Tax Guide for Small Businesses

Running your own jewelry business is fun but challenging; fortunately, the IRS allows you to take some credits to lower your tax burden.
Running your own jewelry business is fun but challenging; fortunately, the IRS allows you to take some credits to lower your tax burden.
© Kevin Dodge/Corbis

Small businesses play a huge role in the United States economy. According to Census Bureau data, 98 percent of the more than 28 million businesses in America have fewer than 20 employees [source: SBE Council]. Small businesses produce 46 percent of the U.S. Gross Domestic Product and accounted for 63 percent of net new job creation between 1993 and 2013 [sources: SBA, SBA].

Small businesses must pay taxes just like individual workers or large corporations. The simple story is that small businesses pay taxes on their net profit; that's the sum of all business earnings minus normal businesses expenses. Depending on the size and nature of the small business, figuring taxes can be straightforward or highly complex. This article will give you a strong foundation for understanding the types of taxes that small businesses pay and ways to lower the tax burden.

First, what is a small business? The U.S. Small Business Administration categorizes all business with fewer than 500 employees as small businesses. For tax purposes, though, we're going to narrow that definition to exclude all corporations. Corporations follow a separate set of tax rules from unincorporated businesses. A more useful definition of a small business, for tax purposes, is any business venture that requires the owner to file a Schedule C — "Profit or Loss from Business" — with the IRS.

The following types of small businesses are required to file a Schedule C [source: IRS]:

  • Self-employed – also known as an independent contractor, this is a business owner who supplies services to other businesses or clients
  • Sole proprietorship – a business owned by one person (with or without other employees)
  • Limited liability company (LLC) – only one member is taxed using a Schedule C
  • Qualified joint venture – spouses who own and operate an unincorporated business without any other employees; if they have employees, it's a partnership, which requires a different tax form

A small business doesn't have to be a taxpayer's only source of income. You can have a salaried position as a middle manager, but also sell handmade sweaters online. The sweater website qualifies as a small business as long as your intention is to make money. If there's no intention to make money — you give the sweaters away as gifts or donate them to a homeless shelter, for example — then it's a hobby, not a business. The IRS doesn't tax hobbies; not yet, at least.

Keep reading to learn what kind of business income is taxable.