The challenges of business income
Internal Revenue Service research indicates that understated business income contributes significantly to the tax gap, with the majority understated by small businesses.
To assist small business and self-employed taxpayers better understand their reporting obligations, this blog entry addresses the issue of income and how to determine gross income.
Business Income, Gross Receipts or Sales
If there is a connection between any income received and a business, the income is business income. A connection exists if it is clear that the payment of income would not have been made if the business did not exist and operate.
Small business owners and self-employed taxpayers must report on their tax returns all income received from their businesses unless specifically excluded by law. In most cases, business income will be in the form of cash, checks and credit card charges.
But business income can be in other forms, such as property or services. There are many forms, including: bartering, real estate rents, personal property rents, interest and dividend income, canceled debt, promissory notes, lost income payments, damages, economic injury payments, as well as kickbacks.
All income earned is taxable. Directing payment of income to a third party does not remove the reporting and payment requirements for small businesses and self-employed taxpayers.
Cost of Goods Sold
Some businesses may make or buy goods to sell. If so, these businesses may deduct the cost of goods sold (COGS) from their gross receipts. To determine these costs, the value of inventory at the beginning and end of the year must be calculated.
There are several factors that go into determining COGS, including: inventory at the beginning of the year; purchases less cost of items withdrawn for personal use; labor costs (generally applies to manufacturing and mining operations); materials and supplies (generally a manufacturing cost); other costs (generally applies to manufacturing and mining operations); and inventory at the end of the year.
Inventory, net purchases, cost of labor, materials and supplies, and other costs are added together. Inventory at the end of the year is subtracted from this total to determine COGS.
Gross Income
To calculate gross income, first determine net receipts (gross receipts minus returns and allowances) and minus the cost of goods sold. Returns and allowances include cash or credit refunds made to customers, rebates and other allowances off the actual sales price. Then add any other income, including fuel tax credits. Gross income must be determined first before deducting business expenses.
Tools to Use
There are tools available to assist small business owners and the self-employed track and report income such as the use of: a formal set of books and records with strong; accounting/financial computer software; and separate bank accounts for business and personal income and expenses.
Small businesses and self-employed taxpayers greatly benefit by accurately recording and reporting all income. Insufficient recordkeeping could cause income to be over-reported and too much tax paid or too little income reported and too little tax paid.
If your a small business and have a back tax issues with income tax or payroll tax there is help available to you.
Showing posts with label Business Structure. Show all posts
Showing posts with label Business Structure. Show all posts
Friday, October 3, 2008
Choosing Subchapter S Corporation as Your Business Type
Subchapter S Corporation
The Subchapter S corporation is a variation of the standard corporation. The S corporation allows income or losses to be passed through to individual tax returns, similar to a partnership. The rules for Subchapter S corporations are found in Subchapter S of Chapter 1 of the Internal Revenue Code.
An S corporation has the same corporate structure as a standard corporation. It is a legal entity, chartered under state law, and is separate from its shareholders and officers. There is generally limited liability for corporate shareholders. The difference is that the corporation files an election on Form 2553, Election by a Small Business Corporation, to be treated differently for federal tax purposes.
Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level.
An S corporation files Form 1120S, U.S. Corporation Income Tax Return for an S Corporation. The income flows through to be reported on the shareholders’ individual returns. Schedule K-1, Shareholder’s Share of Income, Credits and Deductions, is completed with Form 1120S for each shareholder. The Schedule K-1 tells shareholders their allocable share of corporate income and deductions. Shareholders must pay tax on their share of corporate income, regardless of whether it is actually distributed.
The Subchapter S corporation is a variation of the standard corporation. The S corporation allows income or losses to be passed through to individual tax returns, similar to a partnership. The rules for Subchapter S corporations are found in Subchapter S of Chapter 1 of the Internal Revenue Code.
An S corporation has the same corporate structure as a standard corporation. It is a legal entity, chartered under state law, and is separate from its shareholders and officers. There is generally limited liability for corporate shareholders. The difference is that the corporation files an election on Form 2553, Election by a Small Business Corporation, to be treated differently for federal tax purposes.
Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level.
An S corporation files Form 1120S, U.S. Corporation Income Tax Return for an S Corporation. The income flows through to be reported on the shareholders’ individual returns. Schedule K-1, Shareholder’s Share of Income, Credits and Deductions, is completed with Form 1120S for each shareholder. The Schedule K-1 tells shareholders their allocable share of corporate income and deductions. Shareholders must pay tax on their share of corporate income, regardless of whether it is actually distributed.
Choosing a Corporation as Your Business Structure
Corporation
A corporate structure is more complex than other business structures. It requires complying with more regulations and tax requirements. It may require more tax preparation services than the sole proprietorship or the partnership.
Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and generally at the state level. In addition, any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns.
The corporation is an entity that handles the responsibilities of the business. Like a person, the corporation can be taxed and can be held legally liable for its actions. If you organize your business as a corporation, you are generally not personally liable for the debts of the corporation. (Exceptions my exist under state law.)
When you form a corporation, you create a separate tax-paying entity. Unlike sole proprietors and partnerships, income earned by a corporation is taxed at the corporate level using corporate tax rates. Regular corporations are called C corporations because Subchapter C of Chapter 1 of the Internal Revenue Code is where you find general tax rules affecting corporations and their shareholders.
A corporation files Form 1120 or 1120-A, U.S. Corporation Income Tax Return. If a shareholder is an employee, he pays income tax on his wages, and the corporation and the employee each pay one half of the social security and Medicare taxes and the corporation can deduct its half. A corporate shareholder pays only income tax for any dividends received, which may be subject to a dividends-received deduction.
A corporate structure is more complex than other business structures. It requires complying with more regulations and tax requirements. It may require more tax preparation services than the sole proprietorship or the partnership.
Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and generally at the state level. In addition, any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns.
The corporation is an entity that handles the responsibilities of the business. Like a person, the corporation can be taxed and can be held legally liable for its actions. If you organize your business as a corporation, you are generally not personally liable for the debts of the corporation. (Exceptions my exist under state law.)
When you form a corporation, you create a separate tax-paying entity. Unlike sole proprietors and partnerships, income earned by a corporation is taxed at the corporate level using corporate tax rates. Regular corporations are called C corporations because Subchapter C of Chapter 1 of the Internal Revenue Code is where you find general tax rules affecting corporations and their shareholders.
A corporation files Form 1120 or 1120-A, U.S. Corporation Income Tax Return. If a shareholder is an employee, he pays income tax on his wages, and the corporation and the employee each pay one half of the social security and Medicare taxes and the corporation can deduct its half. A corporate shareholder pays only income tax for any dividends received, which may be subject to a dividends-received deduction.
Choosing a Partnership as Your Business Type
Partnership
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
A partnership does not pay any income tax at the partnership level. Partnerships file Form 1065, U.S. Return of Partnership Income, to report income and expenses. This is an information return. The partnership passes the information to the individual partners on Schedule K-1, Partner’s Share of Income, Credits, and Deductions. Partnerships are often referred to as pass-through or flow-through entities for this reason.
Each partner reports his share of the partnership net profit or loss on his personal Form 1040 tax return. Partners must report their share of partnership income even if a distribution is not made.
Partners are not employees of the partnership and so taxes are not withheld from any distributions. Like sole proprietors, partners generally need to make quarterly estimated tax payments if they expect to make a profit.
General partners must pay self-employment tax on their net earnings from self employment assigned to them from the partnership. Net earnings from self- employment include an individual’s share, distributed or not, of income or loss from any trade or business carried on by a partnership.
Limited partners are subject to self-employment tax only on guaranteed payments, such as professional fees for services rendered.
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.
A partnership does not pay any income tax at the partnership level. Partnerships file Form 1065, U.S. Return of Partnership Income, to report income and expenses. This is an information return. The partnership passes the information to the individual partners on Schedule K-1, Partner’s Share of Income, Credits, and Deductions. Partnerships are often referred to as pass-through or flow-through entities for this reason.
Each partner reports his share of the partnership net profit or loss on his personal Form 1040 tax return. Partners must report their share of partnership income even if a distribution is not made.
Partners are not employees of the partnership and so taxes are not withheld from any distributions. Like sole proprietors, partners generally need to make quarterly estimated tax payments if they expect to make a profit.
General partners must pay self-employment tax on their net earnings from self employment assigned to them from the partnership. Net earnings from self- employment include an individual’s share, distributed or not, of income or loss from any trade or business carried on by a partnership.
Limited partners are subject to self-employment tax only on guaranteed payments, such as professional fees for services rendered.
Choosing a Business Structure
Make an important choice about starting your business.
Of all the choices you make when starting a business, one of the most important is the type of legal organization you select for your company. This decision can affect how much you pay in taxes, the amount of paperwork your business is required to do, the personal liability you face and your ability to borrow money. Business formation is controlled by the law of the state where your business is organized.
This blog and entry and the links to business types provides a quick look at the differences between the most common forms of business entities.
The most common forms of businesses are:
Sole Proprietorships
Partnerships
Corporations
Limited Liability Companies (LLC)
While state law controls the formation of your business, federal tax law controls how your business is taxed. Federal tax law recognizes an additional business form, the Subchapter S Corporation.
All businesses must file an annual return. The form you use depends on how your business is organized. Sole proprietorships and corporations file an income tax return. Partnerships and S Corporations file an information return. For an LLC with at least two members, except for some businesses that are automatically classified as a corporation, it can choose to be classified for tax purposes as either a corporation or a partnership. A business with a single member can choose to be classified as either a corporation or disregarded as an entity separate from its owner, that is, a “disregarded entity.” As a disregarded entity the LLC will not file a separate return instead all the income or loss is reported by the single member/owner on its annual return.
The answer to the question “What structure makes the most sense?” depends on the individual circumstances of each business owner.
The type of business entity you choose will depend on:
Liability
Taxation
Recordkeeping
Which structure best suits your business?
One form is not necessarily better than any other. Each business owner must asses his or her own needs. It may be important to seek advice from business experts and professionals when considering the advantages and disadvantages of a business entity.
Of all the choices you make when starting a business, one of the most important is the type of legal organization you select for your company. This decision can affect how much you pay in taxes, the amount of paperwork your business is required to do, the personal liability you face and your ability to borrow money. Business formation is controlled by the law of the state where your business is organized.
This blog and entry and the links to business types provides a quick look at the differences between the most common forms of business entities.
The most common forms of businesses are:
Sole Proprietorships
Partnerships
Corporations
Limited Liability Companies (LLC)
While state law controls the formation of your business, federal tax law controls how your business is taxed. Federal tax law recognizes an additional business form, the Subchapter S Corporation.
All businesses must file an annual return. The form you use depends on how your business is organized. Sole proprietorships and corporations file an income tax return. Partnerships and S Corporations file an information return. For an LLC with at least two members, except for some businesses that are automatically classified as a corporation, it can choose to be classified for tax purposes as either a corporation or a partnership. A business with a single member can choose to be classified as either a corporation or disregarded as an entity separate from its owner, that is, a “disregarded entity.” As a disregarded entity the LLC will not file a separate return instead all the income or loss is reported by the single member/owner on its annual return.
The answer to the question “What structure makes the most sense?” depends on the individual circumstances of each business owner.
The type of business entity you choose will depend on:
Liability
Taxation
Recordkeeping
Which structure best suits your business?
One form is not necessarily better than any other. Each business owner must asses his or her own needs. It may be important to seek advice from business experts and professionals when considering the advantages and disadvantages of a business entity.
Choosing a Sole Proprietorship as Your Business Type
Sole Proprietorship
A sole proprietorship is the most common form of business organization. It’s easy to form and offers complete control to the owner. It is any unincorporated business owned entirely by one individual. In general, the owner is also personally liable for all financial obligations and debts of the business. (State law may also govern this area depending on the state.)
Sole proprietors can operate any kind of business. It must be a business, not an investment or hobby. It can be full-time or part-time work. This includes operating a:
Shop or retail trade business
Large company with employees
Home based business
One person consulting firm
Every sole proprietor is required to keep sufficient records to comply with federal tax requirements regarding business records.
Generally, sole proprietors file Schedule C or C-EZ, Profit or Loss from Business, with their Form 1040. Sole proprietor farmers file Schedule F, Profit or Loss from Farming. Your net business income or loss is combined with your other income and deductions and taxed at individual rates on your personal tax return.
Sole proprietors must also pay self-employment tax on the net income reported on Schedule C or Schedule F. You may also be able to deduct one-half of SE tax on your 1040. Use Schedule SE, Self-Employment Tax, to compute this tax.
Sole proprietors do not have taxes withheld from their business income so you will generally need to make quarterly estimated tax payments if you expect to make a profit. These estimated payments include both income tax and self-employment taxes for Social Security and Medicare.
A sole proprietorship is the most common form of business organization. It’s easy to form and offers complete control to the owner. It is any unincorporated business owned entirely by one individual. In general, the owner is also personally liable for all financial obligations and debts of the business. (State law may also govern this area depending on the state.)
Sole proprietors can operate any kind of business. It must be a business, not an investment or hobby. It can be full-time or part-time work. This includes operating a:
Shop or retail trade business
Large company with employees
Home based business
One person consulting firm
Every sole proprietor is required to keep sufficient records to comply with federal tax requirements regarding business records.
Generally, sole proprietors file Schedule C or C-EZ, Profit or Loss from Business, with their Form 1040. Sole proprietor farmers file Schedule F, Profit or Loss from Farming. Your net business income or loss is combined with your other income and deductions and taxed at individual rates on your personal tax return.
Sole proprietors must also pay self-employment tax on the net income reported on Schedule C or Schedule F. You may also be able to deduct one-half of SE tax on your 1040. Use Schedule SE, Self-Employment Tax, to compute this tax.
Sole proprietors do not have taxes withheld from their business income so you will generally need to make quarterly estimated tax payments if you expect to make a profit. These estimated payments include both income tax and self-employment taxes for Social Security and Medicare.
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