How do you know if your income is taxable in the US? Any income received by a small business is taxable generally. Except when it is specifically exempted by law.When it is exempted by law, it is shown in the tax return but no tax is payable on the same. A full list of all of these taxable and non-taxable incomes can be accessed at Publication 525 of the IRS. In this article, we will deal with the basic understanding of Taxable and non-taxable income of a small business in United States.

 

Some very important points with respect to income can be summarized below:

1.Income can be received in the form of money, property or services. Income is generally taxable when it is generally available to you. Actual receipt of such income is not relevant.

2.Prepaid income is also considered income for the current financial year generally. However, that will not be the case if accrual basis of accounting is followed In that case, you can defer the prepaid income you receive for services to be performed before the end of the next tax year.

3.If your income is received by your agent, then also it will be treated as your income.

4.If you contractually agree that income due to you shall be directed to a third party like your spouse or your parents, it will be treated as your income.

Treatment of some special items:

1.Employee Compensation

Every part that you receive in payment for providing personal services is to be considered as “Employee Compensation”. Salary, wages, bonus, tips, stock options, fringe benefits- all are considered as a part of employee compensation.

You should receive a Form W-2, Wage and Tax Statement, from your employer showing the pay you received for your services.

Special  attention – childcare/babysitting services:

If you provide child care, either in the child’s home or in your home or other place of business, the pay you receive must be included in your income.  If you are not an employee, you are probably self-employed and must include payments for your services on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business. You generally are not an employee unless you are subject to the will and control of the person who employs you as to what you are to do and how you are to do it. These rules apply to babysitting cases as well.

2.Rental Income

If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is generally determined by:

• Whether or not the rental activity is a business, and
• Whether or not the rental activity is conducted for profit.

Generally, if your primary purpose is income or profit and you are involved in the rental activity with continuity and regularity, your rental activity is a business.  

3.Fringe Benefits

Fringe benefits received in connection with the performance of your services are included in your income as compensation as an employee/director/contractor/partner. This is unless you pay fair market value for them or they are specifically excluded by law. Here also, the laws of assignment of income as mentioned earlier will apply. 

4.Partnership Income

A partnership generally is not a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed through to the partners based on each partner’s distributive share of these items. A firm files its information return on Form 1065, U.S. Return of Partnership Income.

Partner’s distributive share means the share of partnership income, gains, losses, deductions, or credits which are based on the partnership agreement. Actual receipt of these components is irrelevant. Further, your distributive share of the partnership losses is limited to the adjusted basis of your partnership interest at the end of the partnership year in which the losses took place. 

5.S Corporation Income

Again an S corporation does not pay tax on its income. Here also, the income, losses, deductions, and credits of the corporation are passed through to the shareholders based on each shareholder’s pro rata share. An S Corp files its return on Form 1120S, U.S. Income Tax Return for an S Corporation. This shows the results of the corporation’s operations for its tax year and the items of income, losses, deductions, or credits that affect the shareholders’ individual income tax returns.

Shareholders must report the share of these items on their return. Generally, the items passed through to you will increase or decrease the basis of your S corporation stock as appropriate.

6.Royalties

Royalties from copyrights, patents, and oil, gas and mineral properties are taxable as ordinary income. It is generally reported in Part I of Schedule E (Form 1040), Supplemental Income and Loss.  However, if you hold an operating oil, gas, or mineral interest or are in business as a self-employed writer, inventor, artist, etc., report your income and expenses on Schedule C or Schedule C-EZ.

 

We will discuss the taxability of most of the above items along with steps to file your return in subsequent articles. Keep following us!