When tax season rolls around most small business owners feel uneasy about their tax preparation. Figuring your business taxes yourself may seem scary, but it’s usually doable. If you keep records of your income and expenses throughout the year, you use them to figure your net taxable income.
What is Taxable Income?
The dictionary defines income as money received, especially on a regular basis, for work or through investments. The two basic types of income are earned and unearned income
Earned income includes money you receive from an employer in exchange for your work or money you make working for yourself. Unearned income includes money you didn’t directly work for, such as interest and dividends, Social Security payments, alimony, etc.
Earned income is the money you earn from working. It includes wages, salaries, tips, and net earnings from self-employment income. It also includes union strike benefits and some types of long-term disability benefits. Unearned income includes things like annuity payments, pension income, distributions from retirement accounts, capital gains, interest income, dividends, passive income generated from rental real estate, alimony, stock dividends, and bond interest.
What Types of Income Must You Pay Tax On?
• wages, salaries, tips, bonuses, vacation pay, severance pay, commissions
• interest and dividends
• certain types of disability payments
• unemployment compensation
• jury pay and election worker pay
• strike and lockout benefits
• bank “gifts” for opening or adding to accounts if more than “nominal” value
• cancellation of debt (unless excludable by law or regulation)
• alimony
• recoveries of items deducted in the previous year
• gain from the sale of property, stocks and bonds, stock options, etc.
• pension and annuity distributions (amounts not contributed by taxpayer with after-tax dollars)
• traditional IRA distributions (amounts deducted in prior years)
• rental income, farm income, business income
• royalties
• trust/estate income, Partnership/S-corporation income
• executor’s commissions
• Social Security benefits (above the base amount)
• notary fees
• most court awards or damages
• fees or property received for services or barter income
• prizes, awards, gambling winnings, and illegal income
• certain scholarships, fellowships, and grants
What is considered Non-Taxable Income
• gifts and most inheritances
• life insurance proceeds
• child support
• certain veteran’s benefits
• dividends on veteran’s life insurance loans
• insurance reimbursement of medical expenses not previously deducted
• welfare payments
• compensatory damages for personal physical injury or physical illness
• workers’ compensation
• some qualified pension distributions for Public Safety Officers
• income from qualifying scholarships
Why Taxable Income is Important
While you are preparing your taxes, figuring out your taxable income will help determine how much income tax you are responsible to pay. Since the federal tax system is progressive, your tax rate generally increases as your income increases.
Marginal tax rates determine how taxable income is taxed and those who pay income taxes are divided up into different ranges known as tax brackets. Income in each bracket is then taxed at a specific rate.
How Does Taxable Income Affect Your Refund
Since a portion of your paycheck goes toward federal taxes there is a chance you paid more federal income tax than you owe based on your taxable income. If this happens you will receive a refund. The more tax you overpaid the bigger your refund.
How to Calculate Taxable Income
1.Determine Gross Sales
Total sales are the gross income of the company for the particular tax year. Depending on the industry, the company may have sold products, leased equipment, licensed intellectual property, charged interest, or billed for fees which all equal gross revenues.
2. Determine Cost of Goods Sold
Your company needs to calculate the cost of goods sold and report it for the determination of gross profit in tax reporting. If the company does not sell products, ignore the cost of goods sold since its operating costs will be reflected elsewhere on the tax return.
3. Itemize Typical Business Expenses
Two IRS forms, 1120 and 1065, call for itemized reporting for specific categories of business expenses. These expenses typically include salaries and wages, repairs and maintenance, bad debts, rent, taxes, interest and depreciation, and more.
4. Calculate Depreciation
For a number of different reasons, there are various depreciation methods for classes of property that allow for different periods over which business equipment and vehicles may be depreciated. In order to promote investment in new equipment, these special deductions allow immediate or accelerated depreciation.
5. Calculate Taxable Income
Taxable Income is calculated by simply subtracting COGS, deductions for ordinary and necessary business expenses, and depreciation from gross income. It is important to note that taxable income may not always be positive, as a company can show a loss that may result in a tax deduction for its owners.
Final Thoughts
Tax code and laws and its complexity are ever-changing, and it is advisable to consult with a professional tax consultant or professional to ensure all appropriate deductions have been made.
Limitless Investment and Capital Tax Preparation Services
The new tax reform law increases both the complexity and potential opportunity in your tax planning. Limitless Investment and Capital leverages its deep tax and industry experience to look in broad scope and great detail at your business so you can navigate the changing path ahead. Our CPA’s, Enrolled Agents and Tax Advisors provide a combination of advisory services, insights, and technologies, help you understand your starting position, model the tax impact of new and amended provisions, analyze your options, and plan and execute your next steps.
Feeling uneasy about your taxes? Get in Touch Today!