The small business sector has been described as the engine room of the economy, as well as the biggest employer in the country – and it’s not hard to see why. Recent research undertaken by the Council of Small Business Organisations of Australia (COSBOA) showed that small businesses were responsible for generating 5.1 million jobs, or around half of private-sector employment. The Australian Tax Office (ATO) says that there are about three million small businesses in Australia, including primary production concerns, which represents around 96% of all business.
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 might 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.
- 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.
You must be careful when calculating any claims to ensure you follow all rules set by the ATO, and you should note:
- Only functioning businesses qualify (it’s not enough just to be a holder of an ABN number).
- It’s important to understand the tax break. It is not a cash hand-out but a deduction from your taxable profit. If you spend $30,000 on a capital purchase, you will receive a 27.5% (26% from July 1 2020) per cent deduction, which equates to an $8,250 reduction in your tax – so you will still be out of pocket by over $20,000 on the purchase. If it’s something, you were going to purchase anyway, good luck and enjoy the benefit. But if you’ve acquired something, or are planning to acquire something, purely to save tax, you might want to think again. What you gain in the year of purchase will gradually be clawed back through reduced deductions in future years.
- The amount you can claim is GST exclusive. This is relevant if your business is registered for GST and can claim an input tax credit on the purchase. The amount you can claim is the GST exclusive price.
- The asset must have been installed and ready for use. This is particularly important if you purchased the asset just before the end of the financial year. If you purchase it before June 30 but don’t have it available for use until July, you can only claim the deduction against profits in the following year.
- You can claim a deduction for secondhand assets.
- To claim the full deduction, the asset has to be used in the business, and if there has been personal use, the deduction needs to be pro-rated to reflect this.
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 per cent 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
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 quarterly and look at your business and personal income for the year and plan the amounts of your estimated quarterly 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, a 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 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 in 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.
Business Entity Type
When you started your business, you decided what type of business entity to form, which in turn determined the way you’ll pay your small business taxes to the IRS and state.
Many small businesses elect to form entities that pass their income through to the owners. The owners are then taxed on their individual income tax returns. Because these types of entities pass the taxable income to the owners, the businesses don’t pay the tax directly to the IRS. They, therefore, would never receive a business income tax refund.
Types of entities that pass their income through to their owners include:
- Sole proprietorship: Single-owner business that reports their income and expenses on the owner’s individual tax return (Form 1040), using a Form Schedule C.
- Partnership: An unincorporated business with two or more owners; files a Form 1065 and issues Forms K-1 to the partners, who include the income and pay tax on their individual returns.
- S-corporations: A corporation that has elected to pass the taxable income from the business through to its shareholders. The S-corp files a Form 1120S and issues a Form K-1 to each shareholder, who then reports the income and pays tax on their individual returns.
- Limited liability company (LLC): Business owners who report income from pass-through companies include the income (along with income from other sources, like wages, interest and dividends, gains on the sale of property or rental income) on their individual 1040s. These individual owners would receive a refund only if their total payments and withholding exceed their total tax liability on the return.
The only type of business entity that can receive a tax refund is a C-corporation. What distinguishes a C-corporation from other business entity types is that its profits are taxed separately from its owners under subchapter C of the Internal Revenue Code. In other words, a C-corporation pays income tax directly to the taxing authorities (using Form 1120). Because of this, a C-corporation could receive an income tax refund if it pays more estimated tax during the year than is due on the final return.
This return would be reflected on the owners, partners, or shareholders’ personal returns based on their total income.
The type of taxes you pay could also result in a tax refund for your business. Let’s take a look at some situations where a business could potentially receive a refund.
- Income taxes: C-corporations is the only business entity that would receive a refund of income tax as discussed above. The owners, partners, or shareholders would receive a refund on their personal returns based on their total income.
- Payroll taxes: Regardless of entity type, if your business withholds and pays payroll taxes, you might receive a refund if your account is overpaid. Some restaurants may also receive a tip credit, which is a tax credit that an employer can claim to recover FICA taxes paid on tips received by employees. The tip credit can be used to reduce the income tax owed by the employer, which could result in a refund.
- Sales or excise taxes: Most businesses are subject to excise or sales taxes, which are typically assessed by states or municipalities. In some cases, either an overpayment of these taxes or reassessment of the property value could result in a refund to your business.
Generally speaking, if you’ve paid more than your actual tax liability, you’re due a refund. But keep in mind that business taxes can be complicated. If you are unsure of how your business is being taxed or whether you should be getting a tax refund, you should find a qualified tax preparer, such as a certified public accountant (CPA) or enrolled agent, to help you.
How to Maximize Your Tax Refund
Many taxpayers deliberately have more tax withheld from their paychecks than is necessary to get a large refund each spring. However, overpaying on your taxes as a small business owner reduces the working capital needed to run your business day-to-day. There are better ways to ensure you get a nice refund each spring. Here are a few suggestions:
Review Personal Bank and Credit Card Statements
Although you should never mix business and personal finances, chances are you may have used your personal bank account or credit card to make a business-related purchase throughout the year. This is why we encourage you to take the time to review your personal bank and credit card statements in order to spot business expenses you may have otherwise missed. Your business accountant should know how to record these expenses in your books so that they can be reflected on your tax return as a business expense.
Prepay Upcoming Expenses
If you have enough cash flow, you might want to consider prepaying upcoming expenses for the year like membership dues, insurance plans, and IT services. Prepaying these costs can result in cost savings in addition to minimizing your taxable net income for the year.
Check for Tax Credits
There are a number of tax credits available to businesses, including federal and state credits. Taking the time to learn about tax credits your business may be eligible for is a great way to make sure you receive the most money back on your tax refund. Be sure to consult with your accountant about any credits you may be entitled to take, either for the current year or future years.
Offer 401(k) Matching
If you offer a 401(k) plan to your employees, consider offering matching, as well. The amount your company matches for retirement contributions is also a qualified business expense under most circumstances. Also, it’s a nice thing to do for your employees!
Speaking of being nice to your employees, we recommend offering incentives like bonuses, gifts, and awards. This isn’t just good from an employee-employer perspective, and incentives can also be tax deductions. To create incentives that can also serve as tax deductions, review the IRS’s guide to fringe benefits.
Home Office Deduction
If you’re a small business owner, chances are you have to work even when you are at home. If you have an office in your home, you may be eligible for a home office deduction—allowances based on the square footage of your office space. You may also be able to claim a portion of your homeowner’s insurance, utility expenses, and depreciation of your home as business expenses.
Do you have to travel a lot for business? Keep track of your business mileage. In 2019, the standard mileage rate for business was $0.58 per mile. Therefore, if you travelled 100 miles per week for business, at the end of the year, you could get a deduction of $3,016 on your taxes. If you need help tracking business mileage, some business expense tracker apps will automatically update your mileage logs.
Getting the Most Out of Your Tax Deduction
To bring this full circle, not every business can get a tax refund. However, small business owners who don’t qualify for a business tax refund could still see the money back on their tax return. There are also many steps you can take to increase the amount of money you get back on your return, such as prepaying expenses and keeping track of tax credits you are eligible for. As with all things tax-related, to get the most bang for your buck we recommend working with a qualified tax preparer, such as a CPA or enrolled agent, to help you.
Can an LLC Get a Tax Refund?
The IRS treats LLC like a sole proprietorship or a partnership, depending on the number of members in your LLC. This means the LLC does not pay taxes and does not have to file a return with the IRS. If you’re the sole owner of your LLC, you must report all profits (or losses) of the LLC on Schedule C and submit it with your 1040 tax return.
Payments based on estimated taxable income
If you’re certain your net income will be less this year than last year, you’ll pay less estimated tax if you base your tax on your taxable income for the current year instead of basing it on last year’s tax.
The problem with using this method is that you must estimate your total income and deductions for the year to figure out how much to pay. This can be difficult or impossible to compute accurately. And there are no magic formulas to look to for guidance. The best way to proceed is to sit down with your tax return for the previous year.
Take comfort in knowing that you need not make an exact estimate of your taxable income. You won’t have to pay the penalty if you cover at least 90 per cent of your tax due for the year.