This brief does not contain legal or tax advice, but it provides a general overview of tax basics for business owners and entrepreneurs. Every business tax situation is unique. Entrepreneurs and small business owners should seek the advice of a licensed tax professional, such as an attorney or a certified public accountant. 

Owning or operating a small business can be incredibly rewarding. It allows you to pursue your passion, build meaningful relationships with customers, and experience the satisfaction of hard work translating into success. Small business ownership provides a sense of independence and personal growth. It also provides an opportunity to make a direct impact on a community while continuously learning and overcoming challenges.

However, keeping a business in compliance can be challenging, and tax season can be overwhelming. With planning and a better understanding of tax obligations, you can save money and stress. The following contains key tax considerations that entrepreneurs and small business owners should keep in mind.

Choose the Right Business Structure

The way your business is structured directly affects tax obligations. Business entity types are taxed differently. Their structures affect tax bills and how income is reported.

• A sole proprietorship and a single-member Limited Liability Company (LLC). These entities typically use pass-through taxation. This means the business itself does not pay income tax. Instead, profits and losses “pass through” to the owner’s personal tax return. Owners report business income on Schedule C of their Form 1040 and are responsible for self-employment taxes.
• Partnerships and multi-member LLCs. These structures also use pass-through taxation but income is reported on a partnership return (Form 1065). Each partner receives a Schedule K-1 to include on their personal return.
• Subchapter S Corporations. These are also pass-through entities, but they allow owners to potentially reduce self-employment taxes by paying themselves a reasonable salary and taking additional profits as distributions. They file Form 1120-S and issue Schedule K-1s to shareholders.
• Subchapter C Corporations. Unlike the others, C Corporations (C Corps) are subject to double taxation. The corporation pays taxes on its profits at the corporate level (Form 1120), and shareholders pay taxes again on dividends received. However, C Corps can offer benefits like retained earnings and broader deductions.

Be aware that your choice of entity affects:

• How profits are taxed.
• The forms you must file.
• Eligibility for certain deductions and credits.
• Exposure to self-employment taxes.
• Liability protection.
• Administrative requirements.
• Long-term business goals.

Consulting a licensed tax professional or CPA before deciding on a business structure can save you money and headaches down the road.

Keep Accurate Financial Records

Good record-keeping is essential. Maintain detailed records of income, expenses, and receipts to ensure accurate tax reporting. Using accounting software can help streamline this process and keep everything organized. Your financial institution can provide an end-of-year summary of purchases and deposits to help with reconciliation.

Pay Attention to Deductions

Some business expenses are tax-deductible, helping lower your taxable income. Common deductions include office rent, utilities, marketing costs, insurance and supplies. If you work from home, even home office expenses may be deductible. The Internal Revenue Service (IRS) calls these deductions “ordinary and necessary expenses to keep your business running.”

Do not forget to track your business mileage if you use a vehicle for business purposes. Keep in mind that commuting mileage does not count towards your deduction. You should also consider your future capital access needs when utilizing deductions. Business funders and investors will look at the financial health of your business when processing loan applications.

Pay Estimated Taxes

If your business is profitable, you may need to make quarterly estimated tax payments. The IRS requires this if you expect to owe more than $1,000 in taxes. Failing to pay on time can result in penalties and interest charges.

Understand Self-Employment Taxes

Self-employed individuals, including freelancers and sole proprietors, must pay self-employment tax, which covers Social Security and Medicare. This tax is about 15.3 percent, but you may be able to reduce your tax liability through deductions.

State and Local Tax Requirements

Tax obligations in Alabama extend beyond the federal level. Depending on your location and the nature of your business, you may need to collect and remit state and local taxes. Some of these taxes may include:

• Sales tax.
• State income tax, or payroll taxes.
• Privilege tax, which is an annual tax imposed on most business entities (corporations, LLCs, LLPs, LPs, and certain trusts) for the privilege of operating in Alabama. The good news is that unless the business’s assets minus liabilities are equal to or greater than $100,000, you are tax-exempt.

Save for Retirement and Reduce Taxes

Retirement savings plans like the Simplified Employee Pension (SEP), Individual Retirement Arrangement (IRA), Solo 401(k)s, and Savings Incentive Match Plan for Employees (SIMPLE) IRAs allow you to save for the future while reducing taxable income. Contributing to these plans can provide significant tax benefits. Visit irs.gov for more information.

Classify Workers Correctly

It is a big step for any business to hire employees. Starting with contractors or gig workers could be a smart step to help your business grow without taking on the responsibility of full-time employees. However, you must know the legal distinctions to avoid misclassifying employees. When your business grows and you hire more employees, make sure you classify them correctly.

It is important to distinguish between 1099 contractors and W-2 employees to avoid tax compliance issues. A 1099-NEC (Nonemployee Compensation) is an IRS form that reports how much you paid a non-employee, such as an independent contractor. It lists the compensation you paid a worker in a given tax year, plus any federal, state, and local taxes withheld. Most often, nothing is withheld. File a 1099-NEC for workers whom you paid at least $600 for services but did not withhold taxes under an employment arrangement. The annual deadline for this is January 31.

Consult a Tax Professional

Taxes can be complex, and mistakes can be costly for any taxpayer. As a small business owner or entrepreneur, working with a CPA or tax professional can help to ensure that deductions are applied correctly, important tax deadlines are met, and unnecessary penalties are avoided.

By staying informed and proactive, small business owners and entrepreneurs can grow their businesses and remain in compliance. Start planning today to make tax season easier and more manageable.

Visit irs.gov and revenue.alabama.gov for additional information.