.
Due Dates for Estimated Tax Payments
| Installment | Due Date |
| 1 | April 15 |
| 2 | June 15 |
| 3 | September 15 |
| 4 | January 15 |
Notice that unlike the payroll tax returns we discuss in Chapter 18, the second and third estimated tax payments do not follow a calendar quarter-end, but instead fall a month earlier. So it won’t be just your imagination each summer when you think, Wait, didn’t I just make an estimated payment two months ago?
When remitting estimated tax payments, you can either mail a paper version of Form 1040-ES, register as an individual to pay online via the Electronic Federal Tax Payment System (EFTPS) website at eftps.gov, or use directpay.irs.gov. The EFTPS site is free to use, as is the DirectPay site if you transfer funds from your bank account, but fees apply if you opt to use a credit card.
Although the IRS expects four estimated installments each year, there’s nothing stopping you from making monthly estimated payments instead. Monthly payments might fit into your household budget easier, and you can raise and lower the monthly amounts throughout the year and get more certainty about where your taxable income level may fall. If you receive W-2 income from a business that’s in excess of your expected tax liability, you can pay your estimated taxes through withholding instead. The IRS considers paycheck withholding to be distributed evenly throughout the year. So if you fund your tax liability through paycheck withholding, you don’t have to file Form 1040-ES. The safe harbor rules apply no matter what method you choose.
Owners and partners of C corporations and LLCs who opt to file tax returns as C corporations must also remit estimated taxes by way of Form 1120-W. The due dates are the same as for personal taxpayers.
Corporations that overpay their estimated tax liability can request a refund before filing their corporate tax return by using Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax. Conversely, underpayment penalties for corporations must be computed by using Form 2220, Underpayment of Estimated Tax by Corporations.
Business State Income Tax Returns
Businesses with operations in more than one state may be required to file a state income tax return in each state they do business. The states that levy income taxes on businesses each have their own forms you’re required to file.
Supporting Tax Forms
Your ownership stake in a business may result in a number of supporting forms that document the amounts of profit or loss that flows to your individual income tax return. You might issue some of these directly from your business, or in the case of Form 1099, you might receive these forms from businesses that pay you for services during the year.
Form W-2
As discussed in Chapter 18, you must issue a Form W-2 to each employee in your business who receives a paycheck. Sole proprietorships are the exception to this rule, as you the owner already report the income or loss of the business on your personal tax return. You’ll only need to pay yourself a salary that would appear on Form W-2 if you have an ownership stake in a S or C corporation, or a limited liability company (LLC) that has elected to be treated as a corporation. Partnerships and LLCs that are recognized as partnerships report the owner’s share of income or loss on Schedule K-1 instead of Form W-2.
You’ll receive a Form W-2 from each business that pays you a salary or wages, no matter if you have an ownership stake or not.
Schedule K-1
This tax form is a subset of Form 1065 filed by partnerships and Form 1120S filed by S corporations. Each partner or S corporation owner receives this form, which documents their share of income and loss generated by the business.
Your personal tax return, Form 1040, has provisions for you to record amounts from Schedule K-1. Each partnership or S corporation you have a stake in will issue Schedule K-1 to you.
Form 1099
There are more than a dozen iterations of Form 1099, but the version you’ll most likely encounter as a business owner is Form 1099-MISC. Other businesses that issue payment to you—often for work as an independent contractor, for example—are required to document accumulated payments of $600 or more in a given year.
This catch-all form is intended to provide the IRS documentation of numerous types of payments, but you’ll most frequently receive a 1099-MISC for these two situations:
Rent: If you own property you rent to another business, the business is required to issue a Form 1099-MISC to you for each calendar year. The rent amount paid to you is reported in box 1 of the form.
RED FLAG
You might need to issue a 1099-MISC to yourself if your business rents property from you. Some business owners own real estate personally and rent it to their business. Or maybe you rent a portion of your house or an outbuilding on your property to your business. Rent your business pays to you is an expense to the business but taxable income to you personally.
Nonemployee services: This catch-all category covers almost anything you do for another business that results in a payment to you. Generally Form 1099 isn’t required to be issued for payments to S and C corporations, but you still might receive 1099s from some of your customers. Sole proprietorships and partnerships are required to receive a 1099 for each year any compensation is paid.
At this point in your life, you’re probably well versed with the annual rite of filing an income tax return. As we’ve noted in this chapter, having an ownership stake in a business can result in more complexity in the spring of each year, or the fall if you opt to extend your filing deadlines.
Federal Income Tax Return
Taxpayers in the United States pay income taxes based on a sliding scale. The lowest-income earners pay 10 percent of income in tax, subject to certain standard deductions and exemptions. Other tax brackets as of this writing are 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent. The dollar amounts associated with these percentages vary based on whether one is filing as a single individual, married couple, or head of household.
In the past, before you owned a business, filing your tax return might have taken only a few minutes. As discussed, many taxpayers are able to take advantage of the simplified Form 1040EZ or Form 1040A.
As a business owner, that’s changed now. Business income of any amount typically requires you to use the full Form 1040, U.S. Individual Income Tax Return, often referred to as the Long Form. You’ll include all sources of income on your tax return as before, along with some additional information that might be new to you:
- W-2 income from your business or any other jobs you’ve held during the year.
- Schedule C if you have income from a sole proprietorship or a single-owner LLC. (We discussed this form in detail earlier in the chapter.)
- Schedule E if you own rental property, including renting any type of real estate to your business.
- Shareholder’s Basis Worksheet if you have income from an S corporation or partnership. The amounts from the Schedule K-1s you receive appear on this form.
RED FLAG
Business owners are sometimes caught off guard by two unexpected taxes. Sole proprietors, partnership owners, and LLC owners who elect to be taxed like partnerships must pay self-employment tax of 15.6 percent of their business income. Employees and employers share the burden of FICA and Medicare taxes, with each paying a total of 7.65 percent. Business owners are considered both employer and employee, and must pay both halves of the tax. In addition, dividends distributed to owners of C corporations may be taxed as capital gains at rates up to 20 percent, depending on the taxpayer’s tax bracket. Your estimated tax payments take into account your entire tax liability for a tax year, including but not limited to income, self-employment, and capital gains taxes.
Most but not all states levy a state income tax. Your state income tax return typically is far less detailed than your federal tax return. States often require you to file a copy of your federal tax return with your state return.
ACCOUNTING HACK
You typically have up to 3 years after the scheduled filing date to amend any income tax returns you file. For personal returns, you’ll file Form 1040X, partnerships use Form 1065X, and corporations use Form 1120X. Amended returns can be used to correct accounting errors that materially misstates your income or to add expenses or deductions that may lower your tax bill.
Getting Help Versus Filing on Your Own
As a U.S. citizen, it’s your responsibility to pay your share of taxes to federal, state, and local government agencies.
Hiring a Professional
As you’ve learned in this book, being involved in a business entails an almost bewildering amount of taxes, returns, and deadlines. You can outsource the payment and processing, as noted in Chapter 12, and you can, and likely should, outsource the filing of any business and personal tax returns to a tax professional. Many tasks are best performed by an expert, and taxes are no exception. The U.S. Tax Code is filled with ambiguities that present both risks and opportunities.
Maybe you’ve seen a news report wherein a reporter asks 20 different tax experts to prepare the same income tax return and gets back many different results. It might seem hopeless if even tax professionals can’t agree on the amount of taxes due, but still, a tax adviser can often save you from yourself.
For instance, many taxpayers avoid legal and rightful deductions in fear of triggering an audit from the IRS. Others set off on a path of handling certain expenses and deductions in a way that becomes set in stone for them, not realizing that along the way they’re overpaying taxes.
With that said, you have multiple options if you want to file on your own. The IRS will mail paper forms to you at no charge if you call 800-TAX-FORM (800-829-3676) or order online at irs.gov/Forms-&-Pubs/Order-Products. If you opt to fill out your tax return by hand, do yourself a favor and triple-check all calculations to ward off unwanted correspondence with the IRS a few months after you file your return.
You have many choices in tax software, both cloud-based and desktop-based. H&R Block (hrblock.com), TaxACT (taxact.com), and TurboTax (turbotax.com) all offer cloud-based services that include electronic filing of your tax returns. H&R Block and TurboTax also offer desktop versions of their products. In all cases, pricing varies based on the complexity of your tax returns, and you might have to pay separate fees for federal and state returns.
Consumer-based services such as this, as opposed to professional tools tax advisers use, walk you through the process and sometimes include “deduction finders” and other aids to help you file correctly while not unnecessarily leaving money on the table.
Because we devote two chapters of the book to spreadsheets (Chapters 21 and 22), we’d be remiss if we didn’t mention the Excel-based version of Form 1040 (excel1040.com). Glenn Reeves has faithfully re-created this venerable tax form every tax year since 1996 and includes every schedule sole proprietorship owners need.
RED FLAG
The IRS doesn’t allow taxpayers to file returns directly online, so you’ll have to go through a tax professional or use an online service if you want to file electronically. But take precautions. Ensure the service you use is a brand-name one. And when using cloud-based services, be sure the website address contains the prefix https:// instead of just http://. The s signifies a secure and encrypted connection. Never enter any tax return information in a site without the s. Your web browser might indicate secure sites, such as with a lock symbol.
In addition, the IRS will provide you with all the forms and instructions you need through its irs.gov website. Using your computer search engine, you can query various tax issues and read summaries from many tax professionals who will share their experiences and opinions with you.
Be aware, however, that if you hire a professional to help you with the preparation of your income tax return, you get the opportunity to have that professional represent you in the case should your tax return get audited. This is one of the greatest benefits of hiring a tax professional—the peace of mind of not having to deal with questions and correspondence from the taxing authorities.
Many things can position your tax return as one that will be examined. Here are some basic rules to watch out for that, if followed, help keep you above the radar of the tax examiners:
Calculate your return correctly: Mathematical mistakes are a leading cause of tax audits. If you use software to complete your tax returns, the software will ensure everything adds up correctly.
Report all your income: Whether you’re filing an individual tax return or a business return, the people and businesses who pay you money are often taking a deduction for the money they pay you and reporting that amount to the IRS, and the IRS is cross-checking to ensure all those deductions are resulting in income reported elsewhere—like on your return.
Don’t cheat: Not only is cheating wrong, but the penalties for intentionally falsifying tax documents are much steeper than those for making honest mistakes.
File all required tax returns: Nonfilers are more likely to raise the attention of the taxing authorities than those who diligently meet every filing deadline.
Be lucky: What does luck have to do with it? Each year tax authorities randomly decide to audit tax returns. Even if you’re doing everything right, you still might have a tax examination in your future. Don’t panic. As long as you saved your documentation and did your best at following the tax rules, you have no reason to be afraid of a tax audit.
The Least You Need to Know
- Every business generates taxable income (or a loss), so every business must file federal and state tax returns.
- Where the income (or loss) from a business is reported depends on the type of business entity, the type of ownership of the business, and the level of business income.
- The information from your business tax returns flows to your personal tax returns via supporting forms.
- If you make a mistake on your tax return or discover unreported income or expenses, you have at least 3 years from the original filing date to amend your return.
- You have several ways to file your taxes, including using tax software or a tax professional.