A common business accounting question that tax practitioners often hear from small-business clients is “Why doesn’t my business get a tax refund?” Taxpayers, in general, receive a refund only when they have paid more tax than was due on their return. The same is essentially true of businesses.
However, just like there are different types of taxpayers, there are different types of businesses, and this has an impact on a small business’s tax refund eligibility. Generally, C-corporations are the only type of business entity eligible for a tax refund. Your business also might receive a tax refund if it overpays on payroll or sales taxes. Here are the factors to consider.
Business entity type
When you started your business, you decided what type of business entity to form, which in turn determined the way you’ll pay your small-business taxes to the IRS and state.
Many small businesses elect to form entities that pass their income through to the owners. The owners are then taxed on their individual income tax returns. Because these types of entities pass the taxable income to the owners, the businesses don’t pay tax directly to the IRS and therefore would never receive a business income tax refund.
Types of entities that pass their income through to their owners include:
Sole proprietorship: Single-owner business that reports their income and expenses on the owner’s individual tax return (Form 1040), using a Form Schedule C.
Partnership: An unincorporated business with two or more owners; files a Form 1065 and issues Forms K-1 to the partners, who include the income and pay tax on their individual returns.
S-corporations: A corporation that has elected to pass the taxable income from the business through to their shareholders. The S-corp files a Form 1120S and issues a Form K-1 to each shareholder, who then reports the income and pays tax on their individual returns.
Limited liability company (LLC): Business owners who report income from pass-through companies include the income (along with income from other sources, like wages, interest and dividends, gains on the sale of property or rental income) on their individual 1040s. These individual owners would receive a refund only if their total payments and withholding exceed their total tax liability on the return.
The only type of business entity that can receive a tax refund is a C-corporation. What distinguishes a C-corporation from other business entity types is that its profits are taxed separately from its owners under subchapter C of the Internal Revenue Code. In other words, a C-corporation pays income tax directly to the taxing authorities (using Form 1120). Because of this, a C-corporation could receive an income tax refund if it pays more estimated tax during the year than is due on the final return.
This return would be reflected on the owners, partners or shareholders’ personal returns based on their total income.
The type of taxes you pay could also result in a tax refund for your business. Here are some situations where a business could potentially receive a refund.
Income taxes: C-corporations are the only business entity that would receive a refund of income tax, as discussed above. The owners, partners or shareholders would receive a refund on their personal returns based on their total income.
Payroll taxes: Regardless of entity type, if your business withholds and pays payroll taxes, you might receive a refund if your account is overpaid. Some restaurants may also receive a tip credit, which is a tax credit that an employer can claim to recover FICA taxes paid on tips received by employees. The tip credit can be used to reduce the income tax owed by the employer, which could result in a refund.
Sales or excise taxes: Most businesses are subject to excise or sales taxes, which are typically assessed by states or municipalities. In some cases, either an overpayment of these taxes or reassessment of the property value could result in a refund to your business.
Generally speaking, if you’ve paid more than your actual tax liability, you’re due a refund. But keep in mind that business taxes can be complicated. If you are unsure of how your business is being taxed or whether you should be getting a tax refund, you should find a qualified tax preparer, such as a certified public accountant (CPA) or enrolled agent, to help you.
How to maximize your tax refund
Many taxpayers deliberately have more tax withheld from their paychecks than is necessary in order to get a large refund each spring. However, overpaying on your taxes as a small-business owner reduces the working capital needed to run your business day-to-day. There are better ways to ensure you get a nice refund each spring. Here are a few suggestions:
Review personal bank and credit card statements
Although you should never mix business and personal finances, you may have used your personal bank account or credit card to make a business-related purchase throughout the year. Review your personal bank and credit card statements for business expenses you may have otherwise missed. Your business accountant should know how to record these expenses in your books so that they can be reflected on your tax return as a business expense.
Prepay upcoming expenses
If you have enough cash flow, consider prepaying upcoming expenses for the year like membership dues, insurance plans and IT services. Prepaying these expenses can result in cost savings in addition to minimizing your taxable net income for the year.
Check for tax credits
There are a number of tax credits available to businesses, including federal and state credits. Take the time to learn what tax credits your business may be eligible for. Consult with your accountant about any credits you may be entitled to take, either for the current year or future years.
Offer 401(k) matching
If you offer a 401(k) plan to your employees, consider offering matching, as well. The amount your company matches for retirement contributions is also a qualified business expense under most circumstances. In addition, it’s a nice thing to do for your employees!
Speaking of being nice to your employees, consider offering incentives like bonuses, gifts and awards. This isn’t just good from an employee-employer perspective — incentives can also be tax deductions. To create incentives that can also serve as tax deductions, review the IRS’s guide to fringe benefits.
Check the home office deduction
If you’re a small-business owner, chances are you have to work even when you are at home. If you have an office in your home, you may be eligible for a home office deduction — allowances based on the square footage of your office space. You may also be able to claim a portion of your homeowners insurance, utility expenses and depreciation of your home as business expenses.
Do you have to travel a lot for business? Keep track of your business mileage. In 2020, the standard mileage rate for business is $0.575 per mile. Therefore, if you traveled 100 miles per week for business, at the end of the year you could get a deduction of $2,990 on your taxes. If you need help tracking business mileage, there are a number of business expense tracker apps that will automatically update your mileage logs.
Getting the most out of your tax deduction
Not every business can get a tax refund. However, small-business owners who don’t qualify for a business tax refund could still see money back on their individual tax returns. There are also steps you can take to increase the amount of money you get back on your return, such as prepaying expenses and keeping track of tax credits you are eligible for. As with all things tax-related, to get the most bang for your buck, it helps to work with a qualified tax preparer, such as a CPA or enrolled agent.
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A version of this article was first published on Fundera, a subsidiary of NerdWallet.