Information and Tax Returns
Financial activity of a business is reported on forms called tax returns and information returns.
Tax returns create a tax liability. For example, a c corporation reports their sales, expenses and net income on their corporate tax return and pays 21% net income tax while filing their return. Tax returns consist of the following components:
Gross Income: Typically, the sales and other revenue
Deductions: Expenses related to conduct of business
Taxable Income: The difference between gross income and deductions
Total Tax Liability: Taxable income x tax rate
Tax credits: they directly reduce tax liability and are offered by IRS as incentives for certain behaviors such as R&D
Tax already paid tax payments made during the year.
Tax due: the difference between tax liability and credits and payments
Tax due (refunded) = (Gross Income - Deductions) x Tax Rate - Tax Credits - Tax Already Paid.
Information returns don't result in a tax liability but provide necessary information to IRS. They are filed by entities that do not pay income tax. For example, a general partnership files an information return to show how the net income was distributed to partners. Each partner will then show their portion of income on his or her individual tax return. IRS will use the received information to make sure the income reported on partners’ individual tax return matches to what was reported on partnership’s information return. In our legal structure section, we will cover federal filing and tax requirements by legal structure. Just like IRS, states may also require tax and information returns. In our states section we will cover the requirements of each state. Returns can be filed by mail or electronically. Electronic filing can be done through an e-file provider only. IRS does not provide such capacity on its website. You can check if your accountant is an e-file provider here: https://www.irs.gov/e-file-providers/authorized-irs-e-file-providers-for-individuals.
As shown in this picture, business tax returns pay tax directly, while information returns pass information to IRS and the business owner, and the owner pays tax on it on his or her personal tax return. While c corporations file tax returns, s corporations and partnerships file information returns and sole proprietors report their business activity directly in their personal tax return.
Business owners have a bevy of tax filing and paying obligations. Both the federal government and the states have the authority to collect taxes. They can be collected both from individuals and businesses. While most people think of a tax as a fraction of net income, there are way more types of taxes than the income tax. The following are the most common taxes imposed on businesses.
Most Common Taxes
Federal Income Tax: Charged on net income by federal government.
Capital Gain Tax: Imposed on income from sale of investment assets as stocks and digital currencies.
State Income Tax: Charged on net income by state. check the state taxes page for more details on this one.
State Revenue Tax: Charged on revenue by state.
Franchise Tax: Annual license to do business in the state.
Sales Tax: Collected from customers as a percentage of a sale.
Payroll Taxes: Paid as a percentage of wages paid to employees.
Estimated Taxes: If previous year’s taxes exceed $1,000, company must make estimated quarterly tax payments. Any overpayment will be refunded after filing annual tax return. Any underpayment must be paid when filing annual tax return.
Profit and Loss
Every tax return has a profit and loss section where the tax-deductible expenses are deducted from the gross sales and the taxable income is calculated. Let’s review a C Corporation that in 2023 had $1mm in revenue, $700k in expenses as well as $400k loss in 2022. In this case, first, we enter the revenue, then we subtract 100% of expenses for the year. The difference is the net income. We are allowed to carry forward losses from previous years up to an amount equal to 80% of the net income. So, from $400k loss we will deduct $240k = net income x 80%. The remaining $160k can be carried forward to 2024. The taxable income is $60k and the tax is 21% = $12,6k.
Gross Revenue (Sales) $1,000,000
Expenses ($700,000)
Net Income $300,000
Loss carryover ($240,000)
Taxable Income $60,000
Tax Credits $0
Tax $12,600
Cash vs Accrual
Before looking at most common business expenses it is important to distinguish between 2 accounting methods: cash and accrual. Cash method recognizes income and expenses when funds have been received or paid. In contrary, accrual recognizes the income and expenses when the payment is due by or owed to the company. In many cases this will be the same date. For example, a retail store is paid the day when the sale is made, or a makeup artist is paid once the service is provided. However, some businesses do not get paid or pay upfront. For instance, a company that supplies rubber to a tire producer supplied 100 units of rubber on December 12th, 2023. According to payment terms the tire producer pays once in a month. So, the payment for December invoice is made on January 1st, 2024. If using the cash method, proceeds from the sale of rubber will be registered on January 1st, 2024. If using the accrual method, the income will be reported in the 2023 tax return. The same logic applies to expenses. The choice of an accounting method is made on the tax return and while, conversions are possible, they should be done by a professional accountant.
Business Expenses
Business related expenses are the most common way of reducing your taxable income. Here is a list of the 12 most common business related expenses:
Home office deduction
Auto and Truck Expenses
Travel and Meal Expenses
Bank and Merchant Fees
Payroll and Salary
Tax and License
Software Development
Contract Labor
Professional Fees
Interest Expenses
Advertising Expenses
Charitable Donations
Tax Credits
Tax credits directly reduce tax liability. For example, a company owes $10,000 in tax but has $2,000 in tax credits. The total tax liability will be $8,000. Tax credits are offered to support certain industries and encourage certain behaviors. For example, Research and Development credit reduces tax liability for companies that conduct research activity in the United States. Employee retention credit was a special tax credit offered to employers that did not lay off their workforce. There are 2 types of tax credits:
refundable
non-refundable
If a refundable credit amount exceeds the tax liability, the difference is refunded to the business. Non-refundable credits are limited to the extent of the tax liability. For example, a business owns $10,000 in tax and has $13,000 in refundable tax credits. $3,000 will be refunded to the business. If the entity has both refundable and non-refundable credits, non-refundables will apply first unless otherwise instructed by IRS. For instance, C corporation Quacky Quack Corp owes $10,000 in tax and has $4,000 in non-refundable credits and $8,000 in refundable credits. The corporation will first apply $4,000, reducing its tax liability to $6,000 and then the refundable $8,000, becoming eligible for a $2,000 tax refund.
Extensions, Installment and Estimated Payments
Most information returns are due on March 15 and most tax returns are due on April 15. Generally. it is possible to take a 6 month extension to file them. A 1 page form is submitted to IRS and an automatic approval is granted. No failure to file penalty will be imposed in that case. “Extension to file” is not an extension to pay. Any tax liability not paid by the original due date will accrue interest even if an extension was filed. If the company does not know its exact tax liability, it should make their best estimate and pay as much as possible. Any overpaid amount will be refunded when the tax return is filed. Any underpayment will be subject to interest. For example, on April 15 the company “Sliced Bread Inc”is not ready to file their tax return. Based on available records it has, it estimated a net income roughly equal to $1,000 and a $210 tax liability. It pays $210 when filing an extension. On October 15 the company finally has all the information to file its tax return. The actual numbers show $900 of net income and therefore $189 tax liability. IRS then refunds $21.
If the entity cannot afford to pay taxes in full, it should apply for an installment agreement. An installment agreement does not exempt from interest but protects from collections. So, if the corporation owes $1,000 in tax and wants to pay it in 10 months, monthly payments will be $100 + 0.05% monthly interest.
IRS and most states require quarterly estimated tax payments if the total liability for the year is $1,000 or more. Failure to make them will result in an underpayment penalty. While it is not always possible to exactly estimate the tax liability at the end of the year, IRS will not impose a penalty if the business paid estimated taxes equal to 100% of the previous year tax liability or 90% of the current year liability. Any overpayment will be refunded. For example, a corporation that in 2022 had $2,000 tax due. In 2023 year pays $500 a quarter in estimated payments. On April 15, 2024, when filing 2023 taxes, it turns out it owes $3,500 in tax. The company files tax return pays the remaining $1,500 and since it paid 100% of the previous year taxes, even though their tax liability is $1,500, no penalties will be assessed.