US Tax 101: Getting to know the basics

The US tax system is among the most complicated and confusing in the world. So it’s hardly surprising that small businesses spend approximately 2.5 billion hours each year preparing tax returns or responding to IRS inquiries about their returns – the equivalent of 1.25 million full-time jobs.

In order to save time and reduce stress, 70% of small businesses employ tax professionals for tax preparation and to represent their interests before the IRS. However, its still a good idea for all businesses to understand the basics of how tax works in the USA.

Here’s what you need to know.

Legal structures

Each legal structure of business has different implications. Here are the main differences between each:

  • Sole proprietorship – This is when you operate an unincorporated business and are the only owner. Sole proprietorship taxes are straightforward, as you can report business income and losses on your personal tax return (Form 1040), using Schedule C.
  • S Corporations – S corporations may pass income directly to shareholders to avoid double taxation. However, you can’t have more than 100 shareholders, all of whom must be US residents and only own one class of stock.
  • C Corporations – This type of business must pay taxes on the company level at a flat rate of 21%. Shareholders must pay personal taxes on the dividends they receive from the business too.
  • Limited Liability Companies (LLCs) – LLC members have two important tax advantages: no double taxation and deductible business losses. You can also have an unlimited number of members (i.e. potential shareholders) in an LLC.

Tax deductions

No matter whether its vehicle expenses and business travel, hiring freelancers and independent contractors or buying suppliers and renting property, every business has a number of expenses to take care of. Thankfully, it is possible to minimise your business taxes by writing off these expenses.

If you’ve only just founded your business, you might be able to write off your start-up costs too, as Ahmed Muneeb from Intuit QuickBooks explains:

“The IRS allows you to deduct up to $5,000 in business start-up costs and up to $5,000 in organisational costs, but only if your total start-up costs are $50,000 or less.”

Paying taxes

The most common types of taxes a business owner needs to be aware of include:

  • Self-Employment Tax – Self-employed individuals are responsible for paying the 15.3% FICA tax. However, half can be deducted on your personal tax return (Form 1040).
  • Payroll Tax – This includes federal income tax withholding, Social Security and Medicare taxes, and federal and state unemployment taxes.
  • Excise Tax – Excise taxes are a tax on the intermediary and are usually included the price of a product. Examples include gasoline, cigarettes and alcohol.
  • Sales Tax – Business owners are responsible for collecting and reporting sales taxes to local and state governments.
  • Property Tax – If you own commercial premises, you’ll need to pay property taxes to the city or county where your business is located.

“Whether you’re flying solo or working with partners, the tax system is set up to help offset those potentially high costs for self-employed professionals at tax season,” adds Muneeb. “Maximising tax deductions by writing off start-up and operating costs can limit your tax liability in relation to your business income.”

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