new ventures business development provides resources for starting and growing businesses
Understanding tax liability
It is important for business owners to understand the main categories of business taxes:
- Income taxes,
- Employment-related taxes,
- Self-employment tax,
- Sales and use tax, and
- Property tax.
Income taxes
The federal and state governments levy income taxes on earnings of any business. Each business, therefore, must file an income tax return with both agencies.
Federal income tax liability will depend on the legal structure of the business.
- Sole Proprietorship: The profit or loss of the business is taxed as personal income and is included on the owner's individual tax return.
- Partnership: Profits are taxed as personal income, and the partners are personally liable for debts and taxes. A partnership files an informational tax return telling the IRS how much each partner earned. The partnership does not pay taxes on this income; each partner reports his or her share of income (or loss) on Schedule E, Supplemental Income and Loss and files it with Form 1040.
- Corporation (General and Statutory Close): Because corporations are considered separate entities, they must file income tax returns and pay taxes.
- S corporation: The S corporation does not file or pay federal taxes on profits of the corporation. Instead, the IRS allows all profits to “pass through” to the individual shareholder's personal tax return. Form 1120S filed by an S corporation is an informational return telling the IRS how much each shareholder earned.
- Limited Liability Company: A single-member LLC is normally taxed as a sole proprietorship. An LLC that has two or more members, unless the owners choose to have the business taxed as a corporation, will be taxed as a partnership and will file an informational return that tells the IRS how much each member earned. The LLC does not pay tax on its income but, as with a partnership, each member reports his or her share of income (or loss) on Schedule E, Supplemental Income and Loss, which is filed with Form 1040.
For information on when to file returns and make tax payments, see IRS Publication 509, Tax Calendars, which is updated annually. The IRS also has free publications that can answer many tax questions. A partial listing of free IRS publications for business owners includes:
- Circular E: Employer's Tax Guide (#15)
- Tax Guide for Small Business (#334)
- Tax Withholding & Estimated Tax (#505)
- Tax Calendar (#509)
- Self-Employment Taxes (#533)
- Depreciation (#534)
- Business Expenses (#535)
- Accounting Periods and Methods (#538)
- Starting a Business and Keeping Records (#583)
- Business Use of Your Home (#587)
- Business Use of a Car (#917)
- Business Reporting (#937)
For more information, call the IRS main number at 1-800-829-3676 or visit the IRS Small Business/Self-Employed website.
For North Carolina residents, federal taxable income is the starting point in determining how much state income tax is owed. Please note that businesses may be required to file estimated tax returns and pay estimated taxes on a quarterly basis.
Employment-related taxes
Business owners are required by law to withhold the following from wages paid to employees: federal income taxes, state income taxes, and FICA (Social Security). Because everyone must pay Social Security Tax, those who are self-employed make their Social Security contribution through the self-employment tax.
Federal employment taxes include:
Federal income tax withholding (FIT): Income taxes must be withheld from employees' paychecks based on the following:
- The employee's filing status (single, married, or married but withholding at the higher single rate);
- The number of dependents (withholding allowances) declared by the employee; and
- The size of the employee's salary.
Federal Form W-4, the Withholding Exemption Certificate, should be signed by each employee and kept on file to determine the amount of tax to withhold.
Federal Social Security and Medicare taxes (FICA): The employee's share of the Social Security tax and Medicare tax must be withheld from the employee's pay. The amounts to be withheld are listed in the most current edition of Circular E, Employer's Tax Guide, published by the IRS. In addition, an owner who is considered an employee of a corporation must complete and submit Form W-4 to the corporation like any other employee, and the corporation must withhold income taxes and a share of Social Security and Medicare taxes from the paycheck.
Federal unemployment tax (FUTA): As an employer, the business must report and pay the federal unemployment tax (FUTA); it is not withheld from the employee's pay. The FUTA rate through 2007 is 6.2 percent of the first $7,000 of the employee's wages for the year. Employers are given a credit for participating in state unemployment programs. The credit reduces the FUTA rate to 0.8 percent for most employers, which translates into $56 for an employee earning $7,000 or more per year. Use Form 940 or 940EZ to report federal unemployment tax. Sole proprietorships and partnerships do not pay the FUTA on the owners' compensation.
Home-businesses: For tax purposes, if the home office is claimed as a business expense, that part of the home must be used “exclusively and on a regular basis.”
North Carolina employment taxes include:
State income tax withholding: New employers must apply with the N.C. Department of Revenue for a withholding identification number (use Form NC-1). State income taxes are withheld from employees’ gross wages according to an authorized formula and/or method. Contact the N.C. Department of Revenue, 1st Floor, South Core, Revenue Building, 501 N. Wilmington St., Raleigh, NC 27604, toll free 877-252-3052. The mailing address is N.C. Department of Revenue, P.O. Box 27431, Raleigh, NC 27611.
North Carolina's unemployment insurance tax: Any employer who pays wages of $1,500 or more within any calendar quarter or who employs one or more workers on any day in 20 different weeks in a calendar year may be liable. Certain employees are exempt from the tax. To determine employer liability, contact the Employment Security Commission, 704-283-7541 in Monroe, 704-694-6551 in Anson County, and 704-342-6131 in Charlotte.
Workers’ Compensation Insurance: State law requires that most employers with three or more employees carry insurance to compensate workers for accidental, on-the-job injury. Some jobs are exempt, including casual, farm, and domestic labor. For more information contact your insurance agent or broker.
It is important to note that the business must periodically deposit the withheld income tax and the employer and employee shares of Social Security and Medicare taxes at an authorized financial institution. The IRS sends coupons to use in making these deposits and provides instructions on how often the funds are required to be deposited.
Wage and Hour Regulations: The provision of the N.C. Wages and Hour Act include minimum wages, overtime, wage payment, payments of promised wages and benefits – such as vacation, holidays, and sick pay – and youth employment. For more information, contact the N.C. Department of Labor, 4 W. Edenton St., Raleigh, N.C., 919-807-2796 or toll free 800-NCLABOR. The mailing address is 1101 Mail Service Center, Raleigh, NC 27699-1101.
Self-employment tax
The self-employment tax applies to income received from working actively in your own business, but not as an employee of that business. A sole proprietor or a partner must pay the federal self-employment tax in addition to regular income tax. The tax is equal to the employer and employee portions of the Social Security and Medicare taxes that you would pay on your compensation if you received it as an employee. The full self-employment tax may not be owed on all of your business earnings. If income from another job is subject to withholding, common for people just getting started in business, the income from the other job will reduce the tax base for the self-employment tax.
Sales and use taxes
In North Carolina, a 4.5 percent sales and use tax is assessed on the retail purchase; retail sale; and rental, storage, use or consumption of tangible personal property or certain services. Most counties also assess a local option sales tax of 2.5 percent. A sales tax number is required for each business before opening.
Property tax
Property tax is administered and collected by local governments. Real and personal property are subject to the tax, which is paid by individuals, corporations, and partnerships owning property in the state. Exemptions include manufacturer’s inventories and inventories of retail and wholesale merchants and tangible personal property held for sale and not manufactured, processed, or produced by the merchant.
Three factors are used to determine property taxes:
- Depreciation: Personal property (machinery, equipment, etc.) is allowed to depreciate annually (once it is placed in service) at a rate established by state law.
- Assessment: Real and personal property are assessed at a ratio unique to the type of property. The assessment ratio is applied to the fair market value of the property to determine the assessed value of the property.
- Millage rate: The local millage rate is applied to the assessed value of real and personal property. A mill is equal to $0.001 and is site specific.
Occupational License Tax : County and municipal governments levy occupational license taxes. State law limits the tax on certain occupations and businesses and prohibits the taxation of others.
Page navigation
Disclaimer
The information presented here is intended as a public service. Although efforts are made to assure that the information is accurate and up-to-date, the user assumes all responsibility for the use of information provided. The sponsors of this website expressly disclaim any liability for the information provided herein.
This website contains links to other Web sites operated by third parties. The linked sites are not under the control of New Ventures Business Development and it is not responsible for their content. These links are provided as a service to our users.