Tax season is upon us and you may feel excitement or anxiety at this time of year. For many Americans, tax season is a time of year to look forward to an income tax refund. Retailers everywhere are offering options to make the most of your tax return with special offers on new cars, home improvement and big ticket items. While much of the news during tax season focuses on individuals receiving refunds, tax season is a dreaded time for most small business owners who have to make a payment to the IRS at this time of year.
Here are 3 important things to know if you owe the IRS anything this tax season.
Refunds are not typical for business owners
When you get a tax refund, you get your own money back. It means you overpaid the IRS for the year and ended up giving them an interest-free loan. It is common for W-2 wage earners to overpay and receive a refund. According to IRS statistics, 66% of individual claimants were eligible for a tax refund in 2022. However, as a business owner, you don’t get all of that compensation in W-2 wages, so you probably won’t overpay your taxes. Overall, this is a good thing for you. You wouldn’t overpay another bill in your business and wait for the vendor to refund you next year. Likewise, overpaying the IRS is not ideal for you.
You must consider making estimated tax payments this year
If you owe the IRS more than $1,000 at tax time, you may be subject to underpayment penalties and interest on your balance due. The IRS is a pay-as-you-go tax agency, and you can’t wait to file your return to start paying your taxes every year. If you owe taxes for the 2022 tax year, you may need to assess your tax credit and remit estimated quarterly tax payments in 2023. The IRS provides a free Estimated Tax Payment Calculator that you can use to calculate your quarterly tax payments for this year. Using your 2021 income tax return and an estimate of your 2022 income, you can determine if you are subject to the estimated taxes and what quarterly amount you will have to pay. The first quarterly payment is due April 18, 2023 and protects you from fines and interest for underpayment.
You control how much you owe in taxes
At this time of year, you’re probably focused on your 2022 tax preparation. You need to put that same energy into 2023 tax planning. Tax planning is a proactive strategy you can use to manage how much you owe in taxes this time next year.
Large corporations have been controlling how much they pay in taxes for decades. Many of the country’s top companies pay $0 in taxes to the IRS. Big companies like Amazon, FedEx and Nike have used the tax law to legally abolish their taxes and enrich their owners. You can exercise the same control when implementing tax saving strategies for your small business. The most effective strategies require an accountant or tax strategist to design and implement a customized tax plan for you. However, there are several options that you can implement independently to reduce your tax bill this year.
You can start evaluating your tax classification. You have the power to choose how your business is taxed. The best option for your tax status depends on your profit level.
As an individual applicant who owns a start-up that is not yet profitable, you can apply as a disregarded entity. Most often, an individual entrepreneur chooses this classification. You will report business income and expenses in IRS Schedule C on your personal income tax return. No special choice is required for this initial tax classification.
As your business grows and profits climb above $13,850, you may choose to file as an S Corporation. You can fill out IRS Form 2553 to choose this tax status. Your election is due by March 15 for calendar year applicants. Once your business has reached that level of profitability, S corporation status protects your income from 15.3% self-employment taxes, resulting in significant tax savings. Consult your tax advisor to get the most out of this tax status for your specific business.
If your business is growing and profits grow above $170,050, you may choose to file a C corporation on IRS Form 1120. You must complete IRS Form 8832 to elect for this tax status. This election is also due by March 15 for calendar year applicants. This classification means that your company pays taxes at the corporate tax rate of 21%. In contrast, at this level of earnings, a lone S Corporation owner would pay taxes at his own rate of 32%. This status protects your income from 11% in individual taxes and saves you over $18,000 in taxes.
You can use these earnings guidelines to determine the best tax classification for your business this year.
No refund, no problem
Overall, you are now armed with the knowledge to turn off all tax refund talks this year and shift your focus from tax prep to tax planning for your business.
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