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’re 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.
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, estimated tax, Social Security and Medicare taxes, federal unemployment tax, filing returns for payments to non-employees 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 from their business owner(s). This means C corporations pay tax on their income, and owners and employees pay taxes on their share of the profits, 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’ve set up is likely a pass-through entity. When a pass-through business earns profits, it does not send a portion of the profits to the IRS. Instead, the profits flow through to the owners of the 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, the business profits and losses are reported on the owner’s individual tax form.
- Partnerships: These businesses, owned by two or more people, file an entity-level tax return. In this type of business, all profits are divided among the owners, who must report their share of the net income on Form 1040 on Schedule E. The partnership itself must file an annual information form with the federal government.
- Limited liability companies (LLCs): LLCs are formed through the state, and all states allow single ownership. This structure protects personal assets and is less of a personal risk. They can be taxed as a sole proprietorship (“disregarded entity”), partnership, C corporation, or S corporation.
- S corporations: An S corporation is not really a separate kind of business structure, but a tax election status. A C corporation or an LLC can apply for S corporation status with the IRS. For a C corporation, S corporation status allows them to avoid double taxation. For an LLC, S corporation status allows the owners to save money on self-employment taxes (Social Security and Medicare) by allowing the owners to be employees of the LLC. Once that happens, the owners only pay Social Security and Medicare on their salary and not the rest of the profits. Businesses with the S corporation have more restrictions and more scrutiny from the IRS, though.
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 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 quarterly 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.
Employment and Payroll Tax
If you have employees or if you are the only employee of your S corporation, 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
- State taxes
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 classification, so be sure to review IRS guidelines. 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.
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 sometimes exclusions for things like food, medicine, clothing, utilities, and newspapers. Before you conduct business, 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, a portion of your property taxes may be able to be deducted. Please contact a CPA to learn about property tax in your state.
State and Local Small Business Taxes
Similar 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.
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 like ours, you can help 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.
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. One way we can help is with ZenBusiness Money, which simplifies your business finances and allows you to easily track expenses and deductions, helping you save money and lessening the aggravation of tax time. Learn more about tax filing and how to get a tax extension.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.