(This post is part of my Small Business Startup & Survival Guide. You can catch up on the whole series here.)
If you’re a W-2 employee, tax time is fairly simple: one return for federal and perhaps one or two for state and local, depending on where you live.
If you’re a small business owner, those numbers increase dramatically. You may be required to file corporate and individual income tax returns, depending on your choice of entity. If you have employees, you must file payroll tax returns. If you perform taxable services or make sales, you can add in sales and use tax returns. You may also be subject to excise taxes, use & occupancy taxes, net profits taxes. Figuring it all out can be stressful. Here’s a quick summary of what you need to know.
(Note that the types and frequency of filing may differ on the state and local level. The information in this post is intended to focus on federal taxes. Be sure and consult with your tax professional for more information on your state and local obligations.)
To begin with, for most businesses, you’re going to need an Employer Identification Number (EIN) – think of it like your Social Security Number for your business. This is the number that you’re going to use to open your bank account and file your tax returns. It’s important once you get the number that you use it: keeping your business and personal finances separate is not only helpful at tax time but it is a key part of maintaining that liability protection that you want. You generally need a new EIN when you start a business or if you change the form of your business, such as converting from a partnership to a corporation.
It’s easy to apply for an EIN and it’s free if you get it through the Internal Revenue Service (IRS) – note that some companies may charge you a fee for the EIN but that’s for their time. The IRS never charges for an EIN.
The fastest way to get your EIN is online. This only applies to U.S. businesses and the responsible person on the application must have a valid Social Security Number, EIN or Individual Taxpayer Identification Number (ITIN). You can apply online directly through the IRS website.
You can also apply for an EIN using a form SS-4 (downloads as a pdf). You can either fax the form to IRS (expect to wait 4 days) or mail the form to IRS (expect to wait 4 weeks). If your legal residence or principal place of business is in one of the 50 states or the District of Columbia, mail or fax form SS-4 to:
Internal Revenue Service
Attn: EIN Operation
Cincinnati, OH 45999
Fax: (859) 669-5760
If you have no legal residence, principal place of business, or principal office or agency in any state, mail or fax form SS-4 to:
Internal Revenue Service
Attn: EIN International Operation
Cincinnati, OH 45999
Fax: (859) 669-5987
Once you have your EIN, you’ll use the number for all business-related correspondence with IRS. You’ll also want to use your EIN on banking and financial information (remember that your business is a separate legal entity) in order to keep reporting requirements consistent. If, for example, you put a business savings account in your personal name, using your personal Social Security Number, the bank will issue the 1099-INT in your name. Ditto for loans, investment accounts and other tax-related moves. Failure to keep those numbers separate can be confusing come tax time for you and for IRS.
All businesses (refer to this handy primer for explanations about business entities) file some sort of annual return. For federal purposes, sole proprietors and SMLLCs will report and pay using their individual income tax return, a form 1040 (downloads as a pdf). Entities taxed as a partnership will report using a form 1065 (downloads as a pdf). Entities taxed as a C corporation will report and pay using a form 1120 while the C corp’s cousin, the S corporation, will report and pay using a form 1120s (downloads as a pdf)
Depending on the amount of income received during the year, you may need to make estimated payments. This is true not only for individuals but for corporations, too. Failure to make enough payments during the year can result in penalties and interest come tax time so be sure to plan in advance. If you don’t need to make estimated payments, you will pay when you file your return each year.
When you own a business and pay employees, you are responsible for payroll taxes. The most well know, Social Security and Medicare taxes, are fixed by rate. For 2015, the employer portion of Social Security tax is 6.2% with a taxable wage base of $118,500 (wages over that amount are not subject to Social Security tax). The employer portion of Medicare tax is 1.45%. There is no wage base limit for Medicare tax (in other words, all wages are subject to Medicare tax).
As the employer, you pay the employer share (6.2% for Social Security tax and 1.45% for Medicare tax) on behalf of your employees. You are also responsible for collecting and remitting the employee portion: you do that by withholding those amounts from your employees’ paychecks. Those numbers are the same for 2015 for employees as for employers (6.2% for Social Security tax and 1.45% for Medicare tax). However, as the employer, you are also responsible for collecting the Additional Medicare Tax of .9% on wages in excess of $200,000 (this is a new tax as part of Obamacare). There is no employer match for the Additional Medicare Tax.
On top of those taxes, you must withhold federal income tax from your employees’ wages. You’ll figure out how to withhold by asking your employees to complete a form W-4 (downloads as a pdf). You don’t file those forms W-4 with IRS but you do hold onto them for your own records.
Once you collect those withholdings, you must deposit them with IRS according to a schedule. The schedule is determined by how much money you collect and is typically monthly. You’ll also report those deposits to IRS. And this is where things can get a little nutty. Your reporting frequency may be different from your deposit frequency. In fact, it is not unusual at all for your business to be required to deposit payroll taxes on a monthly basis but to report those deposits on a quarterly basis. Pay close attention to the due dates for both.
Speaking of paying attention, this is the most important part of the entire article. Lean really, really close to the monitor and read carefully. Payroll taxes are often called trust fund taxes. This is because, as you just read, you are required to collect and remit those taxes on behalf of someone else – in this case, your employees. Unpaid payroll tax liabilities do not disappear. If you close down your business or move away, those liabilities stay with you – and they stay with you personally. Remember all of that stuff I said about separating personal and business liability? It flies out the window when it comes to trust fund taxes. You can be on the hook personally if you don’t pay. Declaring bankruptcy, etc., doesn’t generally absolve you either. Failing to remit those taxes cannot only result in penalty and interest, it can also result in criminal prosecution. So tread carefully here. Don’t ignore your payroll tax liability.
As a business owner, you may also be responsible for paying Federal Unemployment (FUTA) Tax if you paid wages of $1,500 or more in any quarter during the year or if you had one or more employees for at least some part of a day in any 20 or more different weeks during the year. The rate of tax for FUTA is 6% on the first $7,000 you pay to your employees during the year. You may be able to offset that amount with taxes you paid to the state for unemployment tax. This isn’t considered a proper “payroll tax” since this is an employer-only tax, there is no employee portion.
If you are a sole proprietor or have no employees, you are responsible for Self-Employment tax (SE). SE tax is the individual equivalent of the employer piece for Social Security and Medicare taxes. In a typical employer/employee relationship, the employer pays a share of Social Security and Medicare and the employee pays a share of Social Security and Medicare taxes. When you work for yourself, there’s no employer to pay the employer portion – so you have to pick up the slack.
Generally, you must pay SE tax if your net earnings from self-employment were $400 or more. Special rules may apply to those who work for churches, government employees and others (be sure to check with your tax professional to see if any of those special rules apply to you).
Excise taxes may also apply if you perform certain kinds of services or manufacture and sell certain goods. This generally includes “sin taxes” (think alcohol and tobacco) as well fuel taxes, air transportation taxes and more. Many of these taxes are reported on a form 720 (downloads as a pdf). Give the form a once over – as well as check with your tax professional – to find out whether you might be required to pay any excise taxes.
Overwhelmed yet? It can be really tough to keep all of this straight.
My advice? Get help.
A good tax professional can assist you with preparing, filing and paying your taxes. And yes, while there is a cost associated with hiring a good tax professional, remember two important things:
- Your time is valuable.
- There is considerable benefit to getting this right. Mistakes will cost you money. Being late will cost you money. Failing to do anything will cost you a lot of money – and could land you in jail.
I also highly (HIGHLY) recommend finding a good payroll company. Before I opened a business, I thought that payroll companies were only for big companies. I was wrong. Thoroughly and completely wrong. Big companies may have in-house resources to get payroll done correctly but small businesses are those most in need of a good payroll company.
A good payroll company will work with you to make sure that your employees get paid on time and that the proper amount of tax is withheld and remitted. This includes not only federal taxes but state and local taxes.
A good payroll company will also ensure that the proper amounts are withheld for other pre-tax benefits like health insurance and retirement plans.
As for cost? The cost can vary depending on geography, as well as industry. The most important factors, however, are frequency of pay and number of employees. Brian Tierney, Director of Sales & Marketing for Streamline Payroll, LLC offered up some sample costs for you to use as a guideline. For payroll services at Streamline, you can expect to pay in the ballpark of:
1-10 Employees $30-$50
10-25 Employees $50-$80
25-50 Employees $80-$125
Note that the pricing is per pay period, not per employee. Additional costs apply to companies with more than 50 employees who may have Obamacare-related compliance issues.
Pay periods can range from weekly to quarterly, depending on the company. The most desirable pay period from an employer’s perspective tends to be semi-monthly, or two times per month (typically the 15th and 30th). Why twice a month? For one, that equals 24 pay periods per year instead of 26 (if you pay every other week), saving you a bit of money in payroll services. Additionally, calculating payroll and payroll taxes on a monthly basis, as opposed to every other week, keeps accounting clean from month to month and can help your bookkeeper or accountant make more consistent cost and budget projections.
Even when you use a payroll company, remember that it’s still your business on the line with IRS and other tax officials. Use a reputable company – and make sure it’s bonded and insured. Once you find one that you like, pick up the phone and schedule a meeting to discuss your options. You don’t have to wait until December: with today’s computer software, there’s generally a quick turnaround to get started (no more waiting until the beginning of the year).
One last word: if all of this seems rather intimidating, it is. That’s why I recommend that you work with a team to keep taxes straight. And if you’re already behind on your taxes? Don’t despair. It’s fixable. Take a deep breath and contact a good tax attorney.