Income Tax on Profits. For the entity types discussed above, profits flow through to the individual’s personal income tax return to be included in determining adjusted gross income on IRS Form 1040.
Self-Employment Tax. An additional tax on profit at the rate of 13.3% (comprised of 10.4% Social Security and 2.9% Medicare). All types of business entities in which the owner shareholder actively participates are subject to the tax, with the exception of corporations or entities that choose to be treated as a corporation for tax purposes.
Sales Tax. The sale of certain non-exempt goods and select services (such as employment, personnel placement, real property maintenance, landscaping and data processing) are subject to a general sales tax of 6%. In D.C., the tax must be collected and remitted on Form FR-800, quarterly or more frequently depending on the tax liability.
Franchise Tax. Unincorporated businesses (sole proprietorships, LLC’s, partnerships) that operate in the District, that are not exempt, must file Form D-30 if their gross receipts are greater $12,000. Generally, you are exempt if 80 percent or more of gross income comes from personal services actually rendered by its owners or members. Corporations pay franchise tax of 9.75% (minimum $250) on Form D-20.
Estimated Tax Payments. Perhaps the biggest tax change for the small business owner who may have been accustomed to receiving a W-2 and having taxes withheld from the paycheck is having to remit quarterly tax payments to the IRS. Generally, the payments must be made in four equal quarterly installments. The taxpayer can avoid penalties and interest for underpayment by having paid in at least 90% of the current year tax owed or 100% of the prior year tax.
Tax Tip: Individuals who receives wages in addition to self-employment income should consider increasing tax withholding on their W-2 to offset taxes due on profits from their practice.
Withholding Taxes. If you have employees, you must withhold from their pay their portion of the Social Security and Medicare taxes, in addition to the withholding for Federal and D.C. income taxes. This amount, plus the employer’s portion of the payroll taxes, must be deposited with the IRS. Depending on the dollar amount of taxes being remitted, the deposit schedule may be quarterly, monthly or more frequent.
Tax Tip: Because the penalties associated with failing to make deposits and making late deposits can be severe, I recommend the use of a professional payroll service, like the kind offered by many banks.