Definitive Guide to Small Business Tax Rates

Small business entrepreneurs might know everything under the sun about the product or service that they are marketing, but even the sharpest experts in their respective fields might not know that much about how different types of companies are taxed.

If you’re a small business owner, do you know what your tax rates will be? The answer to that question is critical for your financial management and varies widely depending on what type of business you own, as well as other critical factors.

A ‘C’ corporation is taxed at 21%, but an ‘S’ corporation and a sole proprietorship carry different tax rates. The sole proprietor of a company doesn’t have to deal with the same tax rate that a ‘C’ corporation does. One’s personal income tax rate applies when paying taxes on a sole proprietorship.

If you own a business of your own, it can be very beneficial to find out what tax cuts, exemptions, tax deductions, or incentives you might qualify for, as well as knowing all the taxes for which you are responsible. Unfortunately, some entrepreneurs diving into the realm of owning their own business might not realize that they’re also responsible for more than just income tax, including unemployment taxes and payroll taxes.

What kind of small business tax rates are there? What’s my local tax? What’s the minimum tax? How does my small business income impact my tax rate? We answer all of these questions here.

Income Tax Rates

Individuals have to pay tax on their income from wages as well as investments. Corporations also pay income tax on the net income they earn annually. Their net income is how much is left after subtracting business expenses.

In a business that is set up as a pass-through entity, the company itself does not pay income tax. The owner(s) of the business pays income tax. Pass-through entities include LLCs and sole proprietorships. In these cases, owners of the company pay tax on business income at their individual tax rate on their personal return instead of the business.

Employment and Payroll Tax Rates

A small business owner who has employees must incur employment taxes, at both the federal and state levels. Some of the employment taxes include:

1) Federal Income Tax Withholding, in which employers must subtract taxes from an employee’s pay and to pay those taxes to the government on behalf of the employee for that tax year;

2) Medicare Tax: 2.9% (1.45% for the employer and 1.45% for the employee);

3) Social Security Tax: 12.4% on wages paid up to $168,600 (6.2% for the employer and 6.2% for the employee);

4) Federal Unemployment Tax: 6.0% on the first $7,000 that was paid to each employee.

5) State Unemployment Tax (those rates vary from state to state, for example New York taxes are not the same as South Dakota).

Self-Employment Tax Rates

A self-employed person whose net earnings exceed $400 must pay a self-employment tax. If you are self-employed, then you pay 100% of the amount for Social Security and Medicare taxes on your own tax bill.

The IRS defines a self-employment tax as one that has both Social Security and Medicare taxes for individuals who work for themselves. Employees who get paid wages by a company have their Social Security and Medicare taxes withheld from their regular salary.

Employers calculate Social Security and Medicare taxes of most wage earners. A self-employment tax (SE tax) is calculated using Schedule SE (Form 1040 or 1040-SR). The employer-equivalent portion of the SE tax can be deducted in calculating adjusted gross income. Taxpayers in this scenario do not deduct Social Security and Medicare taxes.

Sales Tax Rates

A business owner selling goods or services must collect a sales tax on each taxable sale. Then, you, the owner of the company, have to remit the tax to the state, either every quarter, every month or every week, depending on the volume of sales. There is no federal sales tax, but sales taxes exist in the state and even sometimes on the municipal level, at varying rates. Customers pay sales tax on goods and services when they purchase, but the business is responsible for calculating, collecting and reporting to local and state governments.

Property Tax Rates

Business property tax can either apply to physical land or a business location that you, the entrepreneur, own, or the personal property, or any goods or products, you use to operate your business.

If you own a small business, you might have to get used to the idea of paying business income taxes on more dates than just the April 15 due date that individual filers all over the United States have come to memorize.

When you are employed by someone else, your employer withholds taxes from your paycheck all year based on the amount that you are expected to owe.

When you file before April 15, you generally pay any remaining tax liability if your withholdings were too low, or you get a refund if too much was withheld.

But, if you are a business owner rather than someone else's employee, it's up to you to pay estimated taxes after the end of each quarter, typically based on how much income you earned, or how much income you'd estimated that you would make during that three-month period.

So, now your tax payment deadlines are March 31, June 30, Sept. 20, and Dec. 31. If you miss any quarterly tax deadlines, the penalties and interest for not paying estimated taxes on time could be a big financial hit if you owe a lot or go a long time without paying what you owe. Tax laws are serious.

The quarterly federal taxes you owe will include self-employment tax if you’re a sole proprietor or operate through an LLC. If your business operates as a 'C' corporation or an LLC taxed as a 'C' corporation, and you are also employed by the C corporation or LLC, you do not pay a self-employment tax on the salary you pull from the business in a year, but rather pay only the employee portion of Social Security and Medicare taxes (the business pays the employer share).

A business with employees may also owe quarterly employer taxes, which include Social Security, Medicare taxes and federal unemployment taxes, for those employees. The state taxes you may owe each quarter include state and local income or franchise taxes, sales and use taxes, as well as employment taxes, if you have employees.

Small Business Classifications

There are four main categories of small businesses. They’re not all taxed at the same rate.

‘S’ Corporation:

'S' corporations do not pay income taxes. A Small Business Corporation consists of shareholders who divide their gains or losses and then include the resultant figure(s) on their own personal income tax returns instead. S corporations cannot have more than 100 shareholders, all of whom must be citizens of the United States. S Corporations are only responsible for taxable income at the individual level. Taxable business income can be separated into salary and distribution, with only the former being subject to the self-employment tax. In sole proprietorships, partnerships or LLCs, the self-employment tax applies to the full net business income.

‘C’ Corporation:

A 'C' corporation pays corporate income tax on its income, after offsetting income with losses, deductions, and credits. A 'C' corporation has no restriction on its total number of shareholders. All the company's profits are distributed to the shareholders, who are subject to pay individual income taxes on the dividends they receive. What percentage of dividends each shareholder pays depends on how many shares they own. A C corporation’s tax liability is a flat rate of 21%. At one time, it was 35%, before President Donald Trump signed the Tax Cuts and Jobs Act of 2017 into law. Shareholders in a 'C' corporation pay a double tax. The profit of a company is taxed to the corporation, then also taxed to the shareholders when distributed as dividends.

Sole Proprietorship:

A sole proprietor owns an unincorporated business by himself or herself. Sole proprietorships are subject to pass-through taxation. The owner of the company reports income or loss from his business on his personal tax return, but the business entity itself is not taxed separately.

Limited Liability Company (LLC):

In an LLC, the owners are not personally liable for the company’s debt or liabilities. An LLC combines elements of both corporations and sole proprietorships. An LLC protects its owners from personal responsibility for its debts or liabilities. LLCs can be a single or multiple-member LLC. Unlike sole proprietors, LLCs are given an EIN (Employer Identification Number) in which you can use to file your taxes rather than filing under your Social Security Number. If you are the sole member of a domestic LLC, you are not a sole proprietor if you elect to treat the entity as a corporation.

What is the difference between revenue and profit?

Income generated by a company's operations is revenue. It's what you bring in, before calculating your expenses. Profit is what your net income is after you subtract the total of all your expenses from your earnings. Revenue comes from sales, income from fees, and income generated by property.

Do small businesses pay taxes on revenue or profit? Corporate income taxes are based on the profits that a company declares. Small business owners pay both an income tax and a self-employment tax. According to Nerd Wallet, up to an average of 30% of a small business’ income after deductions might be needed to cover federal and state taxes.

What is the difference between a small business and a big business?

Small businesses are less bureaucratized in their business structure and have more direct communication. Their intimacy, nimbleness and adaptability are some of the advantages of a small business. A big business runs less of a risk of failing because its financial backing is much more substantial. It's much more common for the owner of a small business to be the person who actually runs the company. A bigger business is more likely to be run by managers than by the owner(s).

Takeaways

Now that you understand your tax rates, it’s essential to make sure you are compliant. As a small business, you hardly want to get involved with any issues regarding the IRS. Make sure you understand your tax classification as well, as misclassifying yourself could come with penalties.

All in all, you should now be armed with the knowledge to avoid any penalties and understand how to file your taxes (or get help filing your taxes) this upcoming tax season.

FAQs

What is the best tax structure for a small business?

An S corporation, or S corp, is a business structure that helps owners avoid the double taxation that C corporations face. Instead of the company paying corporate taxes, profits—and certain losses—flow directly to the owners' tax returns. This way, income is only taxed once at the individual level, making it a tax-friendly option for many small business owners.

What percentage should a small business save for taxes?

A good rule of thumb for covering your federal taxes is to set aside about 30% of your business income. John Hewitt, founder of Liberty Tax Service, suggests saving 30-40% of your earnings to cover federal and state taxes. This approach helps ensure you’re prepared when tax time rolls around, avoiding any surprises.

How to organize taxes for small business?

Following best practices for small business taxes can save you time, money, and stress. Start by hiring the right accountant to ensure your finances are handled properly. Always report all income to the IRS and keep detailed records to avoid compliance issues. Separating business and personal expenses is crucial to maintaining clear financial records. Understanding gross and net income differences will help you manage cash flow effectively. Additionally, correctly classifying your business structure can greatly impact your tax obligations. Lastly, managing payroll properly ensures compliance with tax laws and keeps your business running smoothly. You can minimize tax burdens and avoid costly mistakes by staying organized and informed.

How do small businesses avoid paying high taxes?

Small business owners have several smart ways to reduce their tax bills and keep more of their hard-earned money. One effective strategy is paying for health insurance, which can often be deducted as a business expense. Saving for retirement through tax-advantaged accounts secures your future and lowers your taxable income. The qualified business income deduction can further reduce your tax burden. If you use your car for business, don’t forget to track mileage and claim-related expenses. Depreciation expenses allow you to deduct the cost of business assets over time, easing the financial impact of big purchases. The home office deduction can help offset costs if you work from home. Finally, any financing costs related to your business, such as loan interest, may also be deductible. You can maximize your savings and improve your bottom line by leveraging these tax-saving opportunities.

What is the $75 receipt rule?

Employees are required to submit paper expense reports and receipts for the following situations: 1) any expense over $75 where the details of the purchase aren’t clear on the electronic receipt; and 2) all lodging invoices when the credit card statement doesn’t include a detailed itemization of each charge. This helps ensure that all expenses are properly documented and categorized.

Frequent searches leading to this page