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Chapter 6-Income Taxes

  Chapter Selections
Income Tax Forms
First Corporate Return
Tax Planning
State Taxes

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Eventually you will have to deal with income taxes. The income tax laws are extensive and can be confusing for an individual starting a business. This chapter does not cover all the tax ramifications of a new business, however it provides some guidance on complying with the laws. Your CPA should be consulted when you are dealing with income taxes. Income taxes have a direct result and a potentially significant impact on the cash flow of your business.

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Income Tax Forms

Each type of legal entity is required to file a different type of income tax form.

Corporation. A corporation is considered a taxable entity and is required to file a federal Form 1120 and Pennsylvania Form RCT 101.

Partnership. A partnership is not a taxable entity. It is treated as a conduit through which taxable income is passed to the individual partners for inclusion in their respective tax returns. The partnership is required to file Federal Form 1065 and Pennsylvania Partnership Income Tax Form. No tax is due with these forms, however, included with the forms is a schedule K-1 which lists the various items of income and credits to be included on the individual partner's return.

S-Corporation. An S-Corporation is a type of corporation that is specially treated under the tax laws. The government taxes this type of entity in the same manner as a partnership, with certain exceptions. The tax forms required are federal Form 1120S and Pennsylvania Subchapter S Form RCT 101.

Sole Proprietorship. A sole proprietorship is considered to be a component of the individual's personal tax situation. The tax form required is the Schedule-C which is included with the owner's Form 1040. In addition, if the business has net taxable income then a Schedule 1040SE must be prepared to determine the amount of self-employment tax that is due. Pennsylvania follows these same rules with the exception of the self-employment tax which is not levied under the Pennsylvania Tax Laws.

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In addition to the regular tax forms the law requires that if an estimate of the tax is not properly prepaid on a quarterly basis, a non-deductible underpayment penalty will be levied. Since an estimate is based on forecasting the future, and liable to human error, the tax laws provide two safe-harbors to avoid the penalty for underpayment. When this was written, if your payments for each quarter equal the lesser of 100% of the prior year's tax or 90% of the current year's tax, then the penalty can be avoided. (You may want to check the current tax law if you could be subject to the underpayment tax penalty.) Estimates are filed using the following forms:

Corporate Federal-Tax deposit form deposited with your bank.

Individual Federal-Form 1040ES

Due Date The due dates of the various forms are:

Corporate Form 1120 are due the 15th day of the 3rd month after the end of the tax year. The deposit form is due the 15th day of the 4th, 6th, 9th and 12th months of the tax year.

Partnership Form 1065 is due the 15th day of the 4th month after the end of the tax year (April 15 for most partnerships).

Sole Proprietorship Form 1040 is due April 15th. Estimated tax payment Form 1040ES is due quarterly on April 15th, June 15, September 15, and January 15).

Extensions The business owner may request an extension of time to file the tax returns. However, these extensions do not extend the time for paying the tax.

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First Corporate Return

The first tax return a corporation files is very important. As part of that return elections are made which will dictate the way the corporation is taxed for many years to come. Some of the more significant elections that may need consideration are outlined below:

  1. Election to capitalize and amortize costs incurred to organize the business. These can be legal, accounting or similar fees paid to commence operations. Such costs are not normally considered expenses of the corporation and are not deductible unless this election is made.
  2. Election to accrue vacation pay earned but not taken by employees at the end of the tax year. Without this election, vacation pay is not deductible until the year it is taken.

The elections discussed above are only a few of those that may need to be considered in an initial return. A qualified tax practitioner can help plan how best to utilize elections to take advantage of some of the following provisions of the tax laws including:

a. Net-operating loss carryovers
b. Research and development tax credits
c. Business energy tax credits

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Tax Planning

Proper tax planning is essential in order to make the most of the income tax laws. You will probably need to develop a relationship with a qualified professional who has experience with the taxation of your type of business. Tax planning is not a one-time shot right before the return is due. Tax planning is a year-round endeavor requiring communication on both sides - you and your CPA. Proper planning ensures that there are no surprises when the return is filed.

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State Taxes

If your company will be doing business in more than one state, it is essential that you familiarize yourself with the tax laws and filing requirements of those states. Each state has its own rules and regulations; if you are in non-compliance, you may be barred from doing business in that state.

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Income tax laws are quite complicated. The amount you may save by attempting to tackle your own taxes, particularly as they relate to a business, can be greatly overshadowed by the expense you may incur if you make a mistake. This axiom takes on greater significance when the return is for a corporation--especially the first return. However, a far greater consideration than potential mistakes is missing opportunities which may be available to you and your business.

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  Links to other Chapters  

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Chapter One - Selecting a Legal Entity
Chapter Two -Registering with Tax Authorities
Chapter Three - Accounting & Bookkeeping
Chapter Four - Payroll Taxes
Chapter Five - Selecting a Year - End
Chapter Six - Income Taxes
Chapter Seven - Cash Planning & Forecasting
Chapter Eight - Obtaining Credit And Financing
Chapter Nine - Insurance
Chapter Ten - Selecting Professional Advisors