Preparing to File Your Taxes

Some words to the wise when it comes to preparing your tax filings as a small organization. No one likes it, everyone does it, here’s how you can make tax time a little less painful.

Consult A Specialist

Unless you have a lot of experience and are very comfortable filing your own business tax return, I highly recommend consulting someone who does. This should be a CPA, a finance specialist, someone in your network with expertise, or a combination of the three. A CPA can actually file on your behalf because they are certified by state boards of accountancy to do so. Legally, only a certified accountant can charge you for tax advice. A financial specialist can gather, organize, and prepare financial records used in filing your tax return. I often work in coordination with a CPA to help clients through the process. 

Regardless of who you consult, you must still be part of the process. Your advisor(s) will need some detailed information and documentation and probably have follow up questions. Remember those monthly income statements from the ‘Finance Basics’ article? This is their time to shine. Add them all together and you’ve got your annual income statement. Staying organized along the way will save you a lot of time and effort.

However you decide to do it, just be sure to have someone with expertise in your corner. Tax laws and guidelines are incredibly complicated. Whether you are an LLC, 501c3, L3C, or S Corp, you pay taxes, and there are many perfectly legitimate ways to reduce your tax liability. Engaging a specialist might sound expensive, but paying them for their services could easily pay for itself, and give you the peace of mind to know your filings have been done correctly. If you overpay on your taxes it can be a lengthy and difficult process to get that money back; so you want to take every step you can to pay as little as you can, and to get it right the first time.

Deductions & Exemptions

Tax deductions and exemptions reduce your taxable income but in different ways. Deductions, often referred to as "write-offs”, subtract eligible expenses or amounts from your gross income, reducing the amount you are taxed on. Exemptions exclude specific amounts of income from taxation. Let’s explore some common examples for clarity.

As a small business owner or manager you will probably deal more with deductions than exemptions. There may also be some confusion around the difference between a business expense and a tax deduction. It’s tricky because all deductions are expenses but not all expenses are deductions (a square/rectangle scenario). Expenses are any cost incurred in the ordinary course of business operations. Deductions are costs subtracted from the business owner or individual’s income on their tax return. 

For a sole proprietor or owner of a small business, examples of business-related deductions include home office costs, vehicle expenses, insurance premiums, loan interest, depreciation, and legal and professional fees. Examples of personal deductions include certain medical expenses, mortgage interest, charitable contributions, some IRA contributions, and student loan interest.

Tax exemptions for businesses are more limited but some organizations may be exempt from collecting or paying sales taxes (like certain professional services) and some industries may qualify for property tax abatements or incentives for investment in low-income areas or for rehabilitating historic buildings. 501(c)(3) organizations, commonly known as nonprofits, are exempt from income tax - but beware this does not mean they don’t pay other types of taxes! Personal exemptions are far more common. Examples include certain capital gains and interest earned, disaster relief funds, Roth IRA withdrawals (age 60+), a portion of social security benefits, inheritances (up to certain amounts), homestead exemptions, and veteran benefits. Remember all of these (and more) reduce the taxes you owe by excluding some or all of the amounts of these benefits from your taxable income.

Tax Designations

Depending on your business’ elected tax designation you may report your business income and expenses as a part of your personal return or file a separate return. LLCs electing to be taxed as sole proprietorships and partnerships are considered pass-through-entities meaning owners will report business income and expenses on Schedule C as a part of their personal return. LLC’s electing to be taxed as C or S Corps are taxed as separate legal entities from their owners and have their own income tax returns using Form 1120 and 1120-S. Nonprofits do not pay income tax so they do not file a return, instead they disclose financial information to the IRS annually via Form 990. There are pros and cons to each tax designation you might elect for your business; a topic requiring so much relevant information it will have to be another article.

Wrap Up

The tax codes for organizations and individuals are extremely complicated, and this article is just scratching the surface. Having a basic understanding of these principles is critical for any business leader or individual but developing a comprehensive understanding of all the factors is formidable. And there are significant dollars at stake. For these reasons, it’s essential for every small business owner or nonprofit manager to familiarize themselves with the basics. Having a professional to guide you is likely to save you money in the long run. Ask your family, friends, and colleagues if they have a tax professional or financial specialist they like and trust.