- The COVID-19 pandemic led to new tax incentives and programs designed to aid small businesses.
- In 2018, major tax legislation resulted in many changes for small businesses, including new rules for pass-through entities and bonus depreciation.
- You should work with a certified public accountant (CPA) to ensure you are complying with current regulations and paying the right amount.
- This article is for small business owners who want to know what to expect for their tax obligations in 2021.
Although there weren't many major changes to the small business tax code this year, several tax credits, loan programs and acts were created to help businesses weather the effects of COVID-19.
The last major changes to the tax code came in 2018, with the Tax Cuts and Jobs Act, which included a lower corporate tax rate, new rules for pass-through businesses and a tax break for some industries.
"The tax changes were so significant, I would imagine that there's still a lot of issues in terms of digesting what has occurred," said Wayne Winegarden, senior fellow in business and economics at the Pacific Research Institute and managing editor of EconoSTATS.
As a small business owner, it's important to stay up-to-date on current tax laws so you pay the right amount each year. [Doing your taxes on your own? Find the best software to use in our reviews of the best tax software for business.]
Types of small business taxes
Small business taxes vary based on the structure of the business, but here are the five primary small business taxes:
- Income tax. Except for partnerships, all businesses file annual income tax returns. Partnerships, however, file information returns.
- Self-employment tax. This tax is on your net earnings from self-employment and goes toward your Social Security and Medicare obligations.
- Employment taxes. If you have employees, you have taxes (and forms) related to their Social Security and Medicare taxes, federal income tax withholdings and federal unemployment tax. Payroll taxes fall into this category.
- Excise tax. There are several types of taxes that fall into the excise tax category. This affects you if you make or sell certain types of products; operate a certain business type; use specific equipment, facilities or products; or are paid for qualifying types of services. If that sounds vague, it's because it cuts across many categories. The classic examples of products that carry an excise tax are fuel, tobacco and alcohol. You can learn more about excise taxes from the IRS.
- Estimated taxes. Many businesses (sole proprietors, partnerships and S corporation shareholders) must pay quarterly estimated tax payments. This requirement applies if you do not have taxes withheld from each paycheck or do not have a sufficient amount withheld from each paycheck.
Key takeaway: There are several types of taxes small businesses may need to account for, including income tax, self-employment tax, employment taxes and excise tax.
Things to remember in 2021
The coronavirus pandemic resulted in changes to business taxes in 2021. Businesses saw many new tax incentives, breaks and rules as the U.S. government tried to combat COVID-19's toll on the economy. Here are some of the new programs and changes:
- Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act introduced the Paycheck Protection Program (PPP) as an emergency loan that allocated billions of dollars to small businesses. The PPP is a forgivable loan, so long as the funds are utilized to fund payroll, rent/mortgage and utility payments. Any money a business received and was forgiven through the PPP is not considered taxable income for 2020, though any amount that is not forgiven is taxable business income. However, some uncertainty does remain about whether business expenses paid for with the loan will be deductible.
- Economic Injury Disaster Loan (EIDL). To help businesses affected by mandatory shutdowns or economic slowdowns caused by the coronavirus pandemic, the U.S. Small Business Administration (SBA) expanded the EIDL program. A business that receives funding from an EIDL is still required to pay income taxes on this loan.
- Employee Retention Tax Credit (ERTC). Businesses affected by COVID-19 can use the ERTC to retain staff members. To qualify, a business has to have been fully or partially closed due to a government-mandated shutdown or experience a decline in gross receipts of more than 50% for any given quarter when compared with the same quarter in 2019. Employers that qualify for the ERTC are eligible for a tax credit equal to 50% of qualifying wages, up to $10,000 per employee between March 13, 2020, and Jan. 1, 2021.
- Families First Coronavirus Response Act (FFCRA). The FFCRA required certain businesses to provide sick/family leave to employees who were affected by COVID-19. Businesses that made these payments are eligible for tax credits for 100% of the cost of sick-leave pay, family-leave pay, qualified healthcare plan expenses and the employer's share of FICA taxes for sick-leave expenses they incurred under the FFCRA.
- Business interest expense deduction increases. Finally, under the CARES Act, the allowable business interest expense deduction was increased for some business entities from 30% to 50% of adjusted taxable income.
Key takeaway: The CARES Act, EIDL, ERTC and FFCRA played key roles in helping businesses weather the coronavirus storm in 2020. It is important to know how these changes may affect your taxes in 2021.
Previous tax changes
There were also some other minor changes that stemmed from the 2018 tax reform law. As you work with your accountant or tax professional, it's important to understand all of the regulations that were implemented. The noteworthy changes include deductions for pass-throughs, first-year bonus depreciation and net operating loss changes.
- International business. Anthony Parent, founding partner of Parent & Parent LLP, said many small businesses may have a rude awakening if they have significant operations abroad. "There are a lot of small and medium businesses that have some sort of international components. We're trying to get ahead of it and warn people." International taxation and regulation are very complicated, so it's important to work directly with a professional to ensure you're being taxed at the correct rate.
- SALT cap. As of 2020, filers can only deduct up to $10,000 in state and local property and income taxes. Many business owners who operate a pass-through entity in a high-tax state can take advantage of SALT deductions. Winegarden said all business owners should be aware of this cap. "I really think in the high-tax states, the SALT cap is going to be meaningful, more for small businesses, just because they're going to be filing through their personal taxes."
Deduction for pass-throughs and corporations
In previous years, there was a significant deduction for both pass-through and corporate entities. Pass-through businesses are small businesses structured as S-corps, limited liability companies, sole proprietorships and partnerships. Pass-throughs make up approximately 95% of U.S. businesses. The law now provides a 20% deduction for those businesses. The only limitation is for owners of some service-based businesses, like law and accounting firm owners who make more than $315,000 (if the owner is married and filing jointly) or $157,500 (if they are unmarried) per year.
C corporations also got a big deduction: The law lowered the tax rate from 35% to 21%. This slashed rate aims to bring major corporations back to the U.S. to employ workers and create wealth.
First-year bonus depreciation
The first-year bonus depreciation deduction was changed to 100%. In other words, businesses that made eligible equipment and property purchases could deduct the full amount of the purchase price instead of writing off a portion of the expense each year. This provided businesses with more money upfront, which lawmakers hope will be invested back into the business or used to hire workers.
Josh Zimmelman, founder of Westwood Tax & Consulting, said this enables businesses to write off the cost of assets in one shot.
"A company can invest in vehicles, computers and equipment, and claim the entire expense on their … tax return," Zimmelman said.
Winegarden said the break is an incentive for businesses to spend more. "Anything that gets you closer to complete expensing is going to increase the value of the depreciation, lower the tax burden and reward those capital-intensive firms."
Net operating loss changes
Net operating losses (NOLs) can no longer be carried back for two years; instead, they can be applied for an indefinite amount of time going forward. NOLs occur when a business's tax deductions exceed its taxable income. It functions as a form of tax relief for businesses, where business owners can apply a net operating loss to future tax payments.
The change eliminates businesses' ability to restructure taxes completed in years past, but it extends the life span of NOLs indefinitely. However, this can be applied only to 80% of taxable income.
Winegarden said the thinking behind this change is to incentivize businesses to take risks and spend more money. "Knowing you can carry [the net operating loss] forward and indefinitely … lowers the cost of failure," he said.
Key takeaway: Following the 2018 tax reform, there were some other minor changes business owners should be aware of. Specifically, there are now deductions for pass-through entities and corporations, first-year bonus depreciation and net operating loss changes.
Important 2020 deadlines
Due to the COVID-19 pandemic, some tax deadlines were extended in 2020. It is unclear if similar extensions will be provided in 2021. Those extensions included the following:
- S-corps were expected to file their business taxes by March 15.
- The original deadline for 2020 tax returns was pushed from April 15, 2020, to July 15, 2020.
- Quarterly estimated tax deadlines were pushed from April 15 to July 15 (Q1) and June 15 to July 15 (Q2), while Q3 and Q4 deadlines remained Sept. 15 and Jan. 15, 2021, respectively.
Key takeaway: Many of the tax payment deadlines were extended in 2020 because of the COVID-19 pandemic.
Small business tax tips
If you've purchased a business this year or are new to small business tax structures, there are a few things to keep in mind. While it is possible to do your taxes on your own, consider working with a CPA. A tax professional can ensure that your business is taking advantage of all the deductions available and, more importantly, that you're paying everything you owe. Here are five other tips:
- Think about taxes all year long. Small business owners should not treat income taxes as an annual event. Rather, tax planning should be a year-round activity. Waiting until the last minute makes tax preparation more complicated and limits your money-saving options.
- Be aware of law changes. Even with the help of a skilled professional, a small business owner must keep up with new changes. This ensures your tax professional is doing the best possible job and keeps you informed as a business owner.
- Don't make assumptions. Never make business decisions assuming that particular tax breaks will pass or that certain policies will be enacted.
- Choose the right state to incorporate in. You don't need to incorporate your business in the same state in which you run your business. If you are just starting out, here are some of the best states to consider incorporating your business in.
- You don't actually want a tax refund. It is possible to get a tax refund as a small business, but in most cases, it isn't to your benefit. Typically, a refund means you overestimated the amount of taxes you paid, which could have been reinvested back into your business.
Key takeaway: Tax considerations for small business owners include planning for taxes year-round, keeping abreast of any tax changes and choosing the right state to incorporate in.
Top small business tax deductions
This isn't a comprehensive list of tax deductions available to small businesses (and you need to ensure that your business is eligible for these deductions). While this list provides potential deductions, it's best to consider working with a CPA, who can ensure you get all of your relevant deductions.
- Rent. If you rent your office space or retail location, the cost of your rent is fully deductible.
- Home office. If you have a dedicated workspace in your home (it must be regularly and solely used for business), then you are eligible to deduct expenses related to that portion of your home. The simple option is to take $5 per square foot up to 300 feet, but you can break it down as a percentage of the total square footage of your home and itemize your costs related to the space.
- Advertising. Promoting your business not only helps grow your business, but it also may shrink your taxes, as these expenses are fully deductible as well. This includes things such as business cards, fliers and digital marketing.
- Vehicle. As long as you can document and verify that the vehicle is used for business purposes, you can deduct the operation costs. As with the home office deduction, you can choose to use the simple deduction, which is 57.5 cents per mile as of 2020, or you can itemize specific costs.
- Utilities. The basics of keeping your business running are fully deductible as well. You can deduct the costs of utilities such as electricity, water, heat, internet and landline.
- Travel. Business travel costs are fully deductible. These include flights, hotels and other transportation costs you incur while on a business trip.
- Employee salaries. Paying your employees pays off. Their salaries – along with many benefits, like retirement and education offerings – are tax-deductible.
Key takeaway: Some of the top deductions small businesses should be aware of include rent, home office expenses, employee salaries and utilities.
Small business tax resources
Here are some additional resources for learning about taxes:
- The SBA maintains a guide on navigating the tax code and staying up-to-date on your tax responsibilities as a business owner.
- The IRS website has more information about how the Affordable Care Act (ACA) affects small business owners' taxes, although the policies are subject to change.
- If you can choose which state your business will operate in, then you may want to consider the small business tax rates by state. Additional information and recommendations are available at the Tax Foundation.
- The SBA has a helpful guide on choosing the right business structure if you are just starting your business this year.
- The IRS website has additional details on the Small Business Health Care Tax Credit, which provides a tax credit to small businesses that offer healthcare coverage to their employees. You can learn if you are eligible and how to calculate and claim your credit.
- The IRS maintains an information center on self-employed and small business taxes.
- See our recommendations for the best tax software and the best accounting software for small business owners.
Sean Peek and Matt D'Angelo contributed to the reporting and writing in this article. Some source interviews were conducted for a previous version of this article.