Can a Small Business Get a Tax Refund?
Everyone likes tax refunds. If you have a small business, you may be wondering how to get one. CNN Money says that in 2016 the average tax refund was about $3000, and tax refunds are common. The trick is to know how tax refunds work for businesses and how to improve your chances of getting a refund.
For 2018, the changes in the tax law have reduced income tax rates for both individuals and businesses, so if you didn't change your federal income tax withholding on employment income, you may have a chance of getting a tax refund. But if you have business income, there's no withholding, so you will need to understand how tax refunds work for business owners.
Tax Refunds for Business Types
How you get your small business tax refund depends on your business type and your ownership in the business. There are two basic types of businesses when it comes to getting refunds:
• Pass-through Businesses. Most small businesses pay their business income tax through their personal tax return. Sole proprietors and one owner LLC's complete a Schedule C - Profit and Loss for Business as part of the owner's 1040.
Partners in partnerships, owners of multiple-member LLCs, and S corporation owners also have their share of business income included on their personal tax returns. The partnership or LLC files an information tax return, and the owners are given a Schedule K-1 form showing their share of the income.
• Corporations. If you are the owner of a corporation, you might pay on your income in one of two ways. Corporate owners are shareholders, who receive dividends paid out by the corporation. Dividends are taxed to shareholders when they are received. If you work for the corporation as an employee, you are taxed on your annual earnings in the same way as other employees. The corporation itself pays income taxes, and the shareholders pay tax on dividends received.
Any income from your pass-through business, your corporate dividends, or your earnings as a corporate employee is included in your personal tax return, along with any other income.
Withholding, Estimated Taxes, and Tax Refunds
Employees, including corporate executives who are employees, have federal and state income taxes withheld from their pay. But other business owners aren't employees and they don't have withholding taken from payments they receive as owners.
Because business owners don't have income taxes withheld during the year, they must pay their income tax bill periodically during the year through estimated taxes. The dates these estimated taxes are due are based on income from the previous three months. The due dates are April 15, June 15, September 15, and January 15 of the following year.
It's not a good idea to skip paying estimated taxes and to wait until tax time to pay. The IRS can charge you fines and penalties for underpayment.
Don't Forget Self-employment Tax
If you own any of the pass-through businesses described above, you must pay self-employment taxes on your business income, in addition to income tax. Self-employment tax is for Social Security and Medicare, and it's paid at 15.3 percent of your share of the business net income, or the entire business net income if you are a solo business owner.
If you want to get a tax refund you must consider paying enough during the year through estimated taxes or withholding on other income to cover both your estimated income tax liability and your self-employment tax.
How Business Tax Refunds Work
The trick to getting a business tax refund is to pay the IRS more during the year than your total tax bill. That means you must be able to estimate the amount of tax you might owe during the year and pay that amount plus more.
For most business owners, your business income is just a part of your total taxable income, so you must factor in all income sources. This means adding estimated business income and self-employment tax to other income to get a total of all income and taxes due.
How to Get a Small Business Tax Refund
Here are some ways to improve your chances of getting a tax refund:
Work with a tax professional who can sit down with you on a quarterly basis and look at your business and personal income for the year and plan the amounts of your quarterly estimated payments.
Tax preparation software companies also may give you some help in estimating your total income tax liability, including both your business and personal taxes. The top tax preparation providers like TaxAct, H&R Block, and Turbotax have experts that can review your business and personal tax return for items you might have missed.
If you want to calculate estimated taxes yourself, the IRS has an estimated tax calculation worksheet on Form 1040-ES. Or see this article by William Perez, tax planning expert, on how to calculate estimated taxes.
The Drawback of Tax Refunds
Many people use tax refunds as a forced saving, and they over-estimate the amount of tax they must pay in order to get a hefty refund in April. But the drawback is that you don't have the use of that money during the year, and you don't get any interest on it. The IRS is using your money for up to 12 months.
It's a balancing act–– trying to pay enough in estimated taxes and withholding to avoid fines and penalties, and not paying so much that you have a huge tax refund but not being able to use the money during the year.