Cindy McGhee, CPA, Contributor
March 9, 2023
The tax season is upon us, and you may feel excitement or dread at this time of year. For many Americans, tax season is a time of year they look forward to receiving an income tax refund. Retailers everywhere present options for making the most of your tax refund with special offers on new cars, home improvements, and large ticket items. While much of the messaging during tax season centers on individuals getting refunds, tax season is a dreaded time for most small business owners who will be required to make a payment to the IRS this time of year.
Here are 3 key things you should know if you owe the IRS this tax season.
Refunds are not typical for business owners
When you receive a tax refund, you are receiving your own money back. It means you overpaid the IRS for the year and you ultimately provided them with an interest-free loan. It’s common for W-2 wage earners to overpay and be due a refund. According to IRS statistics, 66% of individual filers were due a tax refund in 2022. However, as a business owner, you are not receiving all of your compensation in W-2 wages, making you unlikely to overpay your taxes. Overall, this is a good thing for you. You wouldn’t overpay any other bill in your business and wait for the vendor to refund you next year. Similarly, it’s not ideal for you to overpay the IRS either.
You need to consider making estimated tax payments this year
When you owe the IRS more than $1,000 at tax time, they may charge underpayment penalties and interest on your balance due. The IRS is a pay-as-you-go tax authority, and you cannot wait until you file your return to pay your taxes each year. If you owe taxes for the 2022 tax year, you may be required to assess your tax balance and remit estimated quarterly tax payments in 2023. The IRS provides a free estimated tax payment calculator for you 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're subject to estimated taxes and the quarterly amount you need to pay. The first quarterly payment is due on April 18, 2023, and protects you from penalties and interest from underpayment.
You control how much you owe in taxes
This time of year, you are likely focused on your tax preparation needs for 2022. You need to keep that same energy for tax planning for 2023. Tax planning is a proactive strategy that will allow you to control how much you owe in taxes this time next year.
Big businesses have been controlling how much they pay in taxes for decades. Many of the top companies in the country pay $0 in taxes to the IRS. Major companies like Amazon, FedEx, and Nike have leveraged the tax code to legally eliminate their taxes and enrich their owners. You can exercise that same control when you apply tax savings strategies for your small business. The most effective strategies require a CPA or tax strategist to design and implement a custom tax plan for you. But, there are several options that you can implement independently to reduce your tax bill this year.
You can start by evaluating your tax classification. You have the authority to elect how your business will be taxed. The best option for your tax status is dependent upon your profit level.
As a single filer who owns a start-up that is not yet profitable, you can file as a disregarded entity. It is most common for a sole proprietor to choose this classification. You will report business income and expenses on IRS Schedule C in your personal income tax return. No special election is needed for this initial tax classification.
As your business grows and profits grow above $13,850, you can elect to file as an S Corporation.. You can complete IRS form 2553 to elect this tax status. Your election is due by March 15 for calendar year filers. Once your business reaches this level of profitability, the S corporation status will shelter your income from 15.3% self-employment taxes resulting in significant tax savings. You’ll want to consult with your tax advisor to best leverage this tax status for your specific business.
As your business builds and profits grow above $170,050, you can elect to file as a C corporation on IRS form 1120. You will complete IRS form 8832 to opt into this tax status. This election is also due by March 15 for calendar year filers. This classification means your business pays taxes at the corporate tax rate of 21%. In contrast, at this profit level, a single S corporation owner would pay tax at their own rate of 32%. This status will shelter your income from 11% in individual taxes and save you over $18,000 in taxes.
You can use these profit guidelines to identify the best tax classification for your business this year.
No Refund, No Problem
Overall, you are now equipped with the knowledge to tune out all of the talks about tax refunds this year and upgrade your focus from tax preparation to tax planning for your business.
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