Even the most intelligent business owners have trouble understanding small business tax rates. They might not know how many different types of taxes they have to pay, how each rate is calculated, or which factors have the biggest impact on their final tax bill. The answer to each question isn’t entirely clear because it depends on a variety of factors, like business structure and location.
And as if small business taxes weren’t already complicated enough, this year marked the introduction of the Tax Cuts and Jobs Act, a.k.a. the “Trump Tax Plan.” This law affects the tax rates and reporting duties of many small businesses, especially corporations.
Fortunately, it’s the responsibility of tax professionals like lawyers and accountants, not small business owners, to know the intricacies of business taxes. But learning how tax rates are determined and applied can help you make better financial decisions when growing your business. It’s much easier to move forward with new strategies and investments when you are absolutely certain how much you’ll eventually have to pay in taxes.
In this guide, we’ll lay out every single tax that may apply to your business, how each rate is calculated and how the aforementioned law changes the tax rate for certain business entities.
What are the Different Types of Small Business Taxes?
A U.S. small business must pay up to six types of business taxes. Some businesses have to pay all six while others are only responsible for one. The criteria are highly specific, down to the kind of products you sell and annual income. Thus, you’ll probably have to do a little research to determine which of the following taxes apply to your business.
Here are the six types of small business taxes:
All individuals and business entities must pay income tax. Federal income taxes are paid in all 50 states, whereas 43 states have state income tax.
The way income tax is paid, however, differs tremendously between standard corporations and other types of businesses. Corporations, or C-corps, are subjected to what is known as “double taxation.” The business is first taxed on its net income, which is income that has been adjusted for expenses. If corporate income is distributed to shareholders as dividends, that money gets taxed as well. Each stage of double taxation has its own tax rate.
Sole proprietorships, general partnerships LLCs, and S-corporations, on the other hand, are categorized as “pass-through” entities. This means there is no income tax on the business itself. Instead, the business owners only have to pay taxes on the business income at their individual tax rate and report the business income when personal tax returns are due. The income “passes through” to the individual business owner, rather than being taxed as a business.
Any company with employees must pay payroll taxes, also known as employment taxes. Payroll taxes consist of federal and state income tax withholding, social security taxes, Medicare taxes, state and local payroll taxes, and federal and state unemployment taxes. Some of these taxes are deducted from employee paychecks while others are paid directly by the employer.
In addition to these two responsibilities, employers must also file payroll tax forms and make payroll tax deposits. You can see where payroll taxes got their reputation for being notoriously complicated. This is why many businesses outsource all payroll tax responsibilities to a private payroll company. They’d rather not risk forgetting to file or filing late, which can result in severe penalties.
As the name denotes, self-employment taxes are meant for self-employed individuals. They consist of just two taxes (social security and Medicare) and are only paid if your annual net earnings from self-employment amounted to at least $400. Certain types of self-employment, like working for a religious organization, may be exempt from self-employment taxes.
Excise taxes are only paid by businesses that engage in certain activities or sell certain types of products, like cigarettes, liquor or gasoline. Since excise taxes are an indirect tax, the money is already included in the price of the item. Businesses that apply excise taxes must collect the money and send it to the IRS. Some states also charge a separate state excise tax on top of the federal tax.
Welcome to one of the biggest headaches for entrepreneurs. Sales taxes are applied in every state except for Alaska, Delaware, Montana, New Hampshire and Oregon. If you determine that your products or services are subject to sales tax in your locality, you must collect sales tax whenever a customer makes a purchase.
As of 2019, 24 states require Ecommerce businesses to collect and pay sales taxes if they process more than 200 transactions or earn at least $100,000 in sales per year. Here’s where it gets complicated: Not only do sales tax rates vary from location to location, but some states also tax items based on the location of the buyer, not the seller.
Deadlines for reporting and paying sales taxes vary tremendously from state to state and business to business as well. In some states, sales taxes must be reported and paid each month. Other states require quarterly or annual payments.
The reporting and payment schedule also depends on sales volume. Businesses with higher sales must typically file sales taxes more frequently. For example, your state might require monthly payments from businesses that exceed a certain sales volume and quarterly payments from businesses that fall under that volume.
Property taxes are for businesses that own property, be it commercial property, land, or a physical storefront. Such businesses must pay property taxes based on the location of the property.
When to Pay Small Business Taxes
Most business owners must estimate how much income taxes and self-employment taxes they owe and pay those taxes periodically. Your accountant will help you figure out the amount of each payment, which are based on your estimated taxable income for the whole year.
If your accountant determines that you will most likely owe more than $1,000 in taxes for the year, you must make quarterly state and federal tax payments. These payments will then be deducted from the total amount you owe when you file your tax return. Failing to make estimated payments by the quarterly due date can result in penalties and incur interest on the total amount you owe.
Small Business Tax Rates
The only tax rate that applies to all businesses from a single entity is the corporate income tax rate. Thanks to the Tax Cuts and Jobs Act, the corporate income tax rate went from a maximum of 35% to a maximum of 21%. This applies to all corporations, or C-corps. So, regardless of how much money a corporation makes, it won’t pay more than 21%.
As mentioned earlier, however, corporations are subjected to double taxation. If corporate shareholders take dividends or distributions from business income, that money is taxed at a separate rate. We’ll explain that rate in just a bit.
Most other business entities are pass-through entities. For that reason, business income is reported on the business owner’s personal tax return and taxed at the business owner’s individual income tax rate. In other words, there is no universal rate that applies to all S-corps, LLCs, etc. What we can tell you, though, is the current average income tax rate for certain pass-through entities compared to corporations:
Sole Proprietorships: 13.3%
Small Partnerships: 23.6%
Small S-corporations: 26.9%
Dividend Tax Rates for C-corps
There are two types of dividends: qualified and unqualified. A dividend is considered qualified if the shareholder has owned the stock for at least 60 days. The current rate for qualified dividends is 0% if you earn less than $38,601 per year and up to 20% if you earn more than $425,800. With unqualified dividends, a.k.a. “ordinary dividends,” the tax rate is equal to the shareholder’s regular income tax rate.
Income Tax Rates for Pass-Through Entities
Pass-through entities include sole proprietorships, general partnerships, LLCs, and S-corporations. The tax rate for these businesses is equal to the owner’s individual income tax rate.
Now that the Tax Cuts and Jobs Act is in effect, however, owners of pass-through entities can deduct up to 20% of their business income before determining their individual tax rate. This law only applies to single filers who earn less than $157,500 and joint filers who earn less than $315,000. Professional services, like medical practices and law firms, are also not eligible.
To demonstrate, let’s say a single owner of a pass-through entity reports $90,000 in net business income. This individual could therefore deduct $18,000, making the new net business income $72,000. So, instead of being taxed as someone who makes $90,000, the business owner would be taxed as someone who makes $72,000, which is an entirely different tax bracket.
Employment Tax Rates
Employment taxes include social security tax, Medicare tax and federal and state unemployment taxes. Here are the rates for all four:
- Social Security Tax: 12.4% on wages paid up to $128,400. Most business owners pay half of this amount with business income and take the other half out of employee paychecks. Since self-employed individuals do not have employees, they must pay the full amount on their own.
- Medicare Tax: 2.9% of all wages paid to an employee. Like social security, most business owners split this tax between business income and employee wages. Additional Medicare deductions may apply to certain employees who make more than $200,000 per year.
- Federal Unemployment Tax: 6.2% of the first $7,000 of employee wages. Business owners who pay their state unemployment taxes on time, however, typically receive a credit of 5.4%. Your new FUTA tax rate would therefore be 0.6%.
- State Unemployment Tax: This rate varies from state-to-state and depends on a variety of factors such as industry, employee turnover rate, and the size of your company. The amount of unemployment claims filed by former employees is a major factor as well. In summary, low employee turnover = low state unemployment taxes.
Excise Tax Rates
This rate varies tremendously depending on the type of product or service for sale. You can find the federal excise tax rates for each applicable product or service in the IRS’s Publication 510.
Sales Tax Rates
There are two types of sales tax rates: destination-based and origin-based. Thirty-eight states have the former, which means an item’s tax rate depends on the location of the buyer. So, if your business is based in New York but sells to a customer in Florida, that customer must pay the Florida sales tax because Florida is a destination-based state. You must also collect all local sales taxes for the customer’s location and file a Florida sales tax return before the state’s periodic due date. In summary, you must collect the correct sales tax for each customer located in a destination-based state.
As for the twelve states with origin-based sales taxes, the item’s tax rate depends on the location of the seller. District taxes, on the other hand, are based on the location of the buyer. If you only sell products in your state but in multiple cities or counties within that state, you must collect the correct amount from each locality.
Property Tax Rates
Property taxes rates depend on the property’s registered locality. After purchasing the property, your local tax authority will contact you about your property tax rates and due dates. If the assigned rate catches you off guard, remember that it’s based on the property’s assessed value, as opposed to the market value.
State Small Business Tax Rates
Aside from South Dakota and Wyoming, all states charge taxes on the income of all or certain business entities. For example, if a state does not have an individual income tax, that state likely has a corporate income tax or franchise tax. In other words, at least one business entity has to pay a form of income tax in all but two states.
Here are the three primary types of state small business taxes:
- Corporate Income Tax: Most states charge a corporate tax rate of 4% to 9% on net business income.
- Gross Receipts Tax: Five states have a gross receipts tax instead of a corporate income tax. This tax is based on a business’s total sales, as opposed to net income, which accounts for expenses.
- Franchise Tax: Fifteen states charge a franchise tax along with or instead of a gross receipts tax or an individual income tax. The rate is based on the value of the business’s stock or total assets and typically ranges from 0.1% to 0.9%.
As you can see, state business income tax rates vary tremendously from state-to-state. Thus, the only way to be truly 100% sure about your state’s taxes and rates is to contact your state’s business tax authority. This information is available online but, much like all other important business-related information, you can never be sure until you check with the most reliable source.
Other Factors That Affect Your Tax Bill
There are number of ways in which business owners can lower their tax bills or their taxable income. A good small business accountant is an expert in these tactics because applying them is often the individual’s primary responsibility. If you capitalize on the right deductions or credits, your business’s tax bill could be significantly lower than another business of a similar size and net income.
Tax deductions can be unbelievably advantageous. They lower your taxable income, thus making your business more profitable. Using an asset or expense to keep significantly more income almost feels like getting that asset or expense for free. In fact, many business owners would likely admit that they chose their industry primarily because of eligibility for more deductions.
Take Section 179 for example. With this deduction, you can deduct an asset’s total cost for the same year you bought it.Countless businesses capitalize on Section 179 by purchasing numerous expensive assets in the same year, even if they might not have use for them at this moment in time. Don’t have the money to make the purchase outright? Well, that’s what small business loans are for. If you rent your equipment or your office space, you can deduct your rent payments as well.
Ever wonder why so many people start businesses despite the massive upfront expenses waiting around the corner? That number would probably be a lot lower if it wasn’t possible to deduct up to $5,000 in startup costs. The vagueness of that term makes it increasingly applicable. You can even categorize the costs of researching an industry as “startup costs.”
Tax credits trump tax deductions when it comes to saving money. While tax deductions lower your taxable income, tax credits lower your tax bill directly. You can simply subtract the dollar value of the credit from your final bill. Fewer businesses, however, can meet the requirements for tax credits compared to tax deductions. But that could change very soon.
For instance, using alternative energy sources like wind energy or solar energy can make your business eligible for the Business Energy Tax Investment Credit.
A similar credit is available for businesses that buy hybrid, electric or diesel fuel vehicles. You may also be able to get a tax credit by modifying your physical location to accommodate handicapped individuals. One downside of tax credits is that you must have purchased and started using the equipment or facility in the year in which you are claiming the tax credit. You can use several tax deductions, on the other hand, year after year. With a vehicle, for example, you can deduct the cost of operating it every year it is in use.
Factoring Tax Rates into Decisions
You don’t have to be a tax wizard to run a successful small business. It’s your accountant’s job to know the myriad factors that influence different tax rates. What the business owner needs to know is which tax rates have the biggest influence on the business’s net income and the easiest ways This will prevent your business’s progress from having an unnecessarily negative impact on your taxes.
It’s also important to have a fairly clear idea of how much you’ll owe every quarter. This will allow you to create an accurate and realistic budget, which is an essential requirement for growth and overall success.