Preparing for Filing Your Business Tax Return
It's an annual chore: filing income tax returns. This includes filing federal income tax returns, as well as state and local returns, for businesses and for owners. There is no way to avoid this chore. The best way to handle this responsibility is to be prepared and get started as soon as possible.
Mark your calendar
Pay attention to the filing deadline for income tax returns. If you miss the deadline, you may incur late-filing penalties (these penalties are not tax deductible). The following are federal income tax return deadlines:
- For entities: Partnerships and S corporations reporting on a calendar year basis, which most do, must file their 2020 income tax returns by March 15, 2021. Calendar-year C corporations must file their 2020 income tax return by April 15, 2021. Limited liability companies (LLCs) with multiple members file partnership returns unless they have elected to be taxed as corporations; one-member LLCs file their return with the owner's personal tax return. Sole proprietorships also file their return with the owner's personal tax return.
- For owners: Business owners must file their 2020 income tax returns by May 17, 2021
Check your state for its filing requirements. Many states have the same filing deadlines as the ones for federal income tax purposes. If you do business in more than one state, you may have to file multiple state income tax returns. Pay special attention to filing requirements for businesses doing internet-based transactions. Some states consider this a sufficient connection to them such that state tax returns are required there.
The federal filing deadline may be extended by the IRS if you are located in an area that's been declared a federal disaster area. For example, victims of the California wildfires that began on September 4, 2020, and who had obtained a filing extension (explained below) for their 2019 income tax returns to October 15, 2020, were given until January 15, 2021, to file those returns. In some cases, the extended deadline is six months, but it may be longer. Information about filing extensions for disaster victims can be found from the IRS.
Getting more time to file
If, for any reason, you cannot meet the applicable filing deadline, you can obtain an automatic six-month filing extension just by asking for it. You must submit the request no later than the filing deadline. You do not have to provide a reason for the request. Entities use IRS Form 7004 to request a filing extension. Individuals (including one-member LLCs) use IRS Form 4868.
Getting more time to file the return does not give you more time to pay taxes due. It's advisable to pay as much as you expect to owe to minimize or avoid late-payment penalties. These penalties start to run from the filing deadline without regard to extensions.
Choose your tax preparation method
Decide as soon as possible who is going to prepare and file the return(s). Will you use a CPA or other tax professional? Will the business returns be handled in-house by a company employee? Are you planning to prepare your personal return using tax preparation software?
If you want to use a CPA or other tax professional, as most businesses do, and haven't been working with one, explore your options. Make sure you vet them before making a selection. The IRS has tips on choosing the right tax return preparer for your situation.
If you work with a tax professional, schedule an appointment as soon as possible to discuss your situation. With COVID-19, appointments that used to be in person can be managed by telephone or online.
Gather your tax records
Tax return information is based on the records you have on income and expenses for the year. Typically, this information is in your desktop or cloud-based accounting system and can easily be accessed by a tax professional or other return preparer to complete the return. For example, payroll information about what the business paid in wages and compensation as well as employment taxes — all of which factor into the income tax return — should be easily found in your accounting system.
In addition to annual income and expenses tracked in the accounting system, be sure to have various records and other information on hand to help with return preparation:
- Prior year returns. These show potential carryovers that can be used on current returns to reduce tax liability. They include, for example, net operating losses, general business credit, and capital losses.
- Information about owners' investments. Because partnerships and S corporations pass through income and losses to owners, it's essential that owners know their "basis" in their company. If losses are passed through, they are deductible on an owner's return only to the extent of such basis. For example, an S corporation owner's basis is the amount invested in stock or loans made by the owner to the corporation. Basis information must be included on tax returns (e.g., Schedule K-1 and, where losses are claimed, on Schedule E of Form 1040 or 1040-SR). Partnerships must report on Schedule K-1 of Form 1065 a partner's beginning and ending capital account. The capital account is the amount of capital contributed to the partnership during the year, the partner's share of the partnership's current year net income or loss as computed for tax purposes, any withdrawals and distributions made to the partner by the partnership, and any other increases or decreases to the capital account.
- Asset information. If the business sold assets, it's necessary to have information about their basis to figure gain or loss. For example, if the business sold a building, basis used to determine gain or loss takes into account what the business paid for the building, depreciation claimed for it, and other adjustments.
Supplemental tax information
Business deductions and credits cannot be created out of thin air and must be substantiated by receipts, invoices, canceled checks, and other documentation. This supplemental tax information is not submitted with the return, but should be retained and easily accessible in case of an audit.
In addition to receipts or other paperwork that prove expense amounts, the tax law requires additional documentation in some situations. Examples of required documentation include:
- Special recordkeeping for travel, meals, vehicle, and business gifts. Receipts alone are not sufficient to back up deductions claimed for these expenses. Required records are explained in IRS Publication 463.
- Substantiation for charitable giving. If the business made donations of $250 or more, a written acknowledgment from the organization is required. This and other substantiation rules for charitable donations are in IRS Publication 526.
Consider the impact of out-of-state workers
For federal income tax purposes, the fact that COVID-19 caused many businesses to have employees work from home is not important. But for state and local income tax purposes, this situation may create tax filing problems. Businesses normally file their state income tax returns according to “nexus,” meaning where they have a business connection. Typically, this is where the company is physically located (“physical presence”). However, having workers in another state may create the nexus sufficient to require filing an income tax return and paying state and local taxes in that location.
Remote workers don’t necessarily trigger added tax problems:
South Dakota and Wyoming do not have any corporate income tax, so there is no issue about filing and paying taxes in these states, even if there are employees working there.
About a dozen states have waived on a temporary basis any nexus created by having remote workers due to COVID-19. For example, Massachusetts won’t treat employees working remotely solely because of the pandemic as a reason for a corporation to file a tax return there. Check the income tax rules for all states in which you have employees working remotely (you should know who they are through your payroll system) to determine if you have income tax obligations there.
Consider post-year-end tax saving strategies
The calendar shows that last year has ended, but the opportunities for obtaining additional tax reductions are still available. These involve taking certain actions and making certain elections on tax returns. Here are some examples:
- Maximize retirement plan contributions. The deadline for making tax-deductible contributions to a qualified retirement plan is the extended due date of the return. Don't have a qualified retirement plan for the business? One can be set up and funded through the extended due date. More information about setting up and contributing to a qualified retirement plan may be found in IRS Publication 560.
- Decide how to write off the cost of equipment. If the business bought equipment, machinery, or certain other property in 2020, there are a number of ways to deduct the cost. These include first-year expensing (Section 179 deduction), bonus depreciation, regular depreciation, and a de minimis safe harbor election. The decision on which method to use is made when the return is filed. The choice can affect taxes this year and in years to come. More information about these options is in IRS Publication 946.
- Choose deferral of self-employment tax. Business owners who are self-employed and owe self-employment tax to pay their Social Security and Medicare taxes can elect to defer one-half of the Social Security tax portion on net earnings from March 27, 2020, through December 31, 2020. If this election is made, it means one-half of the deferred amount won't be due until the end of 2021 and the other half by the end of 2022. This option can be used to avoid underpayment penalties by a self-employed person who did not pay enough in estimated taxes or through other withholding.
Filing annual tax returns is a business responsibility that can't be avoided. The sooner you begin the process of prepping for the filing process, the less stressed you'll be and the more opportunities there will be for tax savings. Check Paychex resources on taxes to help you understand various topics and meet your filing responsibilities.