There are many similarities between business and personal taxes when submitting tax returns with the IRS. However, comparing the two will highlight their differences and requirements for successful submission.
You can avoid IRS fines by accurately filing your tax returns on time. Ensuring your personal and business taxes adhere to all applicable tax regulations is crucial.
Let’s examine what distinguishes the two distinct procedures for submitting personal income taxes and managing the extensive responsibilities of submitting business income taxes.
How Does Business Tax Work?
Business tax, otherwise known as corporate tax or corporation tax, is a direct tax collected by the government on the profits or assets of a firm. Corporate tax is challenging, and the laws governing it differ in each state.
To calculate net income (net profit) for a given period, you need to deduct corporate taxes from a company’s gross income. This amount comes from calculating revenue minus the cost of goods.
Let’s take a look at the different kinds of tax that your business needs to know about:
Income tax
The majority of firms must pay income tax. The federal income tax is “pay-as-you-go,” which means that an organization must pay taxes on its earnings as they are generated throughout the year. Employees must also pay personal income tax, often deducted from their monthly salary.
Employer Taxes
When you hire workers for your company, you must pay employment taxes. Your company must pay these taxes to federal, state, and municipal authorities. They typically consist of social security and Medicare taxes, withholding from federal income taxes, and the federal unemployment (FUTA) tax.
Tax on Self-Employment
You must pay the self-employment tax if you are self-employed. This is a fee on social security and Medicare that goes toward your social security benefits. You can receive retirement benefits, disability payments, and other benefits through social security coverage.
How Does Personal Tax Work?
An individual’s income is subject to personal income tax, a tax levied by the government. In other words, an employee’s wages and salaries are subject to income tax.
Due to tax exemptions, deductions, and credits, most people do not pay individual income tax on their whole income. The U.S. Internal Revenue Service provides taxpayers with several deductions, such as those for medical and educational costs, which they can use to lower their taxable income.
Consider a person with an annual income of $400,000 who is eligible for $60,000 in tax deductions. The taxable income in this scenario will be $340,000 ($400,000 – $60,000).
Regarding tax credits, they are applied to lower a taxpayer’s tax liability or amount owing. For instance, if someone owes $60,000 in income taxes, their tax credits total only $10,000. As a result, their tax liability will drop to $50,000 ($60,000 – $10,000).
Moreover, because governments and legal systems vary from nation to nation, so do personal income tax rates. Yet, the majority of countries use what is known as a progressive income tax system, which implies that individuals with higher incomes pay a greater tax rate than those with lower incomes.
Difference Between Personal Taxes vs Business Taxes
If your business is a pass-through entity, the income is transferred to you directly and taxed at your rate. Pass-through business owners include their allocated shares of profits in taxable income under individual income tax and are not subject to corporate income tax or entity-level tax. General partnerships, limited liability companies, c corporations, and sole proprietorships are examples of pass-through entities.
You would file your taxes on Form 1040 because the IRS sees your business and personal income as the same. The amount of money you earn determines your tax bracket. Individual income tax rates apply to all your business income, and personal income tax rates range from 10% to 37%.
In addition, you pay corporate tax rates if you operate a C corporation. No matter how much revenue your company earns, you’ll pay a flat tax rate of 21%. C companies must pay taxes on any dividends or distributions received from the company.
Depending on your income, qualified dividends from stocks you’ve owned for at least 60 days are subject to taxes that range from 0% to 20%. Stocks you have held for less than 60 days that pay nonqualified dividends are taxed at your standard income tax rate.
Using The Right Forms
Different forms are required for reporting business income depending on how your business is set up.
- For a sole proprietorship, complete Form 1040 to record business revenue and Schedule C to disclose business costs.
- C corporation: Submit Forms 1040 and 1120 for your personal and business income taxes, respectively.
- Partnership: Use Form 1065 to file your business return and include information from Schedule K-1 to report business income on Form 1040.
- S corporations should file their company returns using Form 1120-S and their personal income tax returns using Form 1040.
- Limited liability company: Fill out Form 1040 as a sole owner and include business income. Alternatively, if you’d prefer to be taxed as a corporation or partnership for tax purposes, use Form 1120 or Form 1065.
Payroll and Projected Taxes
You are liable for paying estimated and employment taxes as a business owner.
Occupational taxes include social security, medicare, and federal and state unemployment taxes; social security taxes are levied at an average rate of 12.4%. If your company has employees, you are responsible for paying 50% of this sum; the remaining 50% is deducted from employee salaries.
You must pay the total amount of self-employment tax if you are self-employed. Similarly, the Medicare tax rate is 2.9% of earnings paid to employees, shared between you and your workforce. If you work for yourself, you are responsible for paying the entire tax amount.
The first $7,000 paid to each employee is subject to a 6% federal unemployment tax. You can qualify for a tax credit if you also pay state unemployment tax.
Unemployment tax is not due by sole proprietors, and general partners and members of LLCs are considered partnerships.
A business must make four estimated tax payments every year if it anticipates owing at least $1,000 in taxes. Your pay is based on your tax filing status and business income. These payments are applied toward any taxes you owe when you file your annual income tax return.
What Are The Benefits of Tax Deductions?
Making your self-employed firm as profitable as possible requires examining the deductions you are eligible for each year.
You can deduct a home office and a vehicle used for business reasons in two different ways. It pays to perform computations for both to determine which approach is more financially advantageous.
Travel and dinners with clients are tax deductible, but meals consumed as part of entertainment may not be.
Moreover, premiums for health insurance and insurance you purchase to safeguard your business are valid tax deductions. Remember to account for startup, advertising, and retirement plan expenses.
Taxpayers who qualify may deduct up to 20% of their QBI. The net sum of qualified items of income, gain, deduction, and loss from a skilled trade or business constitutes a pass-through’s QBI.
How To File Taxes Electronically
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The following list includes four electronic filing methods for individual taxpayers.
Utilize fillable forms or IRS Free File
If your adjusted gross income is $73,000 or less, use IRS Free File.
Try Free File Fillable Forms if you feel confident filing your taxes on your own.
Use a Website for Free Tax Return Preparation
For taxpayers who qualify, the IRS Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs provide free tax assistance and e-filing.
Use business software
To prepare and file your taxes, use professional tax preparation software transmitted through a digital route that the IRS has permitted.
Locate a valid electronic filing Provider
Tax professionals are authorized IRS e-file providers.
They are qualified to create, send, and handle electronically submitted returns.
Tips For Maximizing Your Personal Tax Returns
- Choose the correct filing status
Selecting a file status is one of the first choices you must make when filing your taxes, and if you’re married, it can impact the size of your refund. While over 96% of married couples file a combined return yearly, it is not always the best choice.
- Accept tax deductions
You should be made aware of several frequently disregarded deductions. Your tax refund could significantly change depending on the deductions you are eligible for.
- State sales tax
- Reinvested dividends
- Out-of-pocket charitable contributions
- Student loan interest
- Child and dependent care
- Increase your contributions to your IRA and HSA
For the prior tax year, you have until the filing deadline to open or contribute to a traditional IRA (unless the deadline is postponed due to a weekend or holiday). This allows you to open the account using your refund after filing your return early and claiming the credit.
- Keep in mind that timing can increase your tax refund
Following the calendar increases the likelihood that taxpayers may receive a greater return. Look for donations or payments you may make before the year ends that will lower your taxable income.
- Become tax credit savvy
As tax credits are a dollar-for-dollar reduction of your taxes, they typically function better as refund boosters than deductions. You can deduct $100 from your taxes if you receive a $100 credit. Many people fail to claim tax credits.
Conclusion
There are several differences between business and personal taxes.
Understanding which group you belong to is vital as it determines which tax bracket you fall into and which forms you must fill out. Both of these are important to know so that you complete the correct information according to the law.