How Income Taxes Work for Boutique Owners
...PLUS how much you should be saving for taxes!
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Today we’re diving deep into a topic that makes a lot of boutique owners sweat – taxes. More specifically, we’re going to be looking at the income tax. This is the tax that you’re already used to filing every year sometime between January – April, so you’re probably at least somewhat familiar with this process. However, things do tend to get a little more complicated once you become a business owner.
Believe me, I know how these topic can make your eyes glaze over. In fact, my income tax class in college was by FAR my least favorite Accounting class, and I told myself I was never going to get into tax work (Oops!). But, I’ll try and break this down as simple as possible for you to understand.
How Income Taxes Work for Sole Proprietors and LLCs
Most of the boutique owners I’ve worked with begin their business as a sole proprietor or LLC business. Both of these types of businesses are known as pass-through entities, which simply means that all of the income & expenses “pass through” to the individual business owner(s) own personal income tax return.
This means that you will report all of your business income & expenses on a Schedule C that is attached to your personal tax return. You can see what the Schedule C looks like here. You will report all your income at the top, and you will be able to list all of your deductible expenses after that.
If you take a look at the Schedule C, you may notice that there are a lot of different expenses listed under Part II that don’t apply to you. Don’t worry, you can find a more boutique-friendly list of deductible expenses in my free download here. Any of these that don’t already have a spot on the Schedule C can be grouped together and reported on the “Other Expenses” line, then listed out under Part V.
Once you subtract all your deductible expenses from you total income, you will get your net profit or loss for the year. This is the number that is reported on your personal tax return.
How Income Taxes Work for LLCs That Elect an S Corp Status
The next most popular business type I see for boutique owners is an LLC that elects to be taxed as an S Corp. It’s important to know that an LLC and an S Corp are the same in regards to their legal/business structure. The only thing an S Corp represents is that they choose to be taxed differently.
There are some significant tax benefits to becoming an S Corp, but I highly recommend you work with an Accountant if you are considering to change your tax status. I’ll do a post another day on the benefits & requirements of making the S Corp election, but for now, I’ll just say it doesn’t really make sense if you have less than $90,000 of PROFIT to show at the end of the year.
So, how to taxes work for an S Corp? Well, just like a sole proprietor or LLC, an S Corp is also a pass-through entity, but the business is required to file it’s own business tax return first. This return is known as an 1120-S, and is typically due around March 15th – one month BEFORE the individual income tax due date of April 15th. You can see what the 1120-S looks like here.
Very similarly to the Schedule C, you will report all business income & deductions on this tax return. Once this tax return is completed, it will generate a K-1 tax document that will report your taxable income for your business. Remember, since you’re on payroll, you will also receive a W-2 to show all your taxable wages and the tax that’s been withheld and paid on your behalf throughout the year.
You will use these 2 documents (K-1 and the W-2) and report the numbers on your personal tax return that is due around April 15th.
How Income Taxes Work for Partnerships
While this type of business structure isn’t quite as popular, it’s still worth explaining here. If you operate as a partnership, you will also need to file a separate business tax return that is due around March 15th on what’s called a Form 1065. You can see what that looks like here. Just like all the other returns, you report all your business income & expenses.
Once everything is completed, it will generate a K-1 for all partners that will reflect your portion of the business taxable income. You will then use this K-1 document to report your portion of the taxable income on your own individual tax return due around April 15th.
Understanding Self-Employment Tax
If you have ever been an employee, I’m sure you are painfully aware of how much can be taken out of your paycheck each pay period for taxes. A majority of these taxes go towards Social Security and Medicare. You may or may not be aware of this, but your employer is also responsible for matching those amounts each paycheck.
As a self employed sole proprietor, an LLC business owner (not an S Corp), or a partnership you have the “benefit” of paying both the employee and employer portion of the Medicare of Social Security tax. This is known as the self employment tax, and for 2023, that rate is 15.3%. That means that for every $10,000 of PROFIT you show, you will pay approximately $1,530 in self employment tax alone.
Welcome to the joys of being a small business owner!
If you’re a new business owner, you might be shocked when you see your first tax bill. That’s why I encourage all business owners to be saving some throughout the year to help pay for this when the time comes.
How Much Should You Be Saving For Taxes?
I get this question a LOT, and the answer can really vary depending on your specific situation. Remember most boutiques are pass-through entities so all of your personal tax matters come into play – how many kids you have, any other jobs you or your spouse may have, etc…
But, as a general rule, I recommend that sole proprietors, LLC owners and partnerships try to set aside approximately 30% of your PROFIT throughout the year. Remember, you’re going to be paying 15% alone in self employment tax.
If you’re an S Corp, you’ll be paying in the 15% for Medicare and Social Security with every paycheck, so I recommend setting aside the extra 15% for the year end tax return.
But remember, it’s 15-30% of your PROFIT, not your total revenue. That means you should subtract your business expenses before calculating this percentage. This is why it’s extremely important to keep up with your bookkeeping throughout the year, so you can have a better indication of what you should be saving.
Taxes are an unavoidable part of running a boutique, but with the right knowledge and preparation, they don’t have to be a source of stress. Be proactive, set some money aside throughout the year to save for taxes taxes, and keep organized & up to date bookkeeping records.
By doing so, you’ll be well on your way to financial success as a boutique owner. Remember, the more you know, the more you can keep doing what you love – serving your customers and growing your business!
Here’s to finding your own version of freedom,
Hi, I'm Megan!
Bookkeeping for the retail industry has some unique complexities that take extra time to manage to ensure accuracy. At Finding Freedom Financial Services, I provide done-for-you bookkeeping services for boutique owners that accurately track these complexities for you so you can have more time and focused energy to dedicate to running your stores. If you’re ready to get your time back, apply to work with me today!