Understanding Business Tax Basics

Most new business owners are surprised by taxes — not just the amount, but the timing and complexity. This module covers the basics so you're not caught off guard. It's an overview, not tax advice — tax law varies by state and changes regularly, so treat this as the map, not the final word for your specific situation.

If you're self-employed or run a default-taxed LLC, you pay self-employment tax of 15.3% on your net business income, covering Social Security and Medicare. A regular employee only pays half this rate because their employer pays the other half — when you're self-employed, there's no separate employer, so you owe both halves yourself. This surprises a lot of new founders. For the full mechanics, including how an S-Corp election can reduce this, see S-Corp vs. LLC: Taxes & How Owners Get Paid.

Employees have taxes withheld from every paycheck automatically. Self-employed people don't have anyone doing that for them — so the IRS expects you to pay estimated taxes four times a year instead of one lump sum the following spring. This is the same "pay-as-you-go" logic behind payroll withholding generally (see the Hiring module) — the system is built to collect tax close to when it's earned, and underpaying can trigger penalties even if you pay the full amount by year end.

Legitimate business expenses reduce your taxable income. Common deductions include a home office (specific rules apply), the business portion of your phone and internet, software and subscriptions, business travel, professional development, equipment and tools, advertising, self-employed health insurance premiums, and retirement contributions (SEP-IRA, Solo 401k).

The rule that governs all of it: expenses must be "ordinary and necessary" for your type of business — ordinary meaning common and accepted in your industry, necessary meaning helpful and appropriate for your business (not that it was strictly required). This is a real legal standard, not just a guideline, and it's the test the IRS applies if a deduction is ever questioned.

Different business structures are taxed differently — covered in full depth in the Business Structures and S-Corp vs. LLC modules. The short version: a sole proprietor or single-member LLC reports business income on Schedule C of their personal return; a multi-member LLC or partnership files a partnership return (Form 1065) with profit passing through to partners; an S-Corp files a corporate return (Form 1120-S) with owners paid a salary plus distributions; and a C-Corp pays corporate tax on profit, then owners pay personal tax again on any dividends — "double taxation," which is why most small businesses not raising institutional money avoid the C-Corp structure.