For every challenge a small business owner faces, you either have to hire someone to help or figure out how to deal with it yourself. Taxes can be a significant challenge for small businesses, especially for new owners just getting started.
So if you’re going to handle the bookkeeping and finances, you need to understand how they work. If you plan on hiring an accountant or tax professional to help with filing, you won’t have to become an expert yourself, but it will still help to understand how tax liability works.
Here’s a guide to understanding the basics of small business taxes and how to calculate what you’re going to owe.
What Are Small Business Taxes?
Small business taxes include many different kinds of taxes that a small business is responsible for paying. These are various payments that your business must make to the federal, state, or local government.
Small business taxes can vary depending on your business entity and business location. Not every entity will have to pay taxes the same way, and certain states and counties or municipalities will have different taxes on small businesses.
How Are Small Businesses Taxed?
Small businesses can be taxed in various ways. The primary tax to deal with is the income tax. Some business structures must pay taxes as a business entity, whereas others allow business owners to pay income tax as individual taxpayers.
Your income determines your tax liability for federal and state income taxes, and you must make quarterly estimated tax payments throughout the year to keep up with your obligations.
Small business taxes include many other possible tax obligations beyond income tax, however. But before you concern yourself with those, you need to be sure you understand your business entity and the specific tax rates and concerns that come with that specific structure.
Business Entity Income Tax Rates
Tax rates will vary depending on your business entity. How is your small business organized, and what kind of legal entity is it?
The critical factor here is whether or not the government recognizes your business as a pass-through entity. A pass-through entity is a business in which all business income passes through to be taxed only on the individual business owner’s personal tax return.
Other companies must make tax payments on behalf of the business instead of letting the income pass through directly to the shareholders.
C-corporations must file and pay taxes on all of their business income according to the corporate tax rate. Then any shareholders who receive dividends will pay taxes on that money again when they file their own personal returns. The corporate tax rate at the federal level in the United States is 21 percent of net income in 2021.
Small C-corporations can file paperwork with the IRS and elect to be recognized as an S-corporation if they meet certain requirements. The main difference between an S-corp and a C-corp is that an S-corp is a pass-through entity, so the S-corporation’s income will pass through the company directly to its shareholders, who will pay taxes on that income as individuals.
Shareholders will divide the corporation’s net income and pay taxes for their portion according to their individual income tax rates. At the federal level, these income tax rates will range from 10% to 37%.
Partnerships are also a pass-through entity, much like the S-corporation. Therefore, each partner will pay taxes for their portion of the net business income at individual tax rates that range from 10% to 37%.
Unlike shareholders in an S-corporation, however, general partners are subject to self-employment taxes as business owners. Find more detailed information about self-employment taxes below.
Sole proprietorships are the most common small business entity. Sole proprietors are not legally distinct from the business itself, so they will pay taxes for all of their business income.
Their income tax rate will depend on their particular tax brackets but range from 10% to 37%. Because they’re self-employed, they will also be required to pay self-employment taxes.
Sole proprietors must also pay estimated taxes on their own individual returns on income throughout the year. Every business and a self-employed individual must make these estimated quarterly payments.
Limited liability companies, also known as LLCs, are taxed according to how they file with the government. LLCs can file to be taxed as an S-corporation or a C-corporation, but that’s not the most common practice.
Generally speaking, single-member LLCs will pay taxes as a sole proprietorship. In contrast, multi-member LLCs will pay taxes as a partnership, both of which mean paying income taxes according to the individual’s personal income tax bracket. Partnerships are pass-through entities, while sole proprietorships don’t exist as an entity separate from the individual.
Other Business Tax Factors
As a small business owner, your net income is the primary information you’ll need for calculating your tax liability. Then there are two more main factors you’ll want to consider to figure out how much you owe in income tax.
You’ll pay more than you’re supposed to if you don’t claim the proper tax credits and deductions on your tax returns.
Tax credits are a valuable way to reduce taxes for small businesses. Using tax credits simply reduces your tax liability, as they effectively serve as a payment from the government to cover part of the tax you owe for the previous year. There are over a dozen tax credits available for businesses, so be sure to take advantage.
On the other hand, tax deductions lower your taxable income before calculating the total tax you owe. This means that deductions can even bring you down into a lower tax bracket if your income is right on the threshold.
You can deduct many or all of your regular and necessary business expenses from your income if you run a business. This can reduce your taxable income considerably if you make sure to keep your receipts and record all of your eligible business expenses. Some deductions even let business owners deduct the costs of new or depreciated assets.
Business Taxes Beyond Federal Income Tax
When you think about small business taxes, federal income tax may be the first thing you think about, but that doesn’t mean it’s the only tax you need to worry about. When it comes to tax calculation and planning for your company, there is a lot you need to keep on your radar.
State Income Taxes
Most states have an additional income tax for individuals and businesses within their borders, but the rates and differing policies for businesses and individuals will vary widely. Seven states don’t charge income tax, and two states only charge tax on investment income.
You will need to look into your own state’s policies to see what taxes you may be subject to. Your state might use a progressive tax rate like the federal government, or they might use a flat tax rate. You’re also likely to need a state tax ID no matter the shape of your particular state income taxes.
Gross Receipts Tax
There are ten states with a gross receipt tax, which is a flat-rate tax on businesses. It taxes businesses at a flat percentage of all income they receive. Because it is calculated according to gross income, not net income, this doesn’t include any deductions for business expenses.
This tax functions like a sales tax, except that the business is expected to pay for it, not the customer. The rate for this tax is generally lower than the normal income tax rate, but it applies to all sales made by that business.
Payroll taxes are taxes imposed as a percentage of employee’s pay. There are federal and state payroll taxes, and some are paid by employers directly, whereas employers pay some with money withheld from employee wages.
Businesses must submit payroll taxes as contributions on employees’ behalf to support Medicare and Social Security at the federal level. The total federal payroll tax is 15.3% of gross employee wages. Half of that is paid by the employer, while the other half is paid through employee withholding.
Payroll taxes at the state level can pay for various other programs, often including unemployment. Employers pay into unemployment regularly so that employees can later apply for those resources if they lose their job.
If you’re not an employee on someone else’s payroll, you still have to pay many of those same taxes, including Social Security and Medicare taxes. This is what’s also called a self-employment tax.
Whereas your employer would withhold a portion of your wages and then pay another portion of these FICA taxes on your behalf, self-employed individuals are responsible for the full amount on their own.
You’ll pay self-employment taxes by filing IRS form Schedule SE, self-employment tax, which is affixed to either form 1040 or form 1040-SR. You must file as long as your net earnings from self-employment are $400 or more.
Excise taxes are extra charges imposed by the government on certain specific products or services. It will only apply if you manufacture or sell certain products or use various equipment or facilities subject to one of these taxes.
IRS form 720, the Quarterly Federal Excise Tax Return, includes most federal excise taxes and instructions for calculating the amount owed. For excise taxes due quarterly, you can use form 720, but you will use IRS form 2290, Heavy Highway Vehicle Use Return, to calculate and pay annual taxes due for using heavy trucks on public highways.
Sales taxes are imposed directly on the sales of goods or services. There is no federal sales tax, but many states and municipalities set a sales tax at varying rates.
You will need to know how your state handles sales taxes. If you need to collect a sales tax determined by your state or municipality, you’ll then need to remit those taxes to the proper authorities regularly.
If you make many sales online, you might also be subject to other states’ sales taxes. If you have a nexus in a state, which means that you do a significant amount of business with customers there, you may be required to remit sales tax for those qualifying purchases. This will depend on laws in each state and the kind of good or service you provide.
Some states may also impose a use tax. This is a tax on a good used by a business if sales tax was not paid initially at its time of purchase.
Property taxes are exactly what the name suggests. They are taxes imposed on property you own, usually determined by the size and value of that property. This varies widely by location, but it can represent a high cost for businesses that own real estate.
Beyond real estate, some states collect property tax levied on valuable business assets, equipment, and vehicles as well. If your company is likely to be subject to this tax, then properly managing your business property tax is going to be an important and significant task.
Get Advice from an Expert
There’s no simple solution or easy equation for calculating the entirety of your small business taxes. A lot will depend on your location, business structure, and the nature of your business. However, taking care of your tax obligations and planning carefully for the money you owe may be a time-consuming and essential task.
Invest in the stability and efficiency of your business by working with a tax accounting expert who knows the specific laws that apply to your business and your location. Working with a professional with knowledge of your context and situation is the only way to get real and reliable information on what you should expect.