On top of running a business, understanding the impact of that income on your income taxes can be confusing for many. If you need to figure out the impact of your business income on your tax liability, you’re not alone. Fortunately, depending on the business structure, with a bit of patience, it’s simple to determine the impact of small business taxes on your personal taxes.
If you own a business, you may have to report business income on your individual income tax return. The effect of owning a business on your personal taxes varies by business structure. Read on to answer, “How does owning a business affect my personal taxes?” based on your unique situation.
How Does Your Business Structure Affect Your Personal Taxes?
The business structure that you choose will directly affect your personal taxes. If you have a sole proprietorship, partnership, LLC, or S corporation, you’ll need to report business income on your individual income tax return.
And if you have a C corporation, you’ll need to file a separate business tax return. In addition, you may need to file information forms for the business with the IRS, even if you pay taxes on your individual income. Read on to understand how.
Sole Proprietorship
Sole proprietorship taxes are the simplest available for a business. If you have a sole proprietorship, business income isn’t separate from your personal income, as it’s not a separate legal business entity. Independent contractors, freelancers, or single-member LLC owners are taxed as sole proprietors by default.
According to the IRS, a sole proprietorship is a disregarded entity and doesn’t need to file a tax return separately from its owners. You’ll report personal and business income with Form 1040. Business revenue and deductible expenses are reported on Form 1040 Schedule C.
The pros of a sole proprietorship are simplified administration and filings. But unless you have a single-member LLC, you don’t have any liability protection for your business.
Partnership
A business partnership is also considered a pass-through entity. Partnerships allocate earnings to the partners, and each partner reports their business income on their individual income tax return. You’ll receive IRS Form Schedule K-1 with all earnings to report on your individual tax return. Then, you’ll use the information on Form K-1 to file Form 1040 Schedule E with the IRS.
Partnerships must file an information return separate from individual returns directly with the IRS on Form 1065. For that reason, partnerships aren’t considered disregarded entities.
The pros of partnerships are that income is reported on your individual income tax return, simplifying filings. However, you’ll have to pay self-employment tax and still need to file FORM 1065 with the IRS for the partnership.
LLC
An LLC is the most flexible structure regarding how business income affects taxes. How a limited liability company or LLC affects your personal taxes depends on how the owners elect to be taxed. An LLC can be taxed as a sole proprietorship, partnership, S corporation, or C corporation.
A single-member LLC is treated like a sole proprietorship. In that case, you’ll report all income on your individual income tax return. An LLC with more than one owner is automatically taxed as a partnership, in which case income is still reported on your individual tax return.
If you elect to be taxed as an S corporation, income will be reported on your individual tax return, but you’ll need to file Form 1120-S to report company earnings, and you’ll receive a Form K-1 to report your individual earnings. Learn more about how LLC tax rates are calculated or how LLCs are taxed.
S Corporation
An S corporation is a pass-through entity so business income will be reported on your individual income tax return. In addition to distributions, reported as K-1 earnings on IRS Form 1040 Schedule E, you could earn wages. In that case, you’ll receive Form W-2.
Finally, the S corporation must file an information return using Form 1120-S to report earnings. Learn more about S corporation vs. LLC.
C Corporation
C corporations are the exception in how they affect your personal taxes. If you have a C corporation, it is always considered a separate legal taxpaying entity. The C corporation must file IRS Form 1120 to report and pay income tax according to the federal business tax rate.
You can receive two types of income from a C corporation. As a shareholder, the corporation may distribute dividends. In that case, you’ll receive Form 1099-DIV and use the information to report dividend income on your personal taxes.
In addition, if you work for or manage the company, you could be considered a company employee and earn W-2 wages. In that case, you’ll report and pay taxes on your personal tax returns for both W-2 and 1099-DIV earnings. Learn more about C corporation tax rates here.
With corporations, you won’t have to pay self-employment tax, but the funds may be double-taxed, as all profits are first taxed at the corporate level, and then you’ll pay individual income tax on all earnings.
Nonprofit
In the case of a nonprofit corporation, also called a 501(c)(3) organization, the company profits don’t affect your personal taxes. However, donations made to 501(c)(3) organizations may be tax deductible up to a certain percentage. If you own a 501(c)(3) organization, you must pay your employees fair market value wages.
The pros and cons of a nonprofit are the possibility of collecting tax-deductible donations for charitable purposes. However, this type of organization requires extensive administrative paperwork and is limited in activities for specific charitable and non-profit purposes.
Get doola for Help with Your Business or Personal Taxes
Owning a business will affect your personal taxes through income generated, regardless of business structure. But small business taxes don’t have to take time away from building your business. The impact on your taxes, whether you can pass through business income, and whether you must pay self-employment tax depends on the business structure.
The best way to handle business and personal taxes is with precise bookkeeping throughout the year. If you want to ensure you keep clear records and have an easier tax season, consider doola Books. It offers simple bookkeeping services designed to help busy founders like you. Get doola Books to streamline bookkeeping, and get doola’s tax package to save even more time to focus on your core business.
FAQs
Are business expenses deductible on my personal taxes?
Yes, business expenses can be deducted from taxable income. However, they are deductible only from the related business income. You could deduct business expenses from other income as a sole proprietor.
How do I report business income on my personal tax return?
Depending on the business structure, you can report business income on your tax return. You can report business income on your personal tax return if you have a sole proprietorship, partnership, S corporation, or LLC.
Can I claim deductions for a home office if I run my business from home?
Yes, you can claim appropriate deductions for a home office if you run your business from home. See IRS guidelines on home office deductions here.
What if my business operates at a loss? How does that affect my personal taxes?
If your business operates at a loss, it could affect your personal taxes. If you’re a sole proprietor, you can deduct business losses from nonbusiness income, such as wages.
Are there any tax credits or deductions available specifically for small business owners?
Yes, there are several tax credits or deductions available specifically for small business owners, including deductions for a home office, advertising, office supplies, and depreciation. You can also qualify for an employee retention credit, work opportunity credit, and retirement plan contribution credits.
Are there any tax implications if I sell my business?
Yes, there are various tax implications to selling your business. Most notably, all income from the business sale will be taxed at applicable state and federal rates. Other implications depend on the business structure and the classification of the sale.
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