12 Tax Terms All Small Business Owners Should Know

Navigating tax terminology can feel like you are swimming upstream. Not every tax term is going to apply to your business. Here is a list of general tax terminology that all small business owners should be familiar with.
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1. Accrual Basis

There are two accounting methods to choose from when reporting income and taxes, accrual basis and cash basis. Accrual basis refers to a method where revenues are reported when they are earned (regardless of when the cash is received from the customer) and expenses are reported when they are incurred (regardless of when they are paid.) 

To gain a better understanding of accrual basis, check out our article, What is Accrual Basis Accounting?


2. Bad Debt

Extending credit to customers is part of doing business but there is an inherent risk that your customer will default and you will never collect the money. When this happens, the receivable is considered uncollectible and written off as a bad debt. 

For tax purposes, the direct write-off method is used when reporting bad debts which means there is no estimating involved. The amount of actual write-offs is reported on the tax return.


3. Business Expenses

Business expenses refer to the costs incurred during the normal course of running a trade or business. If a company operates to make a profit, these expenses may be deductible which will help reduce your tax liability. 

To learn more about deductible business expenses, check out our article, What is a Qualified Business Expense (deduction)?


4. Cash Basis

There are two accounting methods to choose from when reporting income and taxes, accrual basis and cash basis. Cash basis refers to a method where revenues are reported when cash is received from the customer (regardless of when the revenue is earned) and expenses are reported when they are paid (regardless of when they are incurred.) 

If you want to learn more about cash basis accounting, we have a whole article expanding on this topic. Click here to gain a better understanding of What is Cash Basis Accounting?


5. Charitable Contribution

It pays to be charitable! Contributions made to charitable organizations qualified under the IRS may be deductible on your tax return. 


6. Form 1099-NEC

Independent contractor income will be treated a bit differently moving forward. The 1099-NEC is the new tax form used for independent contractors’ payments during the 2020 tax year. However, all other applicable service payments will be reported on the tax form 1099-MISC.


7. Form 1099-MISC

Prior to 2020, the 1099-MISC encompassed everything from independent contractor payments to rental payments. In the upcoming tax season, you will notice a bit of a change. The 1099-NEC is now used for all independent contractor payments. Whereas the 1099-MISC is used for other payments, such as rental payments, awards, and legal fees paid.


8. Independent Contractor

When you hire direct employees, you have complete control over their work. You control and direct both what needs to be done and how it will be done. Independent contractors have much more independence. 

You may hire an independent contractor to accomplish a certain goal, however, you rely on that individual to decide what and how services will be performed. If you would like more info on distinguishing between employees and independent contractors, check out Employee vs Independent Contractor.


9. Self-Employment Tax

Being a small business owner has a lot of perks, but the self-employment tax is not one of them.  Social Security and Medicare taxes are due to the government based on wages with rates of 12.4% and 2.9% respectively. 

If you work for a company this tax burden is shared equally with your employer – you each pay half. If you are self-employed, you have to pay the entire amount yourself.


10. Small Business Corporation (S-Corp)

Corporations experience what is known as double taxation. Income is taxed when the corporation files its income tax return and then shareholders are also taxed on their individual tax returns. 

This would be unsustainable for a small business owner so typically one would become an S-Corp by filing Form 2553 with the IRS. This means that all income, losses, deductions and credits flow through directly to the owner(s) and are reported on a personal tax return at the individual income tax rates. There are IRS requirements to qualify for S-Corp status.

If an S-Corp sounds like you but you would like to learn more about some other options, check out How to Pick the Right Entity Structure For Your Business.


11. Tax Audit

It benefits a small business owner to forge a relationship with a reliable tax professional to help minimize the chance of incorrect or incomplete tax data being reported to the IRS resulting in a tax audit. 

A tax audit is when the IRS reviews and examines your tax return to verify its accuracy. Tax audits range from simple data requests through the mail to a field audit where IRS revenue agents examine your tax return in detail at your place of business.  


12. Tax Credit

Tax credits reduce the amount of tax owed to the IRS. Once you have determined your tax liability, applying for any tax credits you are entitled to will reduce your tax bill. The power of a tax credit is that it is a dollar-for-dollar reduction – unlike a tax deduction.


13. Tax Deduction

There are many business expenses that are tax deductible.  Your taxable income is reduced for all deductible business expenses which means you will pay fewer taxes.

A tax deduction is not a dollar-for-dollar reduction of your tax liability. It simply reduces the total taxable income that is then multiplied by your tax rate to determine how much you owe Uncle Sam.

If you would like to learn more about some tax deductions that may apply to your business, check out What is Deductible (Meals, Entertainment & Travel)?

A tax accountant can help you demystify tax terminology by helping you further understand these tax terms as well as countless others. 

This publication is designed to provide information on federal tax and accounting laws and/or regulations. It is presented with the understanding that the author is not rendering legal or accounting services.

This text is not intended to address every situation that arises or provide specific, strategic tax and/or accounting planning advice. This text should not be used solely to answer tax and/or accounting questions and you should consult additional sources of information, as needed, to determine the solution to tax and/or accounting questions.

This text has been prepared with due diligence. However, the possibility of mechanical or human error does exist and the author accepts no responsibility or liability regarding this material and its use. This text is not intended or written by the practitioner to be used and cannot be used by a taxpayer or tax return preparer, for the purpose of avoiding penalties that may be imposed.

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