Everyone likes tax refunds, and you might be wondering how to get one if you have a small business. The trick is to know how tax refunds work for businesses and how to increase your business deductions to decrease your business income.
Tax Law Changes You Need to Know About
Changes in the tax law (the Tax Cuts and Jobs Act) have reduced income tax rates for both individuals and corporations. A new small business tax deduction has been added, and depreciation deductions for buying new equipment and vehicles have been increased. On the other hand, the entertainment deduction has been eliminated, and other deductions have been cut or changed.
Various COVID-19-related laws might affect your taxes and increase your chances of getting a business tax refund. Some of the changes were one-time assistance measures, like Paycheck Protection Program forgiveness. Others, like the employee retention credit (ERC) and credits for paid sick and family leave, are ongoing and were extended by legislation on March 11, 2021.
Under the most recent ERC legislation, employers can claim a refundable tax credit for their share of Social Security taxes on up to 70% of eligible employee's wages (for a maximum credit of $7,000 per employee per quarter). This applies to wages paid after December 31, 2020, through June 30, 2021. Employers can access these credits immediately by reducing their employment tax deposits accordingly. These perks are in addition to a deferment of employment taxes offered in 2020 under the CARES Act.
The most recent legislation on sick and family leave credits allows employers to receive a tax credit for the sick and family-leave wages paid between April 1, 2020, and September 30, 2021.
If you took unemployment benefits as a self-employed individual in 2020, remember that these benefits are normally taxable. But Congress has made up to $10,200 of unemployment benefits nontaxable for the 2020 tax year for those with modified adjusted gross incomes of less than $150,000. The IRS will recalculate your return if you filed it before this change was made and will issue any resulting refunds in spring and summer of 2021. Each state is taking its own approach to taxing unemployment benefits. Research your state's policy to avoid missteps.
New Business Income Deduction
Business owners (not corporations) in sole proprietorships, partnerships, LLCs, and S corporations can get an additional 20% Qualified Business Income Deduction on their business net income each year. This deduction is in addition to your normal business tax deductions, and it's calculated and included in your personal tax return. There are limitations and qualifications, of course, so check with your tax professional about this.
How Business Tax Refunds Work
The trick to getting a business tax refund is to pay the Internal Revenue Service (IRS) more during the year than your total tax bill. You must be able to estimate the amount of tax you might owe during the year and pay that amount plus more.
Business income is just a part of total taxable income for many business owners, so they 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.
Tax Refunds for Business Types
Most small businesses pay their business income tax through their personal tax return. Sole proprietors and one-owner LLCs complete a Schedule C - Profit and Loss for Business as part of the owner's Form 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.
You might pay tax on your income in one of two ways if you're the owner of a corporation. Corporate owners are shareholders who receive dividends paid out by the corporation. Dividends are taxed to shareholders when they're 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 also pays income taxes.
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.
Tax Refunds for New Businesses
If you started a business during the year, you may be able to take some additional tax deductions for your startup expenses. The IRS considers start-up costs as capital expenses, which means they must be spread out over several years. But you can deduct some expenses in the first year: up to $5,000 of startup costs and up to $5,000 of organization expenses (paying an attorney to create your business document, for example).
Withholding, Estimated Taxes, and Tax Refunds
Employees, including corporate executives who are employees, have federal and state income taxes withheld from their pay. But not all business owners are also 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 usually 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.
The federal government is offering tax relief to anyone in Texas or other states affected by severe winter storms in 2021. Those affected can delay filing 2020 tax returns and paying 2021 estimated quarterly taxes until June 15, 2021. This extension automatically applies to all affected businesses and individuals. The deadline for personal tax returns for all other taxpayers, including the self-employed, was extended to May 17, 2021. Quarterly estimated taxes must still be paid by April 15, however, or penalties will be charged.
Don't Forget Self-Employment Tax
You must pay self-employment taxes on your business income, in addition to income tax, if you own any of the pass-through businesses described above. The self-employment tax is for Social Security and Medicare, and it's paid at 15.3% of your share of the business net income, or the entire business net income if you're a solo business owner.
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 if you want a tax refund.
The CARES Act of 2020 allowed business owners to delay paying 50% of the Social Security portion of their self-employment tax for part of 2020 (from March 27 through December 31). You must pay back the full amount by December 31, 2021, if you deferred paying these taxes. This is a deferral of the tax, not a refund, so you can't get a direct refund if you already paid, but it might reduce your overall taxable income.
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 every quarter and look at your business and personal income for the year and plan the amounts of your quarterly estimated payments.
Tax preparation software companies might also 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 who can review your business and personal tax return for any items you might have missed.
The IRS has an estimated tax calculation worksheet on Form 1040-ES if you want to calculate estimated taxes yourself.
The Drawback of Tax Refunds
Many people use tax refunds as a means of forced saving. They over-estimate the amount of tax they must pay, in order to get a hefty refund in April. But the drawback to this is that they don't have the use of that money during the year. The IRS is using it for up to 12 months, and taxpayers won't get any interest for what could be thought of as a type of loan.
It's a balancing act—you want to pay enough in estimated taxes and withholding to avoid fines and penalties without paying so much that you have a huge tax refund of money you didn't get to use during the year.
One Final Tip: File Soon to Get Your Refund Fast
The sooner you start working on your 2020 tax return, the better. Learn more about the best time to file to get your refund quickly.