The Internal Revenue Service (IRS) announced the beginning of this year’s tax season on February 12, 2021. At that point, small and medium business owners can start sending their tax returns.
For SMBs, this also means the start of highly stressful tax filing time. Among the taxes that small businesses need to file, income tax is the most common. However, multiple requirements to income tax filing and changes often introduced in American legislation make this process very time-consuming for business owners. Lack of time and financial knowledge can lead to tax overpayment, as 52% of business owners admit. Serious problems can also arise if SMBs underpay income taxes due to tax filing errors, which can result in a tax audit and governmental penalties.
To help you meet the tax season fully-armed and prepared, we have compiled a step-by-step guide on smoothly filing income tax in 2021. Read about what tax filing method to choose, where to get the latest tax information, how to keep up with deadlines, and many more in the article.
What is income tax?
Income tax is one of the most common kinds of taxes for SMBs in the USA. However, many business owners still feel confused when faced with the avalanche of legal definitions and income tax requirements. All you need to know is that there are two types of income tax: individual and business. So, what is the difference between them?
A business income tax is a a profit-based (or company net income) tax. The federal government, and in some cases state and local governments, establish the rates that impose the amount of the income tax. SMBs, in their turn, need to pay it and file tax returns to the IRS.
Individual income tax is a tax withheld from an employee’s wages or other personal income. So, a business owner needs to pay it.
- What does a business tax return include?
Income tax calculations are reflected in the business tax return. Investopedia determines a business tax return as a form filed with a tax authority that reports income, expenses, and other pertinent tax information. In the USA, the IRS or local tax agencies play the role of such authority. Usually, companies should file tax returns with income information annually.
Taxpayers file the returns by filling in special forms. Generally, there are three sections: general information, income, deductions, and tax credits. Further in the article, I will speak about these sections and forms in more detail.
- Who has to file a business tax return?
In the USA, all businesses have to file an annual tax return with the IRS. The exception from this rule is partnerships, as they should file an annual information return instead. And their partners must prepare individual tax returns with profits and losses data.
In general, for legal and tax purposes, the IRS defines five types of business structures:
- Sole Proprietorships
- S Corporations
- Limited Liability Companies (LLC)
For each type of business, different tax requirements can be applied.
If you would like to get more detailed information about these types of businesses, visit the IRS official website.
- What is an income tax audit and, when it can be applied to you?
An income tax audit is an examination carried out by the IRS audits to check and ensure the tax return information.
There are four forms of the IRS tax audit:
- Field audit;
- Correspondence audit;
- Taxpayer compliance measurement program;
- Office audit.
The reason for an audit notice can be incomplete or incorrect information in the tax return. To prepare for a tax audit, check your books and reconciliations, and don’t hesitate to apply for professional assistance.
Tax season deadlines
Usually, the tax season in the USA starts at the end of January. Usually, the tax season in the USA starts at the end of January. However, they can change due to tax legislation changes or external factors. (Just as it happened this year.)
In the framework of the tax season, there is a list of important dates, which are fundamental in the tax filing process:
- February 12 – the beginning of the tax season 2021, the first day of individual tax returns filing.
- The first week of March – the beginning of tax refunds of Earned Income Tax Credit (EITC) and Additional Child Tax Credit (ACTC). NOTE: tax refunds can be made only for taxpayers who filed their tax reports electronically with direct deposit and have no issues with them.
- April 15 – the last day for filing 2020 tax returns.
In case a taxpayer needs more time to prepare the tax return, the IRS provides an opportunity to extend the deadlines. Such taxpayers are allowed to file their tax returns until the 15th of October.
To extend tax deadlines, a taxpayer should request no later than on the last day of the tax season. Businesses and corporations should fill in Form 7004 or Form 1138 and send it to the IRS by electronic request (e-file) or make an indication of the extension in the income tax payment. All other types of businesses have their own forms to be filled in that can be found on the IRS website.
It is worth mentioning that the extension of the time to file a tax return does not apply to the deadline for paying taxes. It concerns only the documental part of the tax process. So, taxpayers have to pay all necessary taxes on time, following regular deadlines.
What challenges might small businesses face when filing income tax returns?
SMB owners who manage to file tax returns correctly, pay them on time, and avoid penalties from the IRS, are halfway to building a stable and growing company. However, that’s an ideal scenario. In real life, the tax filing process is full of issues and complications.
Here is a list of the biggest challenges in tax filing:
- Calculations of taxable income
A financial report is a basis for the calculation of taxable income. Thus to avoid incorrect calculations, it’s vital to ensure the accuracy of your financial records.
- Reconciliation of books with the checking bank account
Reconciliation is a headache for business owners who are not yet familiar with online accounting software. Usually, reconciliation takes hours of manual calculations and checks for mistakes. Almost every SMB owner remembers the desperation of trying to find a missing $5.
- Keeping up to date with tax requirements
Financial literacy helps to minimize the risk of errors in tax filing and reduce overpayments as much as possible. However, endless changes in the tax legislation make it difficult to keep yourself updated with all new requirements.
- Finding tax reliefs
Tax reliefs such as tax deductions and tax credits are a must-have tool for those who want to decrease their taxes. However, there’s never enough time or resources to study this accounting mechanism and count all deductible expenses.
- Meeting deadlines
The tax deadline is a nightmare for business owners. It’s difficult to keep up with all deadlines when you are trying to make ends meet in the reports. However, skipping deadlines can lead to financial losses and big problems with governmental tax agencies.
- Avoiding errors in the tax return
No need to say that professional accounting assistance will help to deal with tax return errors. But even an accountant will not be able to avoid mistakes if a business owner has trouble preparing the necessary data.
Sure, these challenges can bring about huge problems! But there are solutions to overcome them. Just take some easy steps that will help to prevent these complications and ensure hassle-free tax filing.
How to file business income tax returns in 6 steps
Step 1: Collect your accounting records
Correct and precise data is the basis of a tax return. To track the cash flow, SMBs need to collect payment information in their books. The biggest challenge here is to reconcile this data with the reports from the checking bank account. This is when online accounting tools can really help.
For example, an accounting software – Synder, provides its users with the feature of fast and accurate import of current and historical data from payment processors (Stripe, Square, PayPal, Amazon, etc.) into accounting platforms. It then makes an automatic reconciliation (just turn on the “automatic sync” button) and all transactions will be synchronized on your QuickBooks or Xero account.
Such software is extremely useful during tax season as it makes detailed reports for each transaction, separating data by tax, fee, location, discount, inventory, and so on. Synder undertakes all mechanical accounting work, reconciles the data, and helps to prepare a list of essential reports, so you as a business owner will be able to concentrate only on tax optimization and a company development strategy.
Only when all transactions are reflected in the books and checking account, can an accountant or a business owner prepare a tax return.
Step 2: Consider possible tax deductions and credits
Many SMB owners do not pay enough attention to tax deductions and tax credits. However, these accounting mechanisms will decrease your tax liability and save your money. In a nutshell, SMBs can deduct some business expenses from income, and as a result, the tax amount will decrease.
Well, how exactly does it work?
Imagine, you made some payments to retirement savings plans or had rent and insurance expenses. Such spendings are deductible according to the USA tax legislation, which means that as a business owner, you will be able to use these expenses to lower taxes. The same scheme applies to tax credits.
The list of expenses that can be used for tax deduction differs depending on the jurisdiction, so you need to check it out in your state tax requirements.
Step 3: Determine the method of withholding employees’ income taxes
One of the responsibilities of a business owner during tax season is to calculate employees’ income taxes and prepare this information for the IRS. The USA legislation identifies two methods of withholding employees’ income taxes: Percentage Method and Wage Bracket Method.
The Percentage Method can be used to calculate federal income tax withholding if a taxpayer has an automated payroll system. It can be applied for any amount of wages. On the other hand, if a taxpayer files payroll manually and an employee’s salary is up to $100,000, then the Wage Bracket Method can be applied.
To find full information about necessary documents and forms, look through the tables and instructions in IRS Publication 15-T.
Step 4: Find the right form
For tax filing, an SMB owner needs to choose and fill in special tax forms. Overall, tax forms differ depending on the business structure of a company (read more about it above). These forms are provided on the website of the IRS.
In particular, taxpayers should pay attention to the Form W-4 (Employee’s Withholding Certificate) that should be filled in by both employees and employers. Information in this form is essential for the determination of income tax. An employee’s wages and pay frequency also impact their federal income tax amount.
Some of the other most popular tax forms are:
- Form 1040 (US Individual Income Tax Return)
- Form 1120 (U.S. Corporation Income Tax Return)
- Form 1065 (U.S. Return of Partnership Income)
- Form 1040-ES (Estimated Tax for Individuals)
- Form 941 (Employer’s Quarterly Federal Tax Return)
- Form W-2 (Wage and Tax Statement) etc.
Besides these, you should remember that for tax deductions and credits, there are special tax form requirements.
Step 5: Fill out your tax return correctly
A tax return completion can be divided into 3 sections:
- General information
- Income report
- Information about all tax reliefs (such as tax deductions, credits, refunds, and so on)
Just follow the form line-by-line and you should face no difficulties.
Step 6: File your tax return to the IRS
The IRS suggests two tax filing options:
- E-file options
- Mailing addresses
To e-file your tax return, you can apply to any of the following services:
- IRS Free File
- Free Tax Return Preparation Site (the IRS Volunteer Income Tax Assistance and the Tax Counseling for the Elderly programs)
- Commercial software
- An Authorized e-file Provider
All in all, in the tax season you can apply for the assistance of an accounting professional.
Though it may seem complicated, tax filing is not an incomprehensible science that you should wait with tension and stress. Thorough and well-planned preparation will help to go through all tax processes without issues. Hopefully, this step-by-step guide will give you a clearer picture of the income tax filing process. And geared with some smart online accounting apps, you’ll get through it more smoothly.
Don’t hesitate to write your feedback and the most worrying questions in the comments below. The Synder team will be happy to help!
We wish you good luck with the upcoming tax season!