Hello, I’m Phyllis Grimes, with a reenactment of an IRS National Phone Forum from May 2008, titled “Calling All First Time Schedule C Filers.”
One of the biggest challenges faced by people starting out in business is understanding and meeting your tax filing requirements. It’s a new, different and potentially overwhelming experience. We want new small business owners to know that the IRS has resources to help you learn about your federal tax responsibilities and avoid common pitfalls.
In an effort to simplify the process for new businesses and encourage businesses to start off on the right foot, thus promoting future growth, the IRS identified a need to improve educational outreach to the first time Schedule C filer community -- new filers as well as those who have been in business three years or less. At the completion of this presentation, we hope you will have a good understanding of a Schedule C business, receive information that will guide you in avoiding potential tax issues, and lead you to resources that will provide relevant and useful information.
As you view this program, it will be helpful if you have a copy of Schedule C to refer to. You can download one from our Web site, IRS.gov. Also, depending on your business requirements, there are other forms and publications you may need, or that you may find helpful. You will not need to have these handy during this presentation, but you may want to make a note of them and download them later. Most are also available in Spanish.
You can find all the forms and publications you need – including Schedule C – at IRS.gov/smallbiz – with a “Z.” Click on “Self-Employed Individuals” to find our Tax Center for Schedule C filers. You can scroll down to “Essential Forms and Publications” to download Schedule C. If you need to, you can pause this program and open a new browser window to find the form.
In this presentation, I will be discussing:
- What a Schedule C is;
- Some basic tips to help new business owners avoid potential problems; and
- Resources for additional information
What is a Schedule C?
If your business is a one-owner business and your business is not incorporated as a C-corporation or S-corporation, you are a Schedule C business. In addition, a one-member Limited Liability Company, or LLC, which is not established as a corporation, will be filing its tax return as a sole-proprietor Schedule C taxpayer.
Let’s take a look at the Form 1040, Schedule C.
Schedule C, “Profit and Loss From Business,” is used to report the business income and expenses for a sole proprietor. On the Form Schedule C in Part 1, lines 1-3 you will report gross receipts earned during the tax year. If your business maintains an inventory for re-sale to customers, or manufactures products for sale, you will report Cost of Goods Sold in Part 1, line 4. The actual computation is reported on page 2, Part 3. In Part 2, lines 8-27 you will report allowable business expenses. The net profit or loss calculated on line 31 is also reported on your Form 1040, line 12, to be included in your gross income, and on Schedule SE, for the computation of Self-Employment Tax. Since the Schedule C net profit or loss is reported on your Form 1040, Schedule C will need to be filed with the Form 1040, which is normally due by April 15th. It is very important to keep good books and records to identify sources of receipts, taxable versus nontaxable, keep track of all deductible expenses, prepare your Schedule C, and support all items reported on the tax return.
We have 7 basic tips for new business owners, to help you avoid potential problems. We will discuss worker classification, depositing trust fund and employment taxes, making your estimated tax payments, and filing and paying all your taxes electronically.
Preparing your Schedule C requires that you maintain good records, and equally important: you must protect both your financial and tax records, so we’ll discuss those important actions. Finally, you might consider hiring a tax professional to help you, and we have some advice for choosing one.
1. Classify workers properly
As you operate your Schedule C business, you may need to hire others to help you. It is critical that you, the employer, correctly determine whether the individuals providing services are employees or independent contractors. If it is determined that the individuals are employees, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. If they are independent contractors, you do not generally have to withhold or pay any taxes on payments. It is important to properly classify your workers from the beginning. If you treat the workers as independent contractors and later it is determined that they should have been treated as employees, it can be costly to you, meaning additional taxes, penalties, and interest.
Let’s take a brief look at each category and some factors you look at in determining whether workers are employees or independent contractors.
Facts that provide evidence of the degree of control and independence fall into three categories:
Behavioral Control: Does the company control or have the right to control what the worker does and how the worker does his or her job? Does the company have control over when and where to do the work, what tools or equipment to use, what workers to hire or to assist with the work, where to purchase supplies and services, what work must be performed by a specified individual, what order or sequence to follow, etc.? Does the company provide specific training to perform services in a particular manner? If the company has control over these factors, you are looking at an employer/employee relationship. If not, it could be an independent contractor.
Financial Control: Are the business aspects of the worker’s job controlled by the payer? These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, does the worker make his/her services available to the relevant market, etc.
Type of Relationship: Are there written contracts or employee type benefits? For example, pension plan, insurance, vacation pay, etc. Will the relationship continue and is the work performed a key aspect of the business?
Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another. You can find more information in Publication 1779, a brochure titled, “Independent Contractor or Employee,” available on IRS.gov.
If the worker is an independent contractor, you will generally not be responsible for withholding and depositing taxes from the payment. But, if you pay the independent contractor $600 or more throughout the calendar year, you are responsible for filing Form 1099-MISC with the IRS and sending one to the independent contractor. The independent contractor will be responsible for providing you with a completed Form W-9, “Request for Taxpayer Identification Number and Certification” before beginning his or her work. This will give you the needed information to prepare Form 1099-MISC at year’s end.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination. If you cannot determine how to treat the worker, you can complete and file Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” with the IRS, who will decide how to treat the workers.
2. Deposit trust fund taxes
If you have employees working for you in your Schedule C business, you will be responsible for withholding and depositing federal income taxes, Social Security taxes, and Medicare taxes. The funds that you withhold from your employees’ wages are referred to as trust funds since you are holding these monies in trust until you, the employer, deposit them into the federal deposit system. As an employer you will also be responsible for reporting and depositing Federal Unemployment Tax (FUTA). It is important that you understand your employer’s responsibility for withholding, reporting, and timely and adequately depositing all employment taxes.
One of the employment taxes to withhold from your employees' wages is income taxes. To figure how much to withhold from each wage payment, use the employee's Form W-4, Employee’s Withholding Allowance Certificate, and the methods described in Publication 15, Employer’s Tax Guide and Publication 15-A, Employer's Supplemental Tax Guide.
Other employment taxes to withhold are the Social Security and Medicare taxes that pay for benefits that workers and families receive under the Federal Insurance Contributions Act, or FICA. The total Social Security tax is 12.4 percent of wages, with the employer paying 6.2 percent. The remaining 6.2 percent is withheld from the employees’ wages. The 2008 wage base limit for Social Security tax is $102,000. The total Medicare tax is 2.9 percent of the wages, with the employer paying 1.45 percent and the remaining 1.45 percent withheld from the employees’ wages. There is no wage base limit for Medicare tax, so all covered wages are subject to Medicare tax.
You may ask, “Which form do I file to report federal income taxes, Social Security, and Medicare taxes?”
Each quarter, many employers who pay wages subject to income tax withholding or Social Security and Medicare taxes will report wages paid and taxes withheld and deposited on Form 941, Employer's Quarterly Federal Tax Return. Form 941 must be filed by the last day of the month that follows the end of the quarter.
To reduce burden for certain small business taxpayers, employers who have an annual employment tax liability of $1,000 or less can file and pay these taxes only once a year instead of every quarter using Form 944, Employer’s Annual Federal Tax Return, instead of Form 941. Eligible taxpayers will be notified by mail. Using Form 944, employers report the wages paid and taxes withheld during the calendar year and file this return and pay the tax due by January 31st of the subsequent year.
The federal unemployment tax is part of the federal and state program under FUTA that pays unemployment compensation to workers who lose their jobs. Employers report and pay FUTA tax separately from Social Security and Medicare taxes and withheld income tax. You pay FUTA tax only from your own funds. Employees do not pay this tax or have it withheld from their pay. Report FUTA taxes on Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, and file it by January 31st of each year. The FUTA tax rate is 6.2 percent and applies to the first $7,000 that you pay to each employee as wages during the year.
Employers have two separate types of employment tax deposits and follow different rules for making timely deposits for these taxes.
First, employers filing Form 941, Employer's Quarterly Federal Tax Return, with $2,500 or more tax due per quarter are required to timely deposit the withheld taxes. If you have a deposit requirement for Form 941, there are two easy ways: make a deposit the same day you pay your employees, or make the deposit before the due date. You either deposit these employment taxes monthly or semi-weekly. For more information on the rules to follow for Form 941 filers, refer to Publication 15.
Second, employers filing Form 940 may also have federal tax deposit requirements. If you have a deposit requirement for Form 940, make the deposit by the last day of the first month after the quarter ends.
In general, you must deposit income tax withheld, and both the employer and employee Social Security and Medicare taxes, by depositing electronically, mailing or delivering a check, money order, or cash to a financial institution that is an authorized depositary for federal taxes. You may be required, or prefer, to use the Electronic Federal Tax Payment System. We will discuss EFTPS in more detail later.
If you have agricultural employees, you will file Form 943, Employer's Annual Federal Tax Return for Agriculture Employees. Publication 225, Farmer’s Tax Guide, provides more information on Form 943.
Remember, if you are an employer, it is important that you understand the federal tax rules. You are responsible for withholding employment taxes, timely and adequately reporting and paying the withheld taxes, and filing the correct employment tax returns to report this information. Failure to deposit the trust funds associated with employment taxes can be costly for a small business owner.
3. Make estimated tax payments
In addition to timely depositing trust fund employment taxes, as a Schedule C filer you must also make estimated tax payments.
Estimated tax payments is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. Estimated tax is used to pay income tax and self-employment tax, as well as other taxes and amounts reported on your tax return.
Self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. You figure SE tax yourself using Schedule SE, Self-Employment Tax, which is filed with your Form 1040.
You may pay all of your estimated tax by the April due date, or in four equal installments. For estimated tax purposes, the year is divided into four payment periods. Each period has a specific payment due date. If you do not pay enough tax by the due date of each of the payment period, you may be charged a penalty -- even if you are due a refund -- when you file your income tax return. Estimated tax payments are generally due the 15th day of April, June, September and January.
You do not have to make the payment due in January, if you file your annual individual tax return by the beginning of February and pay the entire balance due with your return.
Using the Electronic Federal Tax Payment System is the easiest way to pay your federal taxes, including estimated tax payments for individuals as well as businesses. Making timely, estimated taxes in proper amounts will eliminate costly penalties for you and your business.
Visit IRS.gov or see Publications 334, Tax Guide for Small Business, and 505, Tax Withholding and Estimated Tax, to learn more about the self-employment tax that you, as a Schedule C filer, may be liable for.
4. File and pay electronically
Almost all business returns can now be filed electronically. Typically, many businesses use a tax professional to electronically file their business tax returns. However, since the Schedule C is attached to the individual Form 1040 income tax return, which can be filed electronically, you have the capability to electronically file your Schedule C using the same software you use to e-file your Form 1040. Alternatively, you can seek a tax professional’s assistance to electronically file your Schedule C along with your Form 1040.
The Electronic Federal Tax Payment System, or EFTPS, is a secure government Web site. EFTPS is the preferred method for making all federal tax payments. Using this method eliminates most errors made in making federal tax deposits, reducing costly penalties and interest associated with many errors. This system uses the highest level of security available. It’s free, and easy to enroll. Just visit EFTPS.gov, or follow the links from the IRS’s Web site.
EFTPS offers you the convenience and flexibility of making your tax payments over the Internet or by phone. By 8 p.m. Eastern time, at least one calendar day before the due date, you access EFTPS directly to report your tax payment information. You tell EFTPS to move the funds from your account to the Treasury's account for payment of your federal taxes. The funds will not move from your account until the date you indicate in this transaction. You receive an immediate acknowledgement of your payment once it is made, and your bank statement will confirm the payment.
You can initiate your tax payment 24 hours a day, seven days a week, quickly and conveniently from your office or some other location. There are no fees for using EFTPS. As an added convenience, EFTPS allows taxpayers to schedule tax payments in advance, helping you avoid penalties and interest that you could incur if you make payments after their due dates. Businesses can schedule payments up to 120 days in advance of their tax due dates, and individuals up to 365 days in advance. So, you could actually schedule your estimated tax payments for your income tax and self-employment taxes for the entire year in one session. EFTPS will automatically make your payments for you on the due date you indicate. Scheduled payments can be changed or cancelled up to two business days in advance of the scheduled payment date.
You can use EFTPS to make all your federal tax payments, including income, employment, estimated and excise taxes.
To summarize, consider IRS e-file for your personal and business tax returns, and make electronic payments for all federal tax liabilities through EFTPS. As an added bonus, these electronic methods provide an easy way for you to begin keeping reliable business records with electronic copies, saving you office storage space and the expense of paper records.
5. Keep good records
Keeping good records is very important to the success of a business. Here are some reasons for keeping good records:
You need good records to monitor the progress of your business. How can you measure how well your business is doing, or not doing, if you don’t have reliable records that will provide this information for you? Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood that your business will succeed.
All businesses need to have accurate financial statements. These statements, which include a business’s income -- profit and loss -- statements, and balance sheet, can help you in dealing with your bank or creditors and can help you manage your business. In order to prepare, or have prepared, accurate financial statements, you need good records to use in preparing reliable financial statements.
Usually a business receives money or property from many sources. Your business records can help identify the source of your receipts of income. On the Schedule C, you will report your receipts or income in Part 1, lines 1 through 7.
You particularly need this information to separate business from non-business receipts, and taxable from nontaxable income. Good records that identify income and expenses save a lot of time and expense, should you ever have a reason to explain the source of any income or the payment of any expense.
Keeping good records helps you remember to claim and deduct legitimate business expenses. You may forget expenses when you prepare your tax return, unless you record them when they occur. We recommend that you record an expense as soon as possible after its occurrence. Schedule C business expenses are recorded in Part 2, on lines 8 through 27. The Business Use of Home expense is recorded on line 30.
And, finally, you need good records to prepare your tax returns and to support items that are shown on the tax return. These records must support the income, expenses, and credits that you report here. Generally, these are the same records you use to monitor your business and prepare your financial statements. If you have reliable, organized records, preparing a Schedule C and other business tax returns will be a much easier task.
You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of good records will speed up this examination and help make accurate explanations for items in question.
More information about keeping good records is on the IRS Web site. Just link from our Tax Center for Self-Employed Individuals.
6. Protect your financial and tax records
Planning what to do in case of a disaster is an important part of safeguarding your records, so you will be able to continue your business operations.
First, take advantage of paperless recordkeeping – a benefit of filing your returns and paying your taxes electronically. Additionally, many people retrieve bank statements and other documents online, an excellent way to secure financial records.
Be sure to back up your electronic files and store them in a safe and separate location. You can periodically copy them onto a CD, flash drive or other electronic storage device, and send it to a trusted person in another location for safekeeping in case your normal computer backup systems are destroyed. Also, many retail stores sell computer software packages that you can use for recordkeeping.
You should also document valuables and business equipment. One option is to photograph or video the contents of your home and business, especially items of great value. You should store this documentation with someone outside your geographic area, to reduce risk.
The IRS has disaster loss workbooks for individuals -- Publication 584 -- and businesses -- Publication 584-B -- that can help you compile a room-by-room list of your belongings or business equipment. This will help you recall and prove the market value of items for insurance and casualty loss claims if needed.
If you are an employer who uses a payroll service provider, ask the provider if they have a fiduciary bond in place. The bond could protect you in the event of default by the payroll service provider, which would not be a natural disaster but could be a disastrous situation for a business.
How quickly your company can get back to business after a disaster often depends on emergency planning done today. Start planning now to improve the likelihood that your company will survive and recover. Review your emergency plans annually. Just as your business changes over time, so do your preparedness needs. When you hire new employees or when there are changes in how your company functions, you should update your plans and inform your workers and other business contacts.
In the event of a disaster, the IRS stands ready to help. We have valuable information you can request if your records are destroyed. IRS.gov is an indispensable resource as you prepare for and recover from disaster.
7. Consider a tax professional
As a new business owner, you might consider hiring professionals to assist you in handling business processes that you may not be knowledgeable about or may not have sufficient time to take care of properly.
If you pay someone to prepare your tax return, choose that preparer wisely. Taxpayers are legally responsible for what’s on their own tax returns even if they’re prepared by someone else. Most return preparers are professional, honest and provide excellent service to their clients. It’s important for taxpayers to find qualified tax professionals if they need help preparing and filing their tax returns.
Understand that the most reputable preparers will ask to see your receipts and will ask you multiple questions to determine your qualifications for expenses, deductions and other items. By doing so, they have your best interest in mind and are trying to help you avoid penalties, interest or additional taxes that could result from an IRS examination.
Here are some tips to help you choose wisely:
Choose a preparer you will be able to contact, and one who will be responsive to your needs.
Ask if the preparer has prepared returns for your type of business or industry.
Additionally, if you are an employer, you might want to consider having an outside source prepare your payroll and should consider the following information:
As an employer, you are ultimately responsible for the deposit and payment of federal tax liabilities even though the third party is making the deposits. If the third party fails to make the federal tax payments, the IRS may assess penalties and interest on your tax account, and then you become liable for all taxes, penalties and interest due. You may also be held personally liable for certain unpaid federal taxes, meaning those trust fund taxes I discussed earlier.
If there are any issues with an account, the IRS will contact you. IRS correspondence is sent to the address of record so your should not change the address to that of the payroll service provider. This will help you stay informed timely of tax matters involving your business.
For your protection, you should ask the payroll service provider if they have a fiduciary bond in place, which could protect you in the event of default.
Be sure to ask the service provider to enroll in and use the Electronic Federal Tax Payment System, so you can confirm payments made on your behalf. EFTPS maintains a business’s payment history for 16 months and can be viewed online after enrollment. In addition, you should enroll your businesses in EFTPS to make any additional tax payments your provider is not making on your behalf, such as estimated tax payments for income and self-employment tax liabilities. We recommend employers verify EFTPS payments as part of your bank account reconciliation process.
So, if you are not comfortable preparing your own Schedule C or other related business returns, consider hiring a reputable tax professional or payroll service provider to assist.
Conclusion
The IRS has many resources to help you learn about and fulfill your federal tax responsibilities as a Schedule C filer. In addition to the educational materials on our Web site’s Tax Center, we have a free bi-weekly e-mail newsletter just for small business owners and self-employed individuals. You can subscribe right from IRS.gov.
In the Search box, type “Subscription Services” and look for the link to “Subscribe to e-News for Small Businesses.” Just enter your e-mail address and respond to the confirmation message to verify your subscription. Then, every other Wednesday you’ll receive a short e-mail with important upcoming tax dates, news for small businesses, reminders and tips, and links to IRS news releases and special announcements on our Web site.
I hope the information that I have shared today will help make filing Schedule C easier, provide a solid foundation for your successful business and help you manage its growth.
For the IRS, I’m Phyllis Grimes.
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