As tax time approaches, many small business owners are scrambling to try and figure out if/how they might receive a tax refund for the 2020 tax year. Given the situation concerning the pandemic and several laws that have been passed as a result, some things concerning your business taxes may have changed. In this article we look at how a small business owner might get a tax refund and some of the recent tax law changes that could affect you.
Tax Law Changes
Some of the more recent changes that could potentially impact your small business and your tax returns involve a reduction in income tax rates. This year there’s been a small business tax deduction incorporated into the tax code; additionally, the depreciation deductions on equipment and vehicles have increased. That said, there are some deductions that have been removed altogether, such as that for entertainment expenses.
Also, keep in mind that as 2020 saw numerous PPP loans go out, if in fact you applied for a PPP loan and then received loan forgiveness this could affect your business tax refund and whether or not you do receive one for the 2020 tax year. Congressional legislation also extended the employee retention credits and those credits applicable for family leave at the end of 2020. As of the most recent update, employers can get a tax credit for any sick and family leave wages that were paid between Apr. 1, 2020 and March 31, 2021.
2020 also saw many self-employed individuals take an unemployment benefit given the situation surrounding the pandemic; such benefits do become taxable to you. And if you failed to withhold taxes in 2020, you could very well owe upon filing your tax returns this year.
Getting a Tax Refund When Filing Your Returns
One of the surefire ways to get a tax refund when you file is to pay more throughout the year than your typical tax bill. So for example, small business owners will often pay estimated taxes throughout the year. If you can pay more than what you estimate your tax bill to be, you are more likely to receive a tax refund upon filing. Remember, when calculating estimated taxes factor in all relevant income sources, not solely business income. This will give you a more accurate understanding of what your tax bill actually is for that quarter.
In terms of receiving a tax refund, this will depend upon a couple of factors. The type of business entity you have is one determining factor. And your ownership in the company will also impact how/if you get your tax refund. If for instance, you are a sole proprietor, you will pay any business income tax through your personal returns as you are considered a pass-through entity. You will fill out form 1040 as well as a Schedule C showing your company’s profit and losses for the year. This will determine whether you pay income tax or receive a tax refund.
For partnerships, multiple-member LLCs and S Corps, you will also have your portion of any business income earned incorporated into your personal returns. As an owner, you will receive a Schedule K-1 which shows your portion of the business income to be reported on your personal returns.
Corporations on the other hand work a bit differently. As an owner you are also considered a shareholder, you will thus receive dividends from the corporation. You will then be taxed on these dividends on your personal tax returns. The corporation also has to pay business income tax, separate from what the owners pay on their personal returns.
So basically, any and all income from your pass-through entity, corporate dividends, or if you take home a paycheck as an employee of the company, will need to be included on your personal returns.
If You Are a New Business, Will You Get a Tax Refund?
Because you are a startup, there are additional deductions that may be applicable to your company and can therefore be applied to your 2020 tax returns possibly helping you receive a tax refund. Keep in mind, startup costs are generally categorized as capital expenses and so they need to be spread out over a few years. There are some deductions though that you can take immediately such as, for example, if you paid a lawyer to generate startup documents, this can usually be deducted in that first year.
Understanding Estimated Taxes and Tax Refunds
If you are an employee of a company or are an executive who takes a paycheck from the corporation, you most likely have state and federal taxes withheld from that check. If however, you are not technically an employee of your company and consequently do not receive a paycheck, then you are not having your taxes withheld. This is why you are required to pay estimated taxes on a quarterly basis throughout the tax year. These dates are usually April 15, June 15, September 15, and January 15. You need to calculate your business income from the three months prior and pay taxes based on your income tax rate. If you underpay, you could face penalties and fines, so it is important to try and make all estimated tax payments.
Additionally, if yours is a pass-through entity, you also need to pay self-employment taxes on income earned, on top of the actual income tax that you will have to pay. Self-employment tax represents taxes for Social Security as well as Medicare. If you are a sole business owner, you will pay 15.3% of your entire business’s net income for the year.
If you are hoping to get a tax refund, the one thing you absolutely have to do is to ensure you are paying enough in estimated taxes (if not more) and also be sure you are factoring in what you will owe in self-employment tax when paying estimated taxes.