Founder’s Guide to Federal Tax: Everything You Need to Know

Federal Tax Handbook For New Business Founders

Introduction 

Mr. Benjamin Franklin once quoted, ‘ In this world, nothing can be said to be certain, except death and taxes.’  Businesses must pay taxes, but given the current political scenario, you can't be sure what your actual tax rate will be. The United States government depends on federal taxes for funding infrastructure, public services, and other vital initiatives. 

Through various federal tax forms, small enterprises make a substantial contribution to this revenue. For businesses, the world of federal taxes may be a confusing and difficult place to be. Financial success depends on your ability to comprehend the complexities of federal taxes, regardless of your experience level as an entrepreneur or as a startup founder. It is not only necessary for entrepreneurs and founders to comply with federal tax requirements, but it is also strategically imperative.

We will explore the many facets of federal taxes in this extensive blog, illuminating their importance, the several kinds of taxes that businesses must pay, and tactics for optimising your tax position. 

Types of Federal Taxes

Small business entrepreneurs may find it intimidating to navigate the maze of federal taxes. Several federal taxes, such as payroll taxes, excise taxes, income taxes, and self-employment taxes, may apply to your company. Let's examine each of these taxes in more detail and see how your company may be affected by them:

Income Taxes

Income tax is the foundation of federal taxes and is levied on taxable income for both people and businesses. To guarantee proper reporting and compliance, small business owners need to make a distinction between personal and business income.

Payroll Taxes

If you are an employer, this tax must be taken into account. It includes Social Security and Medicare taxes that are withheld from employees' paychecks.

Excise Tax

Certain products and services, like cigarettes, alcohol, fuel, and a variety of upscale goods, are subject to excise taxes. Excise taxes may need to be collected and remitted to the government based on your business operations.

Self-Employment Tax

If you’re a sole proprietor or a partner in a business earning $400 or more annually, you’ll need to pay self-employment taxes, which cover Social Security and Medicare contributions for self-employed individuals.

Understanding each tax category will enable you to make more informed financial and resource allocation decisions and maintain compliance with Internal Revenue Service (IRS) regulations.

Understanding Federal Tax Landscape

The tax landscape is ever-changing due to the frequent introduction of new laws and regulations. You may stay ahead of any changes that might have an impact on your company by keeping up to date with reliable sources, like the IRS website, tax publications, and certified tax experts.

Explore how the progressive nature of federal income tax impacts businesses and individuals. Identify the effects on various income levels of tax brackets and how they operate. The federal tax rate in the United States is progressive, which means that it rises in tandem with taxable income. 

Employer Identification Numbers, or EINs for short, are federal tax identification numbers that are often required for most businesses. Your company is identified by this nine-digit number, which is written as XX-XXXXXXX, on all business tax reporting forms and returns.

You will need EIN irrespective of the fact that you have a business corporation or a partnership, or if you have employees under you, if you file employment, excise, or Alcohol, Tobacco and Firearms returns, withhold wages on income, other than wages paid to a non-resident alien, or if you have a qualified retirement plan.

Additionally, before you open a business bank account, a bank will require your EIN.

Generally speaking, your company will require a Federal Tax Identification Number, or Employer Identification Number (EIN).  There are several ways to apply for an EIN, including online. The IRS is providing this service for free.  To discover if you require a state number or charter, contact your state.  To get more assistance, go to the IRS website: 

irs.gov/Businesses/SmallBusinesses-&-Self-Employed/Employer-ID-Numbers-(EINs)

More on Federal Taxes…

Federal Income Tax Due Date

Typically, April 15th of each year is when federal taxes are due. If April 15 comes on a weekend or for other reasons, the day could shift slightly. October 15 is the next deadline as a result of the extension. 

Tax Bracket Rate

The tax brackets help determine how much money you owe to the IRS annually. 10%, 12%, 22%, 24%, 32%, 35%, and 37% are the seven federal income tax brackets that remain the same from the previous few seasons. Which bracket you are in will depend on your filing status and taxable income (including wages).  

Tax Deductions

The standard deduction is the most common federal tax deduction utilised to lower your federal income tax liability. Based on their filing status, each taxpayer is eligible to claim a standard deduction (which is reviewed annually)  lowers their taxable income by a predetermined amount set by the federal government.

The itemised deduction is an alternative to a standard deduction. With this option, taxpayers can accumulate specific categories of permitted expenses and choose to replace the standard deduction with the total allowable amount of these expenses. These kinds of expenses include medical care, mortgage interest, and charitable contributions.

If your business is run to turn a profit, you can typically deduct your business expenses. Numerous people fail to utilise these deductions: The healthcare tax credit, business use of personal vehicles, depreciation, health insurance deduction,  entertainment costs, business travel, deduction for home office, Startup expenses, cost of training, professional fees, acquisition of Software and Equipment, costs of moving, hiring former employees, and contributions to charities.  For every one of these deductions, there are specific criteria. Check out the IRS website for more details regarding the deductions.

Tax Credits 

While tax deductions lower your taxable income, tax credits reduce your tax liability A taxpayer may choose to immediately lower their tax liability by taking advantage of any eligible tax credit amounts after their tax liability has been determined. The legislative incentive programmes for particular taxpayer categories are linked to all the largest tax credits. 

For instance, low-income individuals can receive tax credits through the Earned Income Tax Credit, while individuals seeking higher education can benefit from the American Opportunity Tax Credit and the Lifetime Learning Credit. And those who have dependents or children can benefit from the Child and Dependent Care Credit. 

Certain federal tax credits are nonrefundable, which means that if they reduce your tax liability, you won't be eligible for any further benefits or refunds for any unused portion of the credit. The Adoption Tax Credit is an illustration of a nonrefundable tax credit; if the credit lowers a taxpayer's tax burden to zero, the taxpayer will  simply not pay any tax.

However, some credits might be refundable. These tax credits have the potential to both waive a taxpayer's burden to 0, and may also benefit taxpayers with a tax refund. For instance, in the event that you are eligible for a $1,000 refundable tax credit and owe $750 in taxes, you will ultimately receive a $250 tax refund. 

Additionally, tax credits provide a dollar-for-dollar reduction in your tax obligation. Typical tax credits for small companies include the following:

Research and Development Credit 

You can qualify for the R&D tax credit if your company conducts approved research.

Work Opportunity Tax Credit

Employers who choose to hire members of specific targeted groups—like veterans or ex-felons—are incentivized by the WOTC.

Credit for Small Business Health Care

If you offer health insurance benefits to your staff, you may qualify for a tax credit to offset the costs.

Marginal and Effective Tax Rates

Marginal tax rates determine the average tax rate and liability for different income brackets, and businesses can strategize to minimise their taxable income within these brackets. Your marginal tax bracket is the one into which your highest dollar amount of income is placed. Your highest tax rate, which is applied to the highest percentage of your income, is in this bracket. To find out your marginal tax percentage. 

Your effective tax rate is the average amount of taxes you will pay, whereas your marginal tax rate is the highest tax bracket you are in. You must divide the total amount of your taxes by your taxable income to determine your effective tax rate. 

What You Can Do Right

The following are some tax optimization strategies small business owners might want to consider.

Stay Updated

Fiscal and economic policies have an impact on federal tax rates. Federal tax rates can be impacted by a number of economic factors, including employment rates, economic growth, and inflation. Rates of taxes are also significantly influenced by fiscal policies, such as decisions made on government expenditure and taxation. Keeping up with financial and economic trends as a small business owner will help you prepare for future changes in tax rates and make well-informed decisions.

Lower Tax Brackets

Knowledge of the credits and deductions available to businesses is essential to reducing their tax liability. In the previous section, we explored deductions and credits and how they might help your bottom line. 

Adhere to Tax Deadlines

There may be fines for missing filing deadlines. Adhere the tax deadlines with our Inkle tax software which not only helps with your taxes but also generates a tax calendar to keep track of upcoming deadlines.

Timing Of Income and Expenses

Small firms can lawfully lower their tax liabilities by using tax-minimising techniques, such as deferring income or capital gains or accelerating expenses. It takes a thorough understanding of federal tax laws and regulations to put these techniques into practice.

Depreciation and Section 179 Expensing

Utilise Section 179 expensing and bonus depreciation to expedite the deduction of eligible business assets.

Qualified Business Income Deductions

A deduction of up to 20% of qualifying business income can be taken under the TCJA for some small firms. This deduction is known as the QBI deduction.

Accurate Recordkeeping

To support your tax positions in the event of an IRS audit and to claim deductions and credits, you must keep up-to-date, well-organised financial records.

Entity Selection

Selecting the appropriate business structure can have a big impact on taxes. To choose the right one for you, compare corporations, partnerships, LLCs, and sole proprietorships. 

It's critical to realise that every kind of business structure has unique tax ramifications and alternatives. For tax purposes, a limited liability firm might decide to be taxed as a corporation, for example, as this tax status offers advantages over partnership tax status in terms of deductions. However, sole proprietorships have their own limitations. Federal taxes for a sole proprietorship are included in the owner's personal income taxes. When there is a partnership, each partner's portion of the partnership's income, gain, loss, deductions, and credits are included on their individual tax returns. Tax filing for S-Corps is similar to Partnerships. Lastly, in the event of a C-Corp, the corporation is required to file and pay corporate taxes; the shareholders are responsible for paying taxes on the distributions they get.

You can obtain IRS publications and tax forms for small businesses and independent contractors on the IRS website at irs.gov/Businesses/Small-Businesses- &-Self-Employed/Small-Business-Forms-and-Publications

Conclusion

Thanks to this extensive guide, you now have the knowledge and abilities to negotiate the complexities of federal taxation properly. Though this is useful guidance, keep in mind that every business is different, and it is strongly advised that you consult tax professionals from Inkle. 

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