A small business requires recordkeeping and payment of taxes. You may be the only employee of a small business, operating as a self-employed independent contractor, but federal income taxes apply to your income. A sole proprietorship is the simplest form of business to set up. You are the owner, and the liabilities of the business are your liabilities. Calculating profit and loss determines income, and you can subtract expenses from income to determine tax liability.
You must pay taxes on the income for a small business. You must also pay self-employment taxes for income in excess of $400 for your small business. If you have an employee, you must withhold federal and maybe state income taxes along with Social Security and Medicare taxes. You pay federal and state unemployment taxes for your employee as well. Self-employment taxes cover your Social Security and Medicare taxes to provide for your future. If you have a sole proprietorship, you file IRS Form 1040, Schedule C and Schedule SE if your net income is greater than $400. Net income is your gross income less expenses incurred in earning the income. Net income determines your tax liability for a small business.
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You can earn $400 in excess of expenses without paying taxes for a small business, but many types of businesses have different limitations. The U.S. tax system requires that you pay as you earn. Most small businesses must file quarterly tax estimates, paying an estimated amount for income and self-employment taxes. If you anticipate you will owe more than $1,000 in taxes, the IRS expects you to make quarterly tax payments. Once you start a small business, you must file a tax return for your business every year, regardless of the profit or loss.
Farming, fishing, government employees, aliens and nonprofit workers have different regulations for self-employment taxes and reporting small business income. Ministers and clergy have special rules for self-employment and small business income. If you work for a church or nonprofit group, you must file a tax return for earnings in excess of $108.28.
You could potentially earn thousands of dollars in a small business and pay no taxes. Your expenses to earn the income may be greater than the income earned. Your Schedule C profit or loss calculations may reflect a loss. If the IRS considers your small business as a hobby, you cannot subtract losses from your other income. You must run a business for profit to deduct losses. The IRS considers a profit for three years out of the last five years as a business, but less than that may turn your small business into a hobby for IRS purposes.