It is not uncommon for small businesses to have no income in the first year, and it’s also possible to have down years with little to no profit even after you’ve been running for a few years.
When tax time comes around, this gives rise to a series of questions.
- Do you need to file if you have no income?
- Can you still deduct your expenses with no income?
- How do you balance paying off small business loans with your taxes?
Unfortunately, there is no simple answer to these questions. Each case is different and the answer will depend on certain factors unique to your business.
Taxes for Small Business: Tax Status
The first thing you need to consider is the tax status of your business. This will depend on the business structure and some of the features of how it operates. In this section, we are going to look at some of the tax requirements for different types of small businesses.
Taxes for Small Business: Sole Proprietorships
Limited Liability Companies (LLC) with a single owner and sole proprietorships are subject to the same tax requirements. In both cases, the individual would need to file a schedule C to report the income and expenses of the business as a part of their personal income tax return.
Filing a Schedule C is not only good for reporting the income of your business, but it is also useful for reporting losses. However, if your business records less than $400 in income and has no expenses to report, there is no need to file a schedule C for a business the IRS treats as a sole proprietorship.
Taxes for Small Business: Partnerships
A partnership and an LLC with two or more owners will both have the same tax requirements. This means that if there is no income and no expenses to report, there is no need to file a tax return. If there is income to report or you have expenses that need reporting, you would file a 1065 for the business.
A 1065 is an informational partnership tax return. Even if the income and expenses pass on to the owners for their personal tax returns, this document is necessary to report the income and expenses of the business.
Taxes for Small Business: S-Corporation
If an LLC chooses the tax status of an S-corporation, it must file a corporate tax return even if there is no income or expenses to report. The purpose of an S-corporation is to avoid double taxation. With this business structure, all income and expenses pass to the owners, shareholders, or members of the LLC, so the business does not pay any taxes itself.
With an S-corporation, the business would file using form 1120S. The business doesn’t actually pay taxes, but this form is necessary to report the income and expenses so the IRS can check them against the returns of individuals.
Taxes for Small Business: Using Deductions
Knowing whether an expense is deductible or not is one of the most confusing parts of filing a tax return for a business. There are some general rules of thumb that can help you determine whether an expense is deductible, but this can be an area where it is better to seek the advice of an accountant.
In general, you can count an expense as a deduction if it is ordinary or necessary. This means the expense is deductible if it is common to businesses like yours or if the expense helps you run your business and make a profit.
Taxes for Small Business: A Small Business or a Hobby?
Another concern is whether the IRS is going to consider your business as a business or hobby. The IRS understands that there may be years where a business does not turn a profit. For that reason, they allow most businesses to report three out of five years of no profit.
If your business were to have more than three years out of five with no profit, it would indicate to the IRS that the business is not engaged to profit, and as a result, it would classify the activity as a hobby. That means you would no longer be able to report losses against any other income you may have.
In some cases, you might be able to continue reporting losses if you can demonstrate that there is an effort to run a profitable business. A previous history of turning a profit would be one way to demonstrate that it is a business and not a hobby. Making changes that show an effort to turn a profit could be another way to show that it is a business.
If the IRS views the activity as a hobby, you can still write off expenses up to the amount of income you made off the hobby. As an example, if you spent $1000 on the hobby and it returned $500 in income, you could write off $500 of those expenses in deductions. However, you could not write off the other $500 against any other income you may have.
Business taxes can be complex. If you have any doubt as to whether you need to file a return for your business or whether a specific expense is deductible, you should consult with a tax professional.