Tax Basics for Business

The freelancer who owed $23,000 she did not have

In 2020, Sarah quit her marketing job and went freelance. She was good — really good. By December, she had earned $110,000 in her first year. More than her old salary. She felt unstoppable.

Then she did her taxes in April.

As an employee, taxes had been invisible. Her employer withheld federal income tax, state tax, Social Security, and Medicare from every paycheck. She never thought about it. As a freelancer, nobody withheld anything. Every client payment landed in her bank account in full, and she spent it like it was all hers.

It was not all hers. She owed $18,700 in federal income tax, $3,200 in self-employment tax (Social Security + Medicare), and $1,400 in state taxes. Total: $23,300. Plus a $1,200 penalty for not making quarterly estimated payments — a requirement she did not know existed.

Sarah had $4,000 in her checking account.

This story plays out thousands of times every year. The tax system is not designed to surprise you — but if you do not understand the basics, it will surprise you anyway.

The four taxes every business faces

There Are No Dumb Questions

"What is the difference between a tax deduction and a tax credit?"

A deduction reduces your taxable income. If you earn $100,000 and have $20,000 in deductions, you pay tax on $80,000. A credit reduces your actual tax bill dollar for dollar. A $1,000 tax credit saves you $1,000 in taxes — regardless of your income. Credits are more valuable than deductions because they directly reduce what you owe, not just what you are taxed on.

"Do I have to pay taxes on revenue or profit?"

Profit. You pay income tax on net income — revenue minus allowable deductions. If your business earned $200,000 in revenue and had $150,000 in deductible expenses, you pay tax on $50,000. This is why tracking expenses meticulously is not just good accounting — it directly reduces your tax bill.

Estimated quarterly taxes

If you expect to owe more than $1,000 in federal taxes for the year, the IRS requires you to make quarterly estimated tax payments. The due dates:

Notice: the quarters are not evenly split. Q2 only covers two months while Q3 covers three. This is an IRS quirk that has confused people for decades.

How to calculate estimated payments:

1. Estimate your total annual income
2. Subtract expected deductions
3. Calculate the tax on the result (income tax + self-employment tax)
4. Divide by four
5. Pay each quarter using IRS Form 1040-ES (or online at irs.gov/payments)

Common business deductions

Deductions reduce your taxable income, which reduces your tax bill. Here are the deductions every small business owner should know:

There Are No Dumb Questions

"Can I deduct meals and entertainment?"

Business meals where you discuss business with a client, partner, or prospect are 50% deductible. Entertainment (sports tickets, concerts) is generally not deductible since the 2017 Tax Cuts and Jobs Act eliminated it. Keep receipts and note who you were with and what business was discussed — the IRS requires documentation for meal deductions.

"What about the standard deduction?"

The standard deduction ($14,600 for single filers, $29,200 for married filing jointly in 2024) is a personal tax deduction — it does not affect business deductions. You claim business deductions on Schedule C (for sole proprietors), and then you also get either the standard deduction or itemized deductions on your personal return. Business deductions and personal deductions are separate systems.

Record-keeping: what to keep and for how long

The IRS can audit returns from the past three years (six years if they suspect significant underreporting). Keep these records for at least that long:

Keep for 3 years minimum:

• Bank statements and credit card statements
• Receipts for all business expenses over $75
• Invoices sent and received
• Mileage logs
• Payroll records

Keep for 7 years (recommended):

• Tax returns and all supporting documents
• Contracts and agreements
• Employment records
• Depreciation schedules

Keep permanently:

• Business formation documents (articles of incorporation, LLC operating agreement)
• Property records
• Annual financial statements

When to hire an accountant

You do not need an accountant to track income and expenses — software handles that. But there are clear trigger points where professional help pays for itself:

Hire a tax preparer (CPA or Enrolled Agent) when:

• Your total income exceeds $75,000/year
• You have employees
• You are deciding between business structures (LLC vs. S-corp vs. C-corp)
• You are taking deductions you are not confident about
• You have been notified of an audit

Hire a bookkeeper when:

• You spend more than 5 hours/month on bookkeeping
• Your transaction volume exceeds 100 per month
• You are consistently behind on reconciling accounts
• You are making errors that your accountant has to fix at tax time

The cost of professional help:

• Bookkeeper: $200-500/month for a small business
• Tax preparation (sole proprietor): $500-1,500/year
• Tax preparation (S-corp or partnership): $1,000-3,000/year
• Full-service accounting (bookkeeping + tax + advisory): $500-2,000/month

A good accountant typically saves you more in taxes than they charge in fees. The S-corp election alone can save a $150,000/year freelancer $10,000-15,000 in self-employment taxes — far more than the accountant costs.

Business structures and tax implications

The S-corp election is the most common tax optimisation for profitable freelancers and small business owners. Once your net income exceeds roughly $60,000-80,000/year, paying yourself a "reasonable salary" and taking the rest as distributions can save thousands in self-employment tax.

Key takeaways

• Four taxes affect businesses: income tax (on profits), self-employment tax (Social Security + Medicare for self-employed), sales tax (on transactions), and payroll tax (on employee wages).
• Self-employed people must make quarterly estimated payments. Missing them triggers penalties. Save 25-30% of every payment for taxes.
• Deductions reduce taxable income. Track every business expense — home office, vehicle, equipment, professional services, health insurance, retirement contributions.
• Keep records for at least three years (seven is safer). Use accounting software. Photograph receipts. The IRS accepts digital copies.
• Hire a professional when the complexity exceeds your confidence. A good CPA saves more in taxes than they charge in fees.
• Business structure matters for taxes. An S-corp election can save thousands in self-employment tax for profitable businesses.