Essential Tax and Legal Terms for Small Businesses
Explore our comprehensive glossary of essential tax and legal terms for small business owners.
Running a small business is an exhilarating journey where you pursue your passion and build something remarkable. But let's face it: knowing the essential tax and legal terms can often make it feel like your small business is entering a foreign land. It's okay if you feel lost because tax literacy is a key issue that small business owners commonly struggle with.
Here's the scoop: you don't need a law degree to succeed in your small business. We've created a practical glossary of essential terms you should know. Consider this list a cheat sheet for demystifying the complexities of business legalese and navigating the legal and tax side of your business.
Whether you're passionate about your product or service or simply navigating the waters of entrepreneurship, understanding these terms is critical for nailing your tax strategies and ensuring long-term success. So, take a moment from day-to-day demands, grab a coffee, and let's dive into the essentials that will empower your business journey.
Business Structures
- C Corporation: A corporation subject to corporate income tax on its profits, taxed separately from any income its owners receive through dividends or salaries. This structure provides limited liability protection to shareholders.
- Corporation: A legally distinct entity separate from its owners, capable of generating profits, subject to taxation, and responsible for legal liabilities incurred in its operations.
- Limited Liability Company (LLC): A business structure offering limited liability protection, similar to a corporation, and a partnership's tax advantages and operational flexibility.
- Partnership: A business structure where ownership is shared among two or more individuals, each contributing to the business's operations. Partners share both the profits and losses based on their partnership agreement.
- S Corporation: A type of corporation that meets specific Internal Revenue Code criteria. Profits are passed through to shareholders and taxed at individual income tax rates, avoiding double taxation on corporate income.
- Sole Proprietorship: A business owned and operated by one individual, where the owner and the business are legally indistinguishable. The proprietor reports all business profits and losses on their personal tax return.
Taxation Basics
- Excise Tax: Government taxes imposed on specific goods at the time of purchase, such as gasoline, to discourage consumption or fund specific programs.
- Income Tax: A government levy on the earnings of businesses and individuals, calculated after deductions and credits. It funds public services and infrastructure; compliance is essential to meet tax obligations and avoid penalties.
- Payroll Tax: Taxes levied on employers and employees, calculated as a percentage of employee salaries, to fund social programs such as Medicare and Social Security.
- Sales Tax: A levy businesses impose on customers for goods and services sold, with the proceeds forwarded to the state government.
- Self-Employment Tax: Taxes paid by self-employed individuals to fund Social Security and Medicare, covering employer and employee contributions.
- Tax Bracket: A range of incomes taxed at a specified rate; higher incomes fall into higher tax brackets, subject to higher tax rates.
Deductions and Credits
- Depreciation: The systematic allocation of the cost of tangible assets over their useful lives for tax purposes, reflecting their gradual wear and tear or obsolescence.
- Bonus Depreciation: A tax incentive that enables businesses to deduct a significant portion of the purchase cost of eligible assets immediately upon acquisition rather than spreading it over the asset's useful life.
- Home Office Deduction: A tax provision that permits self-employed individuals to deduct expenses associated with using a portion of their home exclusively for business purposes based on the home office's square footage relative to the total living space.
- Section 179 Deduction: Allows businesses to deduct the entire purchase price of qualifying equipment and/or software acquired during the tax year.
- Tax Credit: An amount that directly reduces the taxes owed by individuals or businesses, typically providing a dollar-for-dollar reduction in tax liability, making it often more advantageous than a deduction.
- Tax Deduction: An allowable expense subtracted from gross income to lower taxable income, potentially reducing the tax owed.
Financial Statements and Reporting
- Balance Sheet: A financial statement that presents a snapshot of a company's assets, liabilities, and shareholders' equity at a specific date, providing insight into its financial health and solvency.
- Cash Flow Statement: A financial statement that summarizes the inflows and outflows of cash and cash equivalents from operating, investing, and financing activities over a specific period, providing insights into a company's liquidity and ability to meet its financial obligations.
- Fiscal Year: A consecutive 12-month period used for financial reporting and accounting purposes by organizations, which may or may not coincide with the calendar year.
- Gross Income: The total revenue earned from all sources, including sales, services, interest, dividends, rents, or any other business income sources, before subtracting any expenses or deductions.
- Net Income: The total earnings derived from subtracting all expenses from gross income, indicating the profitability of a business after accounting for costs.
- Profit and Loss Statement (P&L): A financial report that summarizes a business's revenues, costs, and expenses over a specified period, providing insight into its profitability or loss during that time frame.
Employment and Payroll
- 1099 Form: A tax form used to report various income received by individuals or businesses that are not considered wages, salaries, or tips.
- W-2 Form: A tax form that employers use to report wages paid to employees and the amount of taxes withheld from their paychecks, submitted to both the employee and the IRS for tax purposes.
- Withholding Tax: The portion of an employee's wages withheld by an employer and remitted directly to the government as an advance payment of income tax owed by the employee for the tax year.
- Work Opportunity Tax Credit (WOTC): A tax incentive provided to employers who hire individuals from designated targeted groups that face significant barriers to employment.
Recordkeeping and Compliance
- Audit: A thorough examination of an individual's or organization's financial records, accounts, and transactions to verify accuracy and compliance with tax laws and regulations.
- Corporate Transparency Act: Legislation aimed at improving transparency in business ownership by obligating companies to disclose information about their beneficial owners to the government to combat financial crimes such as money laundering and illicit financing.
- Employer Identification Number (EIN): A unique nine-digit identifier the IRS assigns to businesses and other entities for tax purposes, similar to a social security number for individuals.
- Filing Deadlines: Critical dates by which tax forms must be submitted to the IRS or other relevant authorities to avoid penalties and ensure compliance with tax regulations.
- Tax Return: A document filed with tax authorities that details an individual's or entity's income, expenses, deductions, and other pertinent financial information used to calculate tax liability or refund eligibility.
Legal Compliance
- Articles of Incorporation: A legal document that establishes a corporation and includes essential information such as its name, purpose, registered office address, and structure, outlining its formation and governance.
- Business License: A permit issued by a government agency that authorizes individuals or companies to operate legally within a specific geographical jurisdiction, ensuring compliance with local regulations and standards.
- Bylaws: Rules and regulations that outline an organization's internal governance and management structure, usually established by the board of directors for corporations or similar entities for other forms of business organization.
- Copyright: An exclusive legal right granted to the creator or owner of original literary, artistic, or musical works, enabling them to control the reproduction, distribution, and public performance of their creations and authorize others to use them under specified conditions.
- Operating Agreement: A legal document that outlines the management structure, operational procedures, and member agreements of a Limited Liability Company (LLC), specifying roles, responsibilities, and decision-making processes among its members.
- Patent: A government-granted license that gives the inventor or assignee exclusive rights to prevent others from making, using, or selling an invention for a specified period, typically 20 years from the filing date of the patent application.
- Registered Agent: A designated individual or business entity authorized to receive legal documents, including service of process, notices, and official correspondence on behalf of a business entity, ensuring compliance with legal requirements and facilitating communication with regulatory authorities.
- Trademark: A distinctive symbol, word, phrase, or design legally registered or established through use by a company or individual to uniquely identify and distinguish their goods or services from those of others in the marketplace.
Advanced Concepts
- Alternative Minimum Tax (AMT): A parallel tax system intended to ensure that high-income individuals, corporations, and estates pay a minimum level of tax by limiting certain deductions, credits, and exemptions allowed under the regular tax system.
- Business Meal Deductions: Expenses incurred for meals considered ordinary and necessary for conducting business are often eligible for deduction up to 50% of the cost. The meal must have a direct business purpose to qualify, and proper documentation must be maintained to substantiate the expense.
- Capital Gains Tax: A tax imposed on the profit realized from the sale or disposal of capital assets, such as property or investments, calculated based on the difference between the asset's sale price and purchase price (cost basis).
- Cost Segregation Analysis: A tax planning technique used to identify and reclassify components of a commercial property to accelerate depreciation deductions for tax purposes. This strategy aims to optimize cash flow by categorizing certain assets as personal property or land improvements, typically with shorter depreciation periods than real property.
- Franchise Tax: A tax imposed by certain states on businesses, typically for the privilege of existing as a legal entity and conducting business within a specific jurisdiction. It is separate from income taxes and is often based on the company's assets or net worth rather than its income.
- Intellectual Property (IP): Intangible creations of the human intellect, encompassing inventions, literary and artistic works, designs, symbols, names, and images used in commerce. IP rights grant exclusive ownership or control over these creations, protecting them from unauthorized use or reproduction.
- Net Operating Loss (NOL): Occurs when a business's allowable tax deductions exceed its taxable income for a specific period, resulting in a loss that can be carried forward or back to offset taxable income in other years, potentially reducing future tax liabilities.
- Pass-Through Taxation: A tax structure where business income is not taxed at the entity level but instead "passes through" to the owners or shareholders, who report the income on their personal tax returns and are taxed at their individual tax rates. This structure is typical for partnerships, limited liability companies (LLCs), S corporations, and sole proprietorships.
- SECURE Act: Legislation aimed at enhancing retirement security for individuals by facilitating greater access to tax-advantaged retirement savings plans and making it easier for businesses to offer such plans to their employees.
Empower Your Business with Knowledge
Understanding these key legal and tax terms enriches your knowledge and empowers you to make informed decisions. At Decimal, we believe knowledge is power and are dedicated to keeping business owners informed. Our goal is to assist you in making strategic decisions and enhancing your small business operations. Contact us today for a free bookkeeping consultation and learn how we can contribute to your business's financial success and growth.
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