Small business owners, please help me understand how business are taxed

[bklyncowgirl]

Listening to a Republican congressmen bemoaning the lot of the small businessman under Obama's tax plan I find myself very confused. I always thought that business owners were liable for taxes only on their net profit (what's left over after business expenses are deducted) but this guy made it sound like he was going to owe taxes on his gross income.

Let's say I'm a small business owner who's business makes $600,000 a year. That's my gross income.

I deduct my business expenses, payroll, supplies, equipment, rents, etc. and I end up with $300,000 That's my net profit.

Am I taxed on my gross income in this case $600,000 or my net profit i.e. $300,000?

Also if I know that I'm going to be taxed at a higher rate at any profits over $250,000 would it not make sense for me to put that $50,000 back into the business instead of taking it as profit?

[Tesha]

1. Essentially all businesses are taxed on their net profits.

There are tricky rules, of course, as to what constitutes
a deductable expense against your revenues.

For example:

Some years, the entire cost of the new Hummer is almost
instantly deductible; other years, it must be depreciated over
a number of years with you being able to deduct only that
year's depreciation,

Some years, all three martinis consumed at that "business
luncheon meeting" are deductible; other years, not so
much.

Tesha

[kestrel91316]

2. I own a sole proprietorship (NOT a corporation) - my business expenses

are used to offset income, resulting in net profit (or loss). The net profit or loss is what goes on my income tax form as business income and that's what I pay social security (at twice the rate employees do) and income taxes on.

Of course, there are all sorts of other taxes, fees, licenses, etc I also have to pay. Those are in most cases independent of gross or net income, so the impact falls disproportionately on tiny businesses like mine. They ARE all legitimate business expenses that offset income, which is pretty small consolation.

[EC]

3. Net profit.

And yes it would be wiser to put the extra $50,000. in improvements or hiring. That's usually what really happens when there is a higher tax and we've been saying for years that this should be rammed into people's heads over and over again.

[postatomic]

4. You are taxed on the net Income

And it depends on how your company is structured. Sole Proprietorship, S-Corp, LLC, or C-Corp. You really can't put money back into your company to avoid paying taxes. If you are a C-Corp you will pay Corporate Taxes on the profits of the Company and the others have to give out profits as personal income.

There are other variables but to answer your question; no, you don't pay taxes on your Gross Sales/Receipts/Etc.

[lumberjack_jeff]

5. I own an LLC

Whatever money is left over expenses becomes taxable income to me.

If taxes go up, I'm motivated to turn more of the gross income into business expenses. If taxes go down, I put the profits in personal savings.

You want to encourage hiring? Raise taxes.

[DURHAM D]

6. It depends on how you are organized.

[Liberal In Texas]

7. It's on net profits. And the RW noise machine as successfully got people believing

that it's on the gross.

My brother runs a small business and because his net sales were a bit over $250K he thought his taxes would be going up under the old dem tax plan. I tried to explain that it would be on what he made net and only go up on what he made over $250K gross.

The repubs are very good at framing the debates to cause the maximum amount of confusion. And they do this on purpose.

[bklyncowgirl]

8. Yes, the Republicans are very good at confusing the issue

I was pretty sure that you paid taxes on net profit but listening to this guy you would have sworn he was going to get hit on the whole thing. He was practically chewing the carpet at the thought of having to feed his family on a mere $400,000.

[alc]

9. $300,000 to answer your question

There are lots of details, but it is a royal pain to deal with taxes when you're just trying to survive.

I've started a few s-corps and worked for a few other startups. There are many differences depending on the situation. One think I'd like to see is taxes spread out over many years. You pay yourself almost nothing for 2+ years, live off savings and invest as much as you can in the business, then make a profit and pay full taxes on what you made that year (individual + corp go together in s-corp)

And your next product may require a $75,000 up front cost (design + master mold) but you're only clearing $40,000 a year. You need 2 years of profit to pay the startup cost, but the first year's profit is taxed if you save it for next year. You may already be maxed out on family/friends/bank loans so you can't speed things up. Or you not have the sales force to add a product yet so you want to hold off so you really don't want to stretch your budget and get a loan to save on taxes. (this is a real situation I've been in)

And, you may clear $300k one year, then back down to $100k the next year. When your big customer says we have money in this year's budget so need to advance next year's order, you're at their mercy. So you average $200k for two years but you're over $250k one year and well under the next year.

[tsuki]

10. Most small business that I know are S Corps. They are not taxed as

a corporation, but the money flows through as dividends to the owners. Those dividends will now be taxed at the personal income tax rate of the owners.

http://www.irs.gov/businesses/small/article/0,,id=98263,00.html

"S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income."

Unless you make more than Net 250K, I do not understand how it will affect a small business.

[taught_me_patience]

11. Net income

Very few small businesses have a net income above 250k.

[indypaul]

12. Your $300k

less a few adjustments for self-emp tax, etc would
still not all be taxable. You could make a contribution
to a retirement plan or other adjustments to arrive at
your Adjusted Gross Income. Then you would deduct your
personal exemptions i.e wife and children and your
itemized deductions for mortgage interest, contributions,
etc. to arrive at your "taxable income." Which with all
these items considered you are more than likely not looking
at anywhere near the $300k. Best advise is make the $300k
first and NEVER confuse gross income with taxable income.