Do personal taxes affect business taxes?
Do you file business taxes together with your personal taxes, or do you need to file them separately? The answer depends on several factors, including what legal structure you’ve chosen for your business. Statistically, the majority of small business owners file both returns together.
At the end of the day, you have to account for all your income to federal and state authorities. Depending on where you live and where your business is located, you may need to do a local return. There are pros and cons to filing separately and together. But the fact is that having a business will absolutely affect your personal taxes. Read on to make informed decisions about the options available.
Pass-through or separate entity?
There are benefits to creating a separate entity when you own a business. This can take several forms, including an LLC or a corporation. Something to keep in mind is that even if you incorporate, you may still create a pass-through entity. What’s a pass-through entity? That’s a separate entity, like a corporation, that passes through its revenue to you as the owner. Pass-through entity owners may still be able to file their business taxes alongside their personal return. You’ll want to make sure you’re incorporating as an S-corp. C-corps, like the big multinationals you may think of when you hear the word “corporation” are stand-alone entities that file and pay separately from their shareholders. Most small businesses opt to become S-corporations, although you’ll want to check with a tax or legal professional to make a decision based on your circumstances and specific type of business.
Doing business under a pass-through entity often means that you pay less taxes. But if you’re in a high tax bracket (for example, if you have a well-paying day job and your side hustle bumps you up to the next bracket), business income can actually cost you more in taxes. Know your numbers and employ tax-mitigation strategies, like investing in retirement funds.
Some pass-through entities will still file a return. These indicate to the IRS what earnings and profits and expenses were for the tax filing year. Again, consult a tax professional.
Tax implications of sole proprietorships and partnerships
If you own your business as an individual, with no additional entity created, like an LLC, partnership, or S-corp, you only need to file your 1040 form. You’ll be required to attach schedules pertaining to your business activities. But, as a passthrough entity, your business earnings will be taxed at your personal rate.
If you’re a freelancer, or an LLC with only one person in it, or if you are an independent contractor, you’re in a similar boat, tax-wise. For all of these, report the revenue from your business efforts and deduct your expenses on Schedule C of your 1040.
For a partnership, you’ll also be filing as a pass-through entity. In this instance, though, you’ll be required to file a separate return known as Form 1065. Partners each pay their share of a partnership’s profits in their own personal return. You’ll get a K-1 from the partnership, and you can use that information to complete Schedule E of your 1040. LLCs can opt to be taxed either as S-corps or C-corps.
Tax implications of S-corps
If you’ve created an S-corp for your business, it’s technically a separate entity and, as such, has to file its own return. You are considered a shareholder, even if you own 100% of the shares. The form that S-corps file is the 1120-S, and this is a reporting of earnings and deductions. As a shareholder in an S-corp, you’ll also receive a form K-1, and this needs to be reported on Schedule E of your personal return. Pass-through entities are considered preferable, where possible, because the entity itself isn’t taxed before passing the income through to you. (This is often referred to as double taxation). So while you’ll want to consult a tax professional or an attorney to understand your specific circumstances, most small businesses do best, tax-wise, with some form of pass-through entity in terms of taxation.
Note that although similar forms are involved, and both are referred to as “pass-through entities,” there are differences in structure to S-corps and partnerships. If you’re a shareholder in the S-corp and are running the business, you may be considered an employee, and as such, may need to get a wage statement. Again, this can be affected by circumstances and industry, so talk to your accountant to see what’s best for you.
While opting to be a C-corp is rarer for small businesses, particularly those starting out, you may explore that taxation structure if you have certain special circumstances. For example, many companies seeking venture funding, including early start-ups, often choose C-corp status instead of the more common S-corp.
|At the end of the day, you have to account for all your income to federal, state, and, depending on where you live and where your business is located, local officials.
Get good advice
It’s tempting to manage business and personal returns on your own, and this can be a smart decision when your business is small or not yet showing significant profits. Side gigs and freelance hustles often don’t add a lot of complexity to taxation. But once you’ve got substantial earnings, employees, or any other factor that could complicate a return, you may benefit from speaking to a tax professional. Additionally, tax laws change from year to year. Particularly during the pandemic, new relief programs and other changes were introduced, and it can be a lot to keep on top of them all and understand if your business is eligible. So if you’re at all in doubt, a good accountant can be one of the smartest investments you’ll make as you grow your business.
Personal taxes and business taxes can affect each other, so it’s good to be mindful of both as you make business moves. You work all year to make your business a success, and then you have to work some more to manage, file, and pay business taxes. Where does that money even go? Find out more during our 30-minute webinar.