This is a guest post by Phillip Christenson, CFA, from Phillip James Financial. I asked him to share his expertise for us small business owners as January 1 is right around the corner. Read on how to choose whether you should be using Schedule C, Form 1065, or something more specific. This summary on tax forms will help you!
So you started a business earlier this year and either didn’t plan for taxes or thought you would just take care of it when the time came. Well, with the end of the year looming, the time has come. And the first question is which form do you need? Schedule C , 1065, 1120, or 1102S? The following advice should be able to guide you in determining which one is right for your own small business. And for those of you looking to start a business, pay attention, as this should be figured out well before tax season.
Generally, the form you need is determined by the type of business you set up, the most popular of which are sole proprietor, partnership, corporation, and limited liability company (LLC). If you are unsure and did not have any professional help in setting up your business, odds are you are a sole proprietor. If you used a lawyer, accountant, or financial planner to help set up your business check with them to see which entity structure was used.
Limited Liability Company (LLC) – The Flexible Corporate Structure
A limited liability company is a business structure that is allowed by state statute which means each state may have different regulations so check your own states rules if you are interested in starting an LLC. You should use a free LLC operating agreement to ensure the business is established correctly.
Owners of the LLC are called members and can include individuals, corporations, other LLCs, and foreign entities. You can also start an LLC with only one member, in which case you will be considered a “Single Member LLC.” The tax form that an LLC should use to file its taxes depends on the elections made by its members and the number of members. This flexible entity can be taxed as either an S-corporation, a C-corporation, a partnership, or as a disregarded entity (schedule C).
If you are the only member of your LLC, then you will be automatically treated like a sole proprietor. Multiple member LLCs are treated as a partnership unless you elect otherwise. If you want to be taxed in a different manner you need to elect it through form 8832 or form 2553 for S-Corps. Once you determine your tax treatment you just use the same forms recommended above for your business structure.
Sole Proprietor and the Schedule C
A sole proprietorship is the simplest, most common type of small business and is required to file annual taxes using a schedule C. The schedule C is just another form in your personal tax return, form 1040. This schedule is used to account for profit and loss from your small business. There is a simpler version of the schedule C called a schedule C-EZ and is used by small businesses with less than $5,000 in business expenses (among other rules). The profit and loss is transferred to page one of your 1040 and included in your taxable income. At the top of the schedule C you need to enter general information about your business, including business name, address, tax id number and other general business information. Part I is where you input your income, returns & allowances, and cost of goods sold. Part II is where you input all of your business expenses such as advertising, office expense, repairs & maintenance, etc. (See the schedule C for the full list). Below the expense section is the calculation for your net income. The second page of the schedule C are supporting schedules which are used to calculate your cost of goods sold, vehicle expenses, and other expenses, which flow to page 1.
Note: If your small business income comes from rents, royalties, or farming income you will not use a schedule C and instead use schedule E (rent/royalties) or F (farming).
Schedule C is one least complicated small business tax forms so if you are just starting out and are trying to control costs and keep things as simple as possible use a schedule C. You will see later that you may still be able to use the schedule C even if your business is set up as a limited liability company (LLC).
Partnership – Think of it like Schedule C for two or more people
A partnership is a business with two or more people, with each contributing money, property, or labor and sharing in the profits and losses of the business. If your small business is organized as a partnership you should file Form 1065 – US Return of Partnership Income. Form 1065 is used to report the income, losses, deductions, credits, and other information from the operation of a partnership. This is an informational return which means the company does not pay any taxes, instead, you as a partner receive a schedule K-1, and pay taxes on your portion of the company’s income. A partnership is often called a “Pass-Through Entity” because all of the income passes thorough to the shareholders and ends up on their 1040. The first page of the Form 1065 works similar to a schedule C requiring general business information, income, expenses, and net income. However, the rest of the form gets more complicated and will take a separate post to get into the details.
There are also special rules for a Husband and Wife partnerships where they can elect to be a Qualified Joint Venture which basically splits your partnership from a Form 1065 into two schedule Cs. More information can be found here.
S Corporation and C Corporation – Now things get complicated.
If your small business is organized as a C Corporation or S Corporation, you should file a Form 1120 or Form 1120S, respectively. These forms can get very complicated and are beyond the scope of this article. More information on these business tax forms can be found on the IRS website under Tax Information for Corporations. There is tax preparation software that can handle these returns, however, due to the complexity it is recommend that you talk to a tax professional.
Other Considerations
Keep in mind; your tax obligations don’t just stop at your annual tax return, as a small business you need to also be aware of self-employment tax, employment tax, excise tax, estimated taxes among other tax issues.
BIO: Phillip Christenson is a Chartered Financial Analyst (CFA) and owner of an Independent Fee-Only Financial Planning Company in Plymouth, MN. He also has a blog that focuses on Personal Finance and Investment issues. His company’s website can be found at http://phillipjamesfinancial.com.
The problem is that regular taxpayers, like you, are missing out on legal and safe deductions, to the tune of hundreds of millions of dollars in unclaimed refunds every year! As a tax professional, it truly breaks my heart, knowing that just a few thousand, or even a few hundred bucks for us “regular guys” out of that vast pool of overcharging could make a world of difference–and they are just sitting there, unclaimed! And with the economy we’re facing now…it’s essential that the “right” professional handles your taxes, books, or other financial matters.
I agree. Not only is there refunds to be claimed but the time savings, I would argue, is even more important. I know it takes some people an entire weekend to complete their taxes. It really comes down to how you value your time. I can watch a youtube video to and learn how to change my own oil but I don’t thinks its worth my time. Adam Smith called it “Division of Labour.”