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Small Business Taxation

Q: Is an S-Corporation required to pay quarterly estimated tax?

Rarely does an S corporation make estimated tax payments. An S Corporation must make installment payments of estimated tax if the total of these taxes is $500 or more:

  • The tax on built-in gains,
  • The excess net passive income tax, and
  • The investment recapture tax.

Q: How do I know if I have to file quarterly individual estimated tax payments?

You must make estimated tax payments for the current tax year if both of the following apply:

  • You expect to owe at least $1,000 in tax for the current tax year, after subtracting your withholding and credits.
  • You expect your withholding and credits to be less than the smaller of:
    • 90% of the tax to be shown on your current year’s tax return, or
    • 100% of the tax shown on your prior year’s tax return. (Your prior year tax return must cover all 12 months.)

There are special rules for:

  • Certain small business taxpayers for periods beginning 2009
  • Certain taxpayers with higher adjusted gross income
  • Farmers and commercial fishermen
  • Aliens
  • Estates and Trusts

Q: What are the penalties for failing to make estimated tax payments?

The United States income tax is a pay-as-you-go tax, which means that tax must be paid as you earn or receive your income during the year. You can either do this through withholding or by making estimated tax payments. If you do not pay enough tax, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. There are special rules for farmers and fishermen. Please refer to Publication 505, Tax Withholding and Estimated Tax, for additional information.

Generally, the payments should be made in four equal amounts to avoid a penalty. However, if you made unequal payments because your income was received unevenly during the year, you may be able to avoid or lower the penalty by annualizing your income. Use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to see if you owe a penalty for underpaying your estimated tax.

The penalty may be waived if:

  1. The failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty, or
  2. You retired (after reaching age 62) or became disabled during the tax year for which estimated payments were required to be made or in the preceding tax year, and the underpayment was due to reasonable cause and not willful neglect.

Q: Do self-employment taxes need to be paid quarterly or yearly?

If you are required to make estimated tax payments, self-employment tax is paid by making quarterly estimated tax payments which include both income tax and social security tax.

Q: When are the quarterly estimated tax returns due?

  • You only make estimated tax payments using payment vouchers. There is not an estimated tax return.
  • Your first estimated tax payment is usually due the 15th of April.
  • You may pay the entire year’s estimated tax at that time, or
  • You may pay your estimated tax in four payments that are due April 15th, June 15th, September 15th, and January 15th of the following year.
  • If the due date for making an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next day that is not a Saturday, Sunday, or legal holiday.

Q: How do partnerships file and pay quarterly estimated tax payments?

  • Partnerships file Form 1065 (PDF), U.S. Partnership Return of Income, to report income and expenses.
  • The partnership passes the information to the individual partners on Schedule K-1, Form 1065 and therefore rarely pays any tax.
  • The partners report the information from the K-1 on their individual returns and pay any taxes due on Form 1040.
  • Because partners are not employees of the partnership, no withholding is taken out of their distributions to pay the income and self-employment taxes on their Forms 1040.
  • The partners may need to pay Estimated Tax Payments using Form 1040-ES.

Q: Must a partnership or corporation file a tax form even though it had no income for the year?

A domestic partnership must file an income tax form unless it neither receives gross income nor pays or incurs any amount treated as a deduction or credit for federal tax purposes.

A domestic corporation must file an income tax form whether it has taxable income or not.

Q: What is the difference between a Form W-2 and a Form 1099-MISC?

Both of these forms are called information returns.

The Form W-2 is used by employers to:

  • Report wages, tips and other compensation paid to an employee.
  • To report the employee’s income tax and Social Security taxes withheld and any advanced earned income credit payments.
  • To report wage information to the employee, and the Social Security Administration. The Social Security Administration shares the information with the Internal Revenue Service.

A Form 1099-MISC is:

  • Generally, used to report payments made in the course of a trade or business to a person who is not an employee or to an unincorporated business.
  • Required among other things, when payments of $10 or more in gross royalties or $600 or more in rents or compensation are paid.
  • Provided by the payer to the IRS and the person or business that received the payment.

Q: How do you determine if a person is an employee or an independent contractor?

The determination is complex, but is based on whether the person for whom the services are performed has the right to control how the person performs the services. It is not based merely on how the person is paid, how often the person is paid, or whether the person works part-time or full-time.

There are three basic categories of factors that are relevant to determining worker classifications:

  • Behavioral control
  • Financial control and
  • Relationship of the parties

For more information on employer-employee relationships, refer to Publication 15, Circular E, Employer’s Tax Guide and Publication 15-A (PDF), Employer’s Supplemental Tax Guide.

If you would like the IRS to determine whether services are performed as an employee or independent contractor, you may submit Form SS-8 (PDF), Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

Generally you should report your nonemployee compensation on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship), or Form 1040, Schedule C-EZ (PDF), Net Profit From Business. You need to pay self-employment tax (comprised of social security and Medicare taxes) on your net earnings from self-employment onForm 1040, Schedule SE (PDF), Self-Employment Tax if you had net earnings from self-employment of $400 or more.

Generally, there is no tax withholding on this income as long as you provide your Taxpayer Identification Number to the payer. Thus, you may have been subject to the requirement to make quarterly estimated tax payments. If you did not make timely estimated tax payments, you may be assessed a penalty for an underpayment of estimated tax. Employees pay their half of the social security and Medicare taxes (i.e., FICA tax), as well as income tax withholding, through payroll deductions.

Q: Does a small company need a tax ID number?

  • A sole proprietor who does not have any employees and who does not file any excise or pension plan tax returns does not need an employer identification number. In this instance, the sole proprietor uses his or her social security number as the taxpayer identification number.
  • If you are the sole owner of an unincorporated LLC (Limited Liability Corporation) that has employees you now need to get a separate EIN to file employment taxes for tax years starting on or after January 1, 2009.

Q: If I pay personal expenses out of my business bank account, should I count the money used as part of my income, or can I write these expenses off?

  • You would include the money in your business income.
  • You would not write off these expenses because they are not ordinary and necessary costs of carrying on your trade or business.
  • Personal, living, or family expenses which are not specifically provided by law are not deductible.
  • It is recommended that you not mix business and personal accounts as this makes it easier to keep records.

Q: For business travel, are there limits on the amounts deductible for meals?

  • Meal expenses are deductible only if your travel requires you to be away from home over night or if the meal is business-related entertainment.
  • You can figure all your travel meals expenses using either of the following methods:
    1. Actual cost. If you use this method, you must keep records of your actual cost.
    2. The standard meal allowance which is he federal M&IE rate. These rates are listed in Publication 1542.
  • The deduction for unreimbursed business meals may also be subject to a 50% limitation.

Q: We are about to hire employees and need to know how much tax to take out and where to send this money?

You will need:

  • To secure a completed Form W-4 (PDF), Employee’s Withholding Allowance Certificate, from each employee.
  • Publication 15, Circular E, Employer’s Tax Guide, and Publication 15-A (PDF), Employer’s Supplemental Tax Guide, to determine the amount of withholding and for directions on depositing the withholding amounts and other employment taxes.

Generally, employers are required to quarterly file Form 941 (PDF), Employer’s Quarterly Federal Tax Return, and annually file Form 940 (PDF), Employer’s Annual Federal Unemployment Tax Return (FUTA), and Form W-2 (PDF), Wage and Tax Statement, with Form W-3 (PDF), Transmittal of Wage and Tax Statements. Some small employers (those whose annual liability for social security, Medicare, and withheld Federal income taxes is $1,000 or less) may file Form 944-SS (PDF), Employer’s Annual Federal Tax Return, instead of Form 941, if the IRS has notified them to Form 944 instead of Form 941. New employers are also eligible to file Form 944, if they will meet the eligibility requirements. New employers filing Form SS-4 Form SS-4(PDF), Application for Employer Identification Number, must

check the “Yes” box or “No” box on line 14 to indicate whether they expect to have $1,000 or less in employment tax liability for the calendar year.

Q: We hired a nanny to look after our baby while we work. How do we pay her social security taxes and properly report her income?

A nanny is considered a household employee:

  • A household employer only has to pay social security and Medicare taxes only on cash wages paid to an employee that exceed the threshold amount for the year.
  • If the amount paid is less than the threshold, no social security or Medicare taxes are owed.
  • If social security and Medicare taxes must be paid, you will need to file Form 1040, Schedule H (PDF), Household Employment Taxes.
  • You must withhold the employee’s portion of the social security and Medicare taxes unless you choose to pay both the employee’s share and the employers share. The taxes are 15.3% of cash wages. Your share is 7.65% and the employee’s share is 7.65%.
  • You may also be responsible for paying federal unemployment taxes, reported on Form 1040, Schedule H.
  • You and your employee may agree for you to voluntary withhold income tax from wages paid to the employee, reported on From 1040, Schedule H.

Q: I use my home for business. Can I deduct the expenses?

To deduct expenses related to the business use of part of your home, you must meet specific requirements. Even then, your deduction may be limited.

Your use of the business part of your home must be:

  • Exclusive (see *exceptions below)
  • Regular
  • For your trade or business, and

The business part of your home must be one of the following:

  • Your principal place of business.
  • A place where you meet or deal with patients, clients, or customers in the normal course of your trade or business.
  • A separate structure (not attached to your home) you use in connection with your trade or business.

NOTE: You do not have to meet the exclusive use test if you satisfy the rules that apply in either of the following circumstances:

  • You use part of your home for the storage of inventory or product samples.
  • You use part of your home as a day-care facility.

Form 1040, Schedule C (PDF) filers calculate the business use of home expenses and limits on Form 8829 (PDF). The deduction is then claimed on line 30 of Schedule C.

If you are an employee and you use a part of your home for business, you may qualify for a deduction. You must meet the tests discussed above plus:

  • Your business use must be for the convenience of your employer.
  • You do not rent any part of your home to your employer and use the rented portion to perform services as an employee.

Employees claim deduction for business use of home as an itemized deduction onForm 1040 Schedule A (PDF). There is a worksheet in Publication 587 to calculate the amount of the deduction.

NOTE: Whether the business use of your home is for your employer’s convenience depends on all the facts and circumstances. Business use is not considered to be for your employer’s convenience merely because it is appropriate and helpful.

Q: If you lease a vehicle, can you deduct the cost of the lease payments plus the standard mileage rate?

If you lease a car you use in business, you may use either:

  • The standard mileage rate. If you choose this method then you must use the standard mileage rate method for the entire period (including renewals).
  • Claim actual expenses, which would include lease payments. If you choose this method only the business-related portion of the lease payment is deductible. This deduction is reduced by an income inclusion amount.

Q: Are business gifts deductible?

If you give business gifts in the course of your trade or business you can deduct all or part of the costs subject to the following limitation:

  • You can deduct no more than $25 for business gifts you give directly or indirectly to any one person during your tax year.
  1. If you and your spouse both give gifts to the same person, both of you are treated as one taxpayer.
  2. Incidental costs such as engraving, packing or shipping do not have to be included in the $25 limit.
  3. Gifts costing $4.00 or less that have your business name permanently engraved on the item, and which you distribute on a regular basis is excluded from $25 per person limit.

You need to have records that prove the business purpose of the gift as well as the details of the amount spent.

Q: I am self-employed. How do I report my income and how do I pay Medicare and social security taxes?

Your self-employment income is reported on Form 1040, Schedule C (PDF), Profit or Loss from Business, or on Form 1040, Schedule C-EZ (PDF), Net Profit from Business, and on Form 1040, Schedule SE (PDF), Self-Employment Tax.

Form 1040, Schedule SE (PDF), Self-Employment Tax is the form that individuals who are self-employed use to compute their liability for social security and Medicare tax.

As a self-employed person:

  • You pay your Medicare and social security taxes the same way you pay your income taxes.
  • You can pay them when you file your income tax return if you expect to owe less than $1,000 in total taxes.
  • You will need to make estimated tax payments if you expect to owe $1,000 or more in total taxes. These payments are made quarterly using Form 1040-ES(PDF), Estimated Tax for Individuals. You will need to figure these taxes at the beginning of the year.

Q: If you have run a small business in the past, but this year there is no income or expenses, is it necessary to file a Schedule C?

If your sole proprietorship business is inactive during the full year, it is not necessary to file a Form 1040, Schedule C (PDF), Profit or Loss from Business, for that year.

Q: What is the due date for business returns?

Some forms and entities have due dates other than the April 15th due date. The instructions for the each type of form used will have the appropriate due date(s) noted:

  • The sole proprietor’s Schedule C of income and expenses is attached to the Form 1040 (PDF). Therefore, the due date is the 15th day of the fourth month following the end of your tax year. For most taxpayers who are on a calendar year, this is April 15.
  • A partnership generally must conform its tax year of the partners unless the partnership can establish a business purpose for having a different tax year. The definition generally states that you must file your return by the 15th day of the fourth month following the end of your tax year.
  • A corporation may use either the calendar year, or a fiscal tax year. The corporate tax return is due by the 15th day of the third month following the end of the tax year.
  • An S corporation generally must use the calendar year, unless the entity can establish a business purpose for having a different tax year. The due date is the 15th day of the third month following the end of the tax year.

Q: Are partners considered employees of a partnership or are they self-employed?

  • Partners of a partnership are considered to be self-employed.
  • The partnership must furnish copies of Schedule K-1 to the partners by the partnership information return due date or extended due date.
  • If you are a member of a partnership that carries on a trade or business, your distributive share of the income or loss from that trade or business is net earnings from self-employment.

Q: I recently formed a limited liability company (LLC). The LLC has no employees. Do I need a separate Federal Tax ID number for the LLC?

If you are the sole owner of the LLC and the LLC has no employees, you will not need a separate Federal Tax ID number.

If you are not the sole owner of the LLC, you will need a separate Federal Tax ID number for the LLC.

Q: For IRS purposes, how do I classify a limited liability company? Is it a sole proprietorship, partnership or a corporation?

A limited liability company (LLC) is an entity:

  • Formed under state law by filing articles of organization as an LLC.
  • Where none of the members of an LLC are personally liable for its debts.
  • Must be classified for Federal income tax purposes as if it were a sole proprietorship (referred to as an entity disregarded as separate from its owner), a partnership, or a corporation. However, if the LLC has employees, for employment tax purposes the LLC will be treated as a corporation.

If the LLC has:

  • Only one owner, (see Publication 555, on community property states), it will automatically be treated as if it were a sole proprietorship (a disregarded entity), unless an election is made for it to be treated as a corporation.
  • Has two or more owners, it will automatically be treated as a partnership unless an election is made for it to be treated as a corporation.

If the LLC does not make a classification election, a default classification of disregarded entity (single-member LLC) or partnership (multi-member LLC) will apply. The election referred to is made using the Form 8832 (PDF), Entity Classification Election. If a taxpayer does not file Form 8832 (PDF), a default classification will apply.