Glossary of Common Business Tax Terms Explained

Glossary of Common Business Tax Terms Explained

Navigating the world of business taxes can feel like learning a new language. Whether you’re a seasoned entrepreneur or just starting your first business, understanding common tax terms is essential. This glossary breaks down key business tax terms into simple language, helping you file confidently and make informed decisions about your company’s finances.

Taxable Income

Taxable income is the portion of a business’s earnings subject to taxation. It’s calculated by subtracting allowable deductions (e.g., operating expenses, depreciation) from gross income. Businesses must report taxable income on their tax returns to determine their tax liability.

Gross Income

Gross income is the total revenue earned by a business before subtracting any expenses. For most businesses, this includes sales revenue, service fees, and other forms of income. Understanding gross income is crucial because it serves as the starting point for calculating taxable income.

Adjusted Gross Income (AGI)

Adjusted Gross Income, or AGI, is used primarily by individuals but is also relevant for sole proprietors or single-member LLCs. AGI is calculated by subtracting specific adjustments (e.g., retirement contributions, health savings account deductions) from gross income. It’s an important figure that affects eligibility for certain tax credits and deductions.

Business Deductions

Business deductions reduce taxable income and lower the amount of tax owed. Common deductions include rent, utilities, employee salaries, and professional services. Some industry-specific deductions may also apply, such as inventory costs for retailers or equipment expenses for manufacturers.

Depreciation

Depreciation refers to the gradual reduction in value of a business asset over its useful life. Businesses can deduct depreciation expenses to reflect the wear and tear of assets like machinery, computers, or vehicles. The IRS provides specific guidelines on how to calculate depreciation through methods like straight-line or accelerated depreciation.

Tax Credits

Tax credits are dollar-for-dollar reductions in the amount of tax owed. Unlike deductions, which reduce taxable income, credits directly lower your tax bill. Common business tax credits include the Research and Development (R&D) Tax Credit, Work Opportunity Tax Credit (WOTC), and energy efficiency credits.

Estimated Taxes

Businesses that don’t have taxes withheld throughout the year—such as sole proprietors or partnerships—must pay estimated taxes quarterly. These payments cover income tax, self-employment tax, and any other applicable taxes. Failure to pay estimated taxes on time can result in penalties.

Self-Employment Tax

Self-employment tax is a combination of Social Security and Medicare taxes paid by self-employed individuals. As both employer and employee, self-employed business owners must pay the full 15.3% tax on net earnings, although part of this amount is deductible when calculating AGI.

Net Operating Loss (NOL)

A Net Operating Loss occurs when a business’s allowable deductions exceed its taxable income in a given year. Businesses can often use NOLs to offset taxable income in other years, either by carrying losses forward or backward (subject to IRS rules).

Pass-Through Entity

Pass-through entities, such as sole proprietorships, partnerships, and S corporations, don’t pay corporate taxes. Instead, their income “passes through” to the owners’ individual tax returns, where it is taxed at personal income tax rates.

Corporate Tax

Corporate tax is the tax imposed on the profits of C corporations. Unlike pass-through entities, C corporations are taxed separately from their owners, and they may be subject to both federal and state corporate tax rates.

Payroll Taxes

Payroll taxes are taxes businesses must pay and withhold from employee wages. They include Social Security, Medicare, federal income tax, and state income tax. Employers are responsible for submitting these taxes to the IRS and state agencies regularly.

FICA (Federal Insurance Contributions Act)

FICA taxes fund Social Security and Medicare. Both employers and employees contribute, with each party paying 6.2% for Social Security and 1.45% for Medicare. Self-employed individuals pay both shares through the self-employment tax.

1099 Form

The 1099 Form is used to report income paid to independent contractors or freelancers. Businesses must issue a 1099-NEC for payments totaling $600 or more during the tax year. Properly filing 1099s is essential to avoid penalties.

W-2 Form

The W-2 form is issued to employees, detailing their annual wages and tax withholdings. Employers must provide W-2s to employees by January 31 of the following year and submit copies to the IRS and Social Security Administration.

Capital Gains

Capital gains refer to the profit from selling a business asset, such as property or stocks. Short-term capital gains (for assets held less than a year) are taxed at regular income tax rates, while long-term gains (held over a year) benefit from lower tax rates.

Section 179 Deduction

The Section 179 deduction allows businesses to deduct the full cost of certain assets (e.g., equipment, software) in the year they are purchased rather than spreading the expense over several years through depreciation. This incentive encourages investment in business growth.

Schedule C

Schedule C is a tax form used by sole proprietors to report business income and expenses. It’s submitted with an individual’s Form 1040 and provides a detailed account of revenue, costs, and deductions.

K-1 Form

The K-1 form is used by partnerships, S corporations, and some trusts to report income, deductions, and credits distributed to owners or shareholders. Recipients use the information on their individual tax returns.

Tax Filing Deadlines

Businesses must adhere to specific filing deadlines. For example:

  • S corporations and partnerships: March 15
  • C corporations: April 15
  • Sole proprietors: April 15 (alongside personal tax returns)

Amortization

Amortization is similar to depreciation but applies to intangible assets like patents or trademarks. It spreads the cost of these assets over their useful life, reducing taxable income gradually.

Franchise Tax

A franchise tax is a fee imposed by some states on businesses for the privilege of operating within the state. It’s not based on income but may depend on revenue, capital, or other factors.

Excise Tax

Excise taxes are taxes on specific goods or activities, such as fuel, alcohol, or environmental impact. Businesses involved in these industries must understand their excise tax obligations.

Withholding Tax

Withholding tax is the portion of employee wages withheld by employers for federal and state income taxes. Accurate withholding ensures employees don’t face large tax bills at the end of the year.

Filing Extensions

If a business needs more time to prepare its tax return, it can request an extension using IRS Form 7004. Extensions typically grant an additional six months but don’t extend the time to pay any taxes owed.

Tax Compliance

Tax compliance refers to adhering to tax laws and regulations, including accurate reporting, timely filing, and paying taxes due. Businesses that fail to comply may face penalties, audits, or legal action.

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