As a small business owner, you already have enough to worry about. By the time tax season comes around, the last thing you want to think about is the amount of tax you owe. With tax rates subject to change every year and the legal jargon that goes into discussing them, it can quickly become an overly complex topic, so it’s important to understand the basics.
Whether you’re coming up on the first anniversary of your small business or still in the process of outlining your business plan, this beginner’s guide to taxes will explain the ins and outs to simplify the process when tax season comes around. Additionally, you’ll learn about the individual taxes that affect small businesses and how they are calculated.
What is the small business tax rate?
As a small business owner, taxes can be difficult because of the number of factors that determine how much you owe. Because of the circumstances that impact taxes, there isn’t a set small business tax. Rather, there are several types of taxes that small business owners have to think about.
To begin with, small businesses are subject to state, local, and federal tax obligations. Depending on your location, you may only have to pay federal taxes, while in other locations, you will need to pay state, local, and federal taxes. You can find your state tax obligations here to see if you are subject to these tax obligations.
In conjunction with your local and state obligations, your business structure also plays a large role in determining which income tax return forms you’ll need to file. As a small business owner, you will likely need to focus on the two main types: corporations and pass-through entities (such as LLCs and sole proprietorships). Below, we’ll discuss these primary business structures and how this impacts your tax rate.
Tax Rate for Corporations
Corporations are usually liable for income, self-employment tax, estimated tax, Social Security and Medicare taxes, federal unemployment tax, filing returns for payments to nonemployees and other transactions, and excise taxes. They also can claim some tax benefits, specifically special tax deductions.
It’s important to note, though, that not all corporations are treated the same. C corporations, for example, are recognized as a separate tax-paying entity than their business owner. This means C corporations pay tax on their income, and owners and employees pay taxes on whatever they earn, also known as dividends. This creates a double tax.
For C corporations, dividends can be classified into two categories: ordinary or qualified. Ordinary dividends — sometimes referred to as unqualified dividends — are taxable as normal income, while qualified dividends are taxed differently. Qualified dividends, if they reach a certain requirement, are taxed at lower capital gain rates.
Since the exact corporate tax rate can vary and be confusing, we recommend that you reference the Internal Revenue Service (IRS) website or contact a tax professional, such as a certified public accountant (CPA).
Tax Rate for Pass-Through Entities
If you’re not a C corporation, the type of business you have set up is likely a pass-through entity. When a pass-through business earns profits, it does not send a position of the profits to the IRS. Instead, the profits flow through to the owners or members of a business. The owners are then responsible for paying the tax to the IRS. That means that pass-through businesses pay individual income taxes, not corporate income taxes. Since they avoid the trouble of double taxation, pass-through entities compile all of their allocated shares of profits into a taxable income. This income then goes under the individual income tax.
Pass-through entities include:
- Sole proprietorships: Sole proprietors are single owners and do not need to file another tax return. Instead, all of the net income from their business must pay payroll taxes and is subject to the Schedule C tax form.
- Partnerships: These businesses, owned by two or more people, file an entity-level tax return. In this type of business, all profits go to the owner, who must report their share of the net income on Form 1040 on Schedule E.
- Limited liability companies (LLCs): LLCs are formed through the state, and most states allow single ownership. This structure protects personal assets and is less of a personal risk. They can be taxed as a partnership, corporation, or as part of the tax return of their members.
- S Corporations: Businesses with the S corp structure are only allowed to have one class of stock and no more than 100 shareholders who are U.S. citizens or residents. An S corp is a type of business that doesn’t have to pay the Self-Employed Contributions Act (SECA) tax on their profits. Instead, they must pay themselves “reasonable compensation,” which is subject to the Federal Insurance Contributions Act (FICA) tax and Social Security.
As you can see, a big benefit of setting up your business as a pass-through entity is that it makes everything simpler when it comes to taxes. Business owners can combine their personal and business income for tax purposes, with all business profits only being taxed once.
Types of Taxes for Small Businesses
There are a number of factors to consider when calculating how much money your small business will need to pay in taxes. Aside from your business structure, local, state, and federal laws may apply to your business. As taxpayers, understanding the factors that impact your small business’s taxes will help when it comes to filing your annual tax report.
The main types of taxes for small businesses are:
- Income tax
- Employment and payroll tax
- Self-employment tax
- Excise tax
- Sales tax
- Property tax
Most small businesses will need to file an annual income tax return for their business income. Every business needs to file a return based on their business entity type, which can be found here.
It’s important to note that the federal income tax is a pay-as-you-go tax, meaning that you must pay the taxes as you earn them. If you do not pay the federal income tax as you go or make estimated tax payments, you can pay additional taxes when you file your tax return.
The estimated tax is what you pay as you receive income throughout the year. Your income tax rate typically increases as your individual income increases. If you don’t pay enough of the estimated tax or make late payments, you may be charged a penalty.
Individuals who should pay the estimated tax include:
- Sole proprietorships
- S corporations
Employment and Payroll Tax
If you have employees, you will be responsible for employment taxes. Not only will you be subject to additional taxes, but you will also need to file additional forms. The IRS website provides an explanation of employment taxes, which includes due dates, how to correct, and how to file forms.
Employment taxes cover:
- Social Security and Medicare taxes
- Federal Unemployment Tax Act (FUTA) tax
- Federal income tax withholding
Employment taxes take into account their filing status (single, married, etc.), additional income, how often the employee is paid, and tax cuts. When completing this form, you will need the employee’s W-4 form to provide vital information.
The self-employment (SE) tax is for self-employed individuals, meaning that they work primarily for themselves. However, self-employment tax can vary for LLC owners depending on their structure and classifcation, so be sure to review IRS guidelines on whether you need to file or not.This tax covers Medicare tax and is used to pay into your coverage under the Social Security system.
The self-employment tax rate is 15.3%, 12.4% of which goes toward Social Security and 2.9% of which covers Medicare. While filing, you can deduct what is considered the employer-equivalent portion of your tax, such as business expenses, which helps adjust your gross income. For example, a business expense can involve what you need for your home office.
The excise tax is specific to certain industries and for certain circumstances. If you do any of the following, you may need to file an excise tax form: operate certain types of businesses (for example, those that use trucks and fuel); use different types of equipment, facilities, or products; manufacture or sell particular products; and receive payments for specific services.
Excise taxes through the federal government that are reported on Form 720 consist of several categories. This form includes various categories of taxes:
- Communication and air transportation taxes
- Environmental taxes
- Fuel taxes
- Manufacturers taxes on the sale or use of different articles
- Tax on the first retail sale of heavy tractors, trailers, and trucks
Sales tax is dependent on the state in which you conduct business. Businesses that sell goods and services often need to pay a sales tax in their state. However, there are some exclusions: food, medicine, clothing, utilities, and newspapers. Before you conduct business, you should check to see if you need to register to pay or collect sales tax in your state.
In most cases, your state and local governments will collect property tax. This tax applies to small businesses operating with taxable property; although, the exact rules can be different since your local government is in charge of imposing this tax.
Even though each state can have individual criteria for what property is taxable, here is a general list of taxable property:
- In some states, you might be charged for real estate property, such as land, items attached to the land, homes, wharves, condominiums, and factories.
- Moveable personable property, such as airplanes, boats, cars, computer equipment, furniture, jewelry, and tools
Since every state has different guidelines for property tax, and there isn’t a standard flat rate, exact calculations will vary. If you work out of your home or run your business from your home, property taxes may able to be deducted. Please reference this resource to learn about property tax in your state or contact a CPA.
State and Local Small Business Taxes
Similarly to property taxes, business taxes can vary at the state and local levels. This is why it’s important to get the right tax information for your state. This way, you can prepare for taxes and ensure compliance with local, state, and federal tax laws. Currently, 43 states and local municipalities require residents to pay personal income tax. This local and state income tax is in addition to the federal income tax.
When determining tax rates and meeting deadlines for tax filings in your local area, referencing this resource can be helpful in ensuring that you have the most up-to-date information for paying local taxes. As mentioned, you will also need to file federally for your business’s taxes, which can be completed online. The IRS website provides detailed information about which forms you will need to complete, how to access them, and how to pay taxes, which can be found here.
Managing Your Small Business Taxes
In addition to tax requirements, many states require small businesses and self-employed individuals to file an annual report. Without this report, you may not be able to remain in good standing. If critical compliance dates are missed, your business might be subject to penalties and fees that can remove your business’s right to operate. By using an annual report service, you can ensure that all of your compliance deadlines and tax deadlines are met and done correctly.
Being a small business owner is hard enough. When it comes to the end of the tax year, you might consider hiring a tax professional like a CPA to simplify this process. This way, you can avoid the hassle and costly fees, focusing instead on running your business. Getting up to speed with the tax laws helps ensure that you meet critical deadlines and avoid penalty fees that take away from your hard-earned business income. Keep in mind that as a small business owner, you will likely be required to pay the typical personal tax return and business income tax; although, this depends on your type of business.
At ZenBusiness, we’ve been in your shoes, which is why we’ve made it our mission to help simplify the process of being a small business owner. We offer affordable solutions for small businesses to succeed and thrive by offering educational resources in addition to business formation services.