Do businesses get tax refunds? The short answer is yes, but the process of getting a refund is dependent on a number of factors, including the type of business entity, the amount of taxes paid, and the types of tax deductions claimed. Here, we'll discuss how business owners get tax refunds, give you advice on increasing your refund, and provide tips for spending your refund wisely.
Business Entities + Taxes: What You Need to Know
A business entity refers to the legal structure of a business. The most common types of business entities are sole proprietorships, partnerships, limited liability companies (LLCs), S Corporations, and C Corporations. Each entity type has its own advantages and disadvantages, and the tax implications vary depending on the business entity type chosen.
Sole proprietors and partnerships are not separate legal entities from their owners, meaning both the income and losses of the business are reported on the owners' personal tax returns.
LLCs, S Corporations, and C Corporations are separate legal entities from their owners and provide limited liability protection to separate business assets from the personal assets of the owners, members, and shareholders.
Here's a breakdown of the tax implications for each entity type:
- Sole proprietorship: Income and losses are reported as personal income. The business owner is responsible for paying self-employment taxes on the business income.
- Partnership: Income and losses are reported as personal income for each partner. The business itself does not pay taxes.
- LLC: An LLC can choose to be taxed as a sole proprietorship, partnership, or S Corporation where income and losses are reported as personal income, or as a C Corporation where double taxation applies (the business pays corporate tax on income, and the owners pay personal tax on dividends).
- S Corporation: An S Corporation is taxed similarly to a partnership or LLC, where income and losses are reported on the shareholders' personal tax returns. S Corps don't pay corporate tax.
- C Corporation: A C Corporation pays corporate taxes on its income, and the shareholders pay personal income taxes on any dividends they receive.
Pass-through taxation refers to the taxation of business income at the individual level rather than the business level. This means that any income or loss the business faces "passes through" to the owners' personal tax returns. Sole proprietors, partnerships, LLCs, and S Corporations all use pass-through taxation.
For example, let's say a restaurant's owner and head chef form an LLC — which would be considered a multi-member LLC — where they've outlined a 51% stake and a 49% stake, respectively.
Say the business does well, and the income received from countless happy patrons is calculated as business income (separate from the owners' personal finances). At tax time, both the owner and the chef report their share of all of the business income on their personal income tax returns.
If the restaurant made a net profit of $400,000 after expenses, the first owner would claim $204,000 on their personal income tax return (51%), and the chef would claim $196,000 (49%). Each would pay personal income tax on their declared income amount. However, the LLC itself does not pay separate business income taxes as it is not registered as a corporation.
Types of Business Tax
Small and medium-sized businesses (SMBs) have a lot of different taxes to pay in order to do business in the United States. If you're just starting out or need to gain a better understanding of your tax obligations, you're not alone.
Here are some of the most common taxes that small and medium-sized businesses are responsible for paying:
- Income tax: A tax on the income earned by both individuals and businesses.
- Self-employment tax: A tax paid by those who work for themselves, which is equivalent to the Social Security and Medicare taxes that are withheld from traditional employee paychecks.
- State franchise tax: A tax on income that is levied by some individual U.S. states on top of federal income tax, typically for the privilege of doing business in that state.
- Sales and use tax: A tax on the purchase of goods and services, which is typically a percentage of the sale price and is paid by the buyer.
- Payroll tax: Taxes including federal income tax (withheld from employees), federal unemployment tax (paid by employers), and FICA taxes for Social Security and Medicare programs (paid by both employees and employers).
- Property tax: A tax on the value of real estate and other types of property, which is paid by the owner of the property.
- Excise tax: A tax on specific goods or services, such as gasoline, tobacco, alcohol, and airline tickets.
Small Business Tax Rate
The small business tax rate varies depending on the legal entity type in question and the amount of income the business earns. Sole proprietors and partnerships are not taxed as separate entities; therefore, income is reported on the owners' personal tax returns and the tax rate is based on the owners' individual tax brackets.
For LLCs, S Corps, and C Corps, the tax rate depends on the federal corporate tax rate (which is currently 21%) and state corporate tax rates levied by the state where the business is registered. Most states (but not all) tax corporations on their business income, so it's important to review the requirements for your specific state to understand your tax obligations.
Several factors can affect the small business tax rate. For example, if a business owner invests in assets that qualify for accelerated depreciation, the business may be able to reduce its taxable income and, therefore, its tax liability. On the other hand, Social Security taxes can be a significant expense for small business owners, who are responsible for paying both the employer and employee portions of the tax.
Working with a tax professional can help small business owners identify all possible deductions and credits to ensure they're taking advantage of all available tax-saving opportunities.
How to Increase Your Business Refund
There are many ways you can increase the tax refund your business receives. By taking advantage of as many opportunities as possible, you may be able to generate an annual surplus that can be used to further your business goals.
Keep Accurate Records
Keeping accurate records of your income and expenses is important for several reasons, including the ability to identify all possible tax deductions and credits your business is eligible for. This includes keeping receipts, invoices, and bank statements to support your claimed deductions when filing your taxes.
Deductions and credits refer to any expenses or financial activities that are eligible for tax relief, which can help lower your overall tax bill and increase your return.
Maximize Your Deductions
Writing off legitimate business expenses is an essential part of reducing your tax liability and getting the biggest tax refund, especially if you're self-employed. Common deductions include the following:
- Office supplies and equipment, such as computers, printers, and software
- Rent or lease payments for office space or equipment
- Business-related travel expenses, such as airfare, hotels, and meals
- Advertising and marketing expenses, such as website design, business cards, and brochures
- Professional development or education expenses, such as training courses, conferences, and seminars
Claim Available Tax Credits
Tax credits are a type of tax incentive that can help reduce your tax liability and increase your return. Unlike deductions, which reduce your taxable income, tax credits serve as a direct reduction of your tax bill. Common tax credits include:
- Research and Development (R&D) Tax Credit, which is available to businesses that invest in research and development activities.
- Work Opportunity Tax Credit, which is available to businesses that hire employees from certain targeted groups (think veterans, ex-felons, etc.).
- Small Business Health Care Tax Credit, which is available to businesses that provide health insurance to employees.
- Energy Efficiency Tax Credits, which are available to businesses that invest in energy-efficient equipment or renewable energy systems.
To determine the tax credits for which your business may be eligible, it's important to research the various options and consider consulting with a tax professional who can help you determine which credits to apply for.
Take Advantage of Depreciation
Depreciation is a tax deduction that allows businesses to recover the cost of certain purchased assets over time, such as equipment, vehicles, hardware, office furniture, and more. The depreciation deduction is intended to reflect the wear and tear of these assets as they are used in the business over time. Depreciation allows you to lower the taxable income for your business and, in turn, your tax liability.
Instead of deducting the full cost of an asset in the year it was purchased, you can spread the deduction over the useful life of the asset. For example, let's say your business purchases a computer for $1,000. If you estimate the useful life of the computer to be five years, you can deduct $200 per year ($1,000 divided by 5) as a depreciation expense on your tax return. This reduces the taxable income of your business by $200 each year for five years.
Donate to Charity
Charitable donations are a great way to support causes that you care about while also potentially lowering your tax burden. When you make a donation to a qualified charity, you may be eligible to deduct the donation on your tax return, reducing your taxable income and lowering your overall tax liability.
Qualified charities include organizations that are recognized as tax-exempt by the Internal Revenue Service (IRS) and may include nonprofit organizations, religious institutions, and some government entities.
Contribute to Retirement Plans
Contributing to a retirement plan can be a smart way to save for retirement and potentially reduce your tax liability along the way. Many retirement plans, such as a 401(k) or IRA, offer tax benefits that can help increase your return.
Consider a Home Office Deduction
If you work from home, you may be able to deduct a portion of your home expenses from your tax obligations. To qualify for the home office deduction, you must use a specific area of your home regularly and exclusively for work. This can be a dedicated room or a portion of a room that is used only for performing your business tasks.
If this is the case, you can deduct a portion of your home expenses, such as rent or mortgage payments, internet and phone bills, property taxes, utilities, and even home maintenance costs. The amount you can deduct is based on the percentage of your home used for your business.
Review Your Estimated Tax Payments
As a self-employed individual or business owner, you are responsible for paying estimated taxes throughout the year. Estimated taxes are typically paid quarterly and are based on the income you expect to earn for the year.
Making the correct estimated tax payments throughout the year can help you avoid penalties and interest charges from the IRS, as well as avoid the stress of underpaying your estimated taxes, which can lower your return amount.
Seek Professional Advice
A knowledgeable tax professional can help you identify which deductions and credits are available to you, determine the correct amount of estimated taxes you should be paying, help you estimate your total income and deductions for the year, and calculate your tax liability based on those estimates.
10 Smart Ways to Spend Your Refund
So, do businesses get tax refunds? Yes — but how should you spend your refund once it arrives? Many people spend their personal tax refunds on vacations, new items for their homes, or completely frivolous purchases (retail therapy, anyone?). But your business refund is different. If you want to spend it wisely, you have multiple options:
- Invest in a new business: If you're looking to expand your business or start a new one, use your tax return to invest in a new venture.
- Invest in reskilling: New skills can help you increase your income and advance in your career. Consider using your tax return to take classes or enroll in a certification program.
- Start an emergency fund or refill your savings: A solid emergency fund can help you navigate unexpected financial challenges. Consider using your tax return to start or refill your emergency fund.
- Pay off high-interest debt: High-interest debt can be a major drain on your finances. Consider using your tax return to pay off high-interest debt such as credit cards.
- Reinvest to grow your business: Reinvesting in your business can help you grow and increase your earning potential for the future.
- Spend on home improvements: If you own a home, use your tax return to make home improvements, increase the value of your home, and potentially provide a return on your investment when you decide to sell.
- Invest in something frivolous: While it's important to be responsible with your finances, it's also important to enjoy the fruits of your labor. Consider using a portion of your tax return to indulge in something frivolous that brings you joy. If you spend it on a business vacation, you may even be able to deduct it!
- Set your children up for financial success: Use your tax return to invest in your children's education or add to their savings accounts, setting them up for a brighter financial future.
- Invest in upskilling: Similar to reskilling, upskilling is the enhancement of your existing skills and knowledge through continuous learning.
- Pay it forward: Consider using your tax return to make a charitable donation or support a cause you believe in. Not only does this help others, but it can also provide tax benefits.
Business Tax FAQs
Will I Get a Tax Refund if My LLC Loses Money?
Do businesses get tax refunds when they lose money? How much do you get back on taxes for a business loss? When a business incurs a loss, it may be able to deduct that loss. If the business has other sources of income, such as capital gains or rental income, the loss can be used to reduce the tax liability on that income. If the loss is greater than the business's other sources of income, the excess loss can typically be carried forward to future tax years.
How Do I Get a Tax Refund for a Small Business?
Getting a tax refund for a small business can depend on several factors, including the type of business entity, the business's income and expenses, and the deductions and credits available to the business.
As mentioned above, you can increase your return by keeping accurate records, maximizing your deductions, claiming available tax credits, taking advantage of depreciation, donating to charity, contributing to retirement plans, considering a home office deduction, reviewing your estimated tax payments, and seeking professional tax advice.
What Are Estimated Tax Payments, and When Are They Due?
Estimated tax payments are quarterly payments made to the IRS and state tax agencies to pay taxes on the income you estimate your business will earn for the year. These tax payments are due on April 15, June 15, September 15, and January 15 of the following year.
How Long Do I Need to Keep My Business Tax Records?
You should keep your business tax records for at least three years from the date you filed your tax return in case your business is audited or you need to go back through your records to submit deductions that were missed.
What Is the Difference Between a Tax Deduction and a Tax Credit?
A tax deduction is a specific expense or category of expenses that can be subtracted from your taxable income. This reduces your overall taxable income, reducing the amount of taxes you owe. A tax credit is a dollar-for-dollar reduction in your tax liability. This means that the value of the credit is subtracted directly from the amount of tax you owe.
It's no secret that business taxes can be complicated, and it's essential to work with an expert to ensure you're taking advantage of the tax-saving opportunities available to you. By following the tips above, you may be able to increase your business refund and have a better idea of how to spend it wisely. Incfile supports small and medium-sized businesses with stress-free accounting and bookkeeping services to help you navigate the complex world of business taxes.