Thinking about starting your own business?
Small business is the backbone of the American economy. But it comes with its own set of rules and laws. As a new business owner, know the difference between business and personal taxes.
Business taxes depend on the type of business you own and how you use deductions. A successful business owner knows how to use deductions to save on tax money.
Personal taxes are about the amount of income you receive from different sources and how you use personal deductions to your advantage.
Read on to learn more about the differences between personal taxes and business taxes.
Your Personal Taxes
Every person with a taxable income in America must file a personal tax return. This is Form 1040. The 1040 has several categories of income and deductions.
If you work for someone else, your income comes in the form of wages. To report this, you’ll receive a form from your employer called a W-2.
Interest and Dividends
Another source of personal income is interest and dividend income. Interest income is income made from investments. This includes loans you make to others and collect interest on.
Dividend income is money you make from ownership in stocks or companies.
Rental and Business Income
Rental income is exactly as it sounds: income you make from rental properties. And if you own a small business, you may file what’s called a Schedule C. This is your personal business income.
Note, we’ll discuss corporate business income later. But if your business is not a corporation, you claim the income on your personal tax return.
Like with a corporation, your Schedule C has gross sales, cost of goods sold (COGS) and operating expenses. Sales minus COGS and operating expenses equal net income.
If you work as a contractor or freelancer, you receive income from other companies. You report this income on a Form 1099 for miscellaneous other income.
Now that you’ve totaled your income, the next step is to take personal tax deductions. Here are some of the most common personal tax deductions:
- Mortgage interest
- Health savings account contributions
- Student loan interest
- Child tax credits
- Medical expense
- State and local taxes
- Charitable contributions.
Personal Tax Rates
After you take your deductions, you’re left with Adjusted Gross Income (AGI). This is the income you use to figure out how much you owe in taxes.
Tax rates vary depending on your AGI. The lower your personal income, the lower your tax bracket.
Here’s a list of the tax brackets from the 2017-2018 tax year. These tax amounts change depending on the tax laws in place at the time.
Your Business Taxes
Now that we’ve covered the types of income and deductions you file with personal taxes, let’s take a closer look at business taxes.
As we mentioned earlier in the article, you can file business taxes on your personal tax return. But that depends on the type of business you have.
The Four Types of Businesses for Tax Purposes
1. Sole Proprietorship
A sole proprietorship is the type of business filed on a schedule C of your personal tax return. The income is considered personal income.
2. S Corporation (S Corp)
An S Corp files a separate tax return called a Form 1120S. This entity doesn’t pay taxes on its own. The income from an S Corp flows through to your personal tax return and considered personal income.
3. General Partnership
This type of business is like an S Corp in that the income flows through on your personal tax return. But it has a different business tax filing form called Form 1065.
4. C Corporation (C Corp)
The C Corp files taxes on a Form 1120. This entity is separate from its owners. A C Corp pays taxes on its own, taxed at the corporate tax rate.
How you choose what type of business you run depends on your tax accountant. It also depends on your industry and what tax laws are a better benefit to your business.
No matter the type of entity, you’ll report income, expenses, and other tax deductions on your tax forms.
One way that personal and business taxes differ is by the deductions. Businesses have a wider range of deduction options. This includes the following:
- Labor expenses, salaries, and wages for employees
- Car, truck, and travel expenses
- Depreciation and amortization
- Rent and utilities
- Marketing and advertising expenses
- Mortgage interest and interest on equipment debts
These are a few of the ways businesses lower their taxable income with deductions.
Business Tax Rates
Like with personal tax rates, business tax rates differ depending on the tax laws in place. In the past, there have been different tax rates for different business income brackets. But in 2018, it changed to a 21% flat tax rate for all C Corp income.
All other types of businesses are taxed at personal tax rates.
It is important to note that business owners are responsible to pay their own taxes. This is not usually the case with personal taxes.
If you earn a wage from an employer, that employer can withhold taxes for you. But with a business, you’re also responsible for social security, Medicare, and unemployment taxes.
Understanding Your Tax Situation
Owning your own business is a great accomplishment. But it comes with its own set of rules and laws. As a business owner, it’s important to know these tax laws.
Business taxes differ from personal taxes in many ways. They file differently, operate under different rates, and include more deductions. Discuss these issues with your tax adviser to be sure you’re doing everything the right way.
For more information on business taxes, check out our business tax blog. We’ve got everything you need to know about taxes and tax relief.