Income Tax for Small Businesses: What You Need to Know

Let’s face it, dealing with taxes isn't the highlight of running a company. However, they play a massive role in your cash flow and bottom line. Getting them sorted is key to avoiding penalties and keeping operations moving. In this guide, we break down the essentials to help you stay financially healthy and plan.

What is Business Income Tax?

Business income tax refers to the amount of money you owe based on your company's yearly profits. The IRS requires you to pay business taxes on your net profit, the amount that remains after you deduct business expenses. Accurate record-keeping, which involves tracking income and expenses as you go, is essential for filing correctly.

How you handle the income tax also depends on which business entity you've chosen. Sole proprietors and partnerships pass profits through to the owners’ personal returns. Corporations follow separate rules. Limited liability companies (LLCs) get the option to choose how they’re taxed.

How Income Tax Impacts Your Business

Business income taxes influence how you manage money and make decisions. They affect the amount of money you can invest in growing your business. The taxes you have to pay can also affect your hiring decisions and cash reserves. 

Strategic planning goes a long way toward maintaining financial stability. It can be as simple as timing your next big purchase or hire to your advantage. Setting aside funds year-round or making quarterly payments helps smooth out your cash flow and lowers stress come tax season. Plus, accurate bookkeeping doesn't just simplify filing—it protects you in case of an audit.

Different Types of Business Taxes

Business owners deal with several types of taxes. Each comes with its own rules and deadlines. Here's an overview:

• Income Tax: Rates depend on your net profits after expenses. They also vary according to your business structure.

• Sales Tax: If you sell taxable goods or services, you’re responsible for collecting and remitting sales tax to state or local governments. Rules vary depending on where you operate and what you sell.

• Payroll Taxes: Once you hire employees, you’ll need to withhold income taxes and pay Social Security, Medicare, unemployment taxes, and, in most cases, workers’ comp premiums.

• Industry-Specific Taxes: You may face additional taxes tied to your products, equipment, services, or location.

How to Calculate and File Income Tax for Small Businesses

To calculate business income tax, you need to determine your taxable profit. Here's how to get started:

1. Calculate Your Gross Income

Add up all revenue from your company's sales and services. Include any returns and discounts. Don't forget income from sources like interest earned on bank accounts or profits from the sale of assets and equipment. You need to include all investment returns.

2. Subtract Business Expenses

Deduct the cost of goods sold, meaning the total costs used to create your products or services. Deduct expenses such as rent, utilities, supplies, and professional services. The IRS requires expenses to be both ordinary (common in your industry) and necessary (helpful for your business).

3. Apply Any Depreciation

Capital assets, such as equipment and vehicles, lose value over time. You can deduct this depreciation according to IRS schedules. You can also spread the cost over several years.

4. Determine Any Pass-Through Deduction

If you run a sole proprietorship, partnership, LLC, or S-Corp, the new pass-through deduction allows you to deduct up to 20% of your business income on your Form 1040.

5. File Your Forms

Depending on your business structure, you'll file different forms. If you're a sole proprietor, you use Schedule C with your personal returns. Corporations file separate business tax returns. If you're unsure, consider working with tax professionals. They understand income tax for small businesses and can identify opportunities to save.

Deductions for Business Owners

Business deductions can reduce your overall tax liability. Here are some examples:

• Common Deductible Expenses: These include office supplies, marketing costs, professional development, and business insurance premiums. You can deduct home office expenses if you use part of your home exclusively for business purposes.

• Vehicle Expenses: Deduct these using either actual costs (including gas, maintenance, repairs, and insurance) or the standard mileage rate. Keep detailed records of business mileage and purposes for all business-related trips.

• Professional Services: Accounting, legal advice, financial services, and consulting fees are often deductible.

• Equipment and Technology Purchases: You can deduct these in the year of purchase through Section 179 deductions or bonus depreciation, rather than spreading costs over multiple years.

Strategies to Minimize Your Business Income Tax Liability

Continuous tax planning helps you stay compliant while legally minimizing your tax liability. Here are a few strategies:

Time Your Income and Expenses

For most businesses, the tax year runs from January 1 to December 31. Delaying invoices until January can push taxable income into the following year. Purchasing equipment in December lets you claim deductions sooner. For example, a $10,000 equipment purchase before the end of the year could reduce your tax bill by several thousand dollars.

Maximize Your Retirement Contributions

As a small business owner, you can save with accounts like SEP-IRAs and Solo 401(k)s rather than traditional IRAs.

Deduct Health Insurance Premiums

If you’re self-employed, premiums for you, your spouse, and any dependents may be fully deductible. That means a $500 monthly premium could save you $1,800+ a year in taxes (assuming a 30% tax rate).

Revisit Your Business Structure

The type of business entity can make a big difference. For example, switching from a sole proprietorship to an S-Corp might reduce self-employment taxes. A C-Corp has flat tax rates that may benefit higher-profit businesses.

Work With Professionals

Tax rules can be complex, and strategies vary by industry and location. An accountant or tax advisor can help you identify any deductions you’re missing and guide you through the process.

Managing Business Income Taxes With Justworks

Tracking income and expenses year-round helps you avoid the stress of tax season and make more informed business decisions. However, running payroll and managing taxes can eat up time. The right tools can help.

Modern HR platforms such as Justworks PEO offer integrated payroll and tax services. They automatically calculate and file payroll taxes, lowering the risk of errors and helping you stay compliant. With real-time integrations to popular accounting software, Justworks makes it easier to prepare for tax season. Get started with Justworks today.