Business taxes can be quite complicated for new business owners and seasoned entrepreneurs alike, so it makes sense to learn the basics of business taxes before you file. And since small businesses often are given incentives in the form of tax credits and special deductions, learning business tax basics can save your company money as well. This section includes a checklist of business tax deductions, an overview of payroll taxes, primer on what a tax auditor is looking for, links to tax forms, and related resources.
Employment and Payroll Taxes
Employers are responsible for withholding taxes from their employees' paychecks, sending them to the proper government agencies, and other employer tax obligations. The most significant tax obligations are FICA, federal unemployment, and state unemployment taxes.
- FICA - The Federal Insurance Contributions Act (FICA) provides a federal system of support for the elderly, their survivors, the disabled, and the hospitalized. As the name suggests, it functions as a sort of insurance program. FICA encompasses both the Social Security and Medicare programs. Employers must withhold a specified amount from employee wages and pay a matching amount. These taxes have different rates, and only social security tax has a wage base limit.
- Federal Unemployment Tax - The Federal Unemployment Tax Act (FUTA) is the federal system for the payment of unemployed compensation to workers who have lost their jobs. Only the employer pays FUTA tax, though they can generally take a credit against payment into FUTA against payments into state unemployment funds.
- State Unemployment Tax - Each state has a different rate at which unemployment tax must be paid and different wage limits from which taxes are calculated.
- Payroll Services - Although not a tax, a common expense for businesses relating to taxes is the hiring of a payroll service. Payroll services can help save time and money by calculating and processing payroll and remitting payroll taxes in a timely manner.
Business Audits by the IRS
When the IRS conducts an audit of a business they investigate much more than just the business. The IRS examines the owner closely. An awareness of the typical concerns for the IRS a business owner can take care not to take actions that might cause concern or suspicion for an IRS auditor. In some cases some activity that may appear suspicious will be entirely innocuous, or even necessary. In those circumstances extra efforts to collect and maintain records and other evidence to support your legitimate purpose can be invaluable in alleviating an investigator's concerns. Some common red flags IRS agents are trained to look for include:
- Lifestyle doesn't match reported income - Dressing humbly during an audit can be more effective than wearing your most intimidating or sophisticated outfit;
- Mingling personal and business expenses - small business owners should not mix personal and business expenses and maintain records that reflect a clear division between accounts;
- Lots of auto expenses - especially when a business owner has one car they use for both business and personal trips a log of business related auto expenses, a mileage log, and other documents can be helpful to show you haven't included expenses arising from personal use.
- Cash businesses - Underreporting, skimming, or diverting funds is easiest when there are primarily cash transactions. As a result the IRS looks most closely at businesses that deal predominantly with cash.
- Heavy use of contractors - Businesses that rely heavily on "independent contractors" may be suspected of seeking to avoid employment obligations such as payroll taxes. If the business controls the contractors closely the IRS may deem them to have been employees, resulting in back taxes and penalties.
- Failure to report income - Purposefully failing to report income is a criminal matter and should be taken with the utmost seriousness.
- Mismatched taxes and employees - Incomplete or inaccurate payroll taxes can trigger an investigation. Ensure that your payroll taxes are complete and match with your claimed employees.