How Much Tax Do Small Businesses Pay?

How Much Tax Does a Small Business Pay?
How Much Tax Does a Small Business Pay?. flyfloor/Getty Images

The Trump administration has made tax reform a key to its agenda, and the new Tax Cuts and Jobs Act, signed in December 2017, comes with several key changes to how small businesses pay taxes and how much tax they pay. What does the term "business tax" mean and how does it affect your small business? 

What is the Small Business Tax Rate?

When you think of "business taxes," you think of the federal and state business income tax rate.

But the National Federation of Independent Business says most small businesses don't pay tax at a business rate. About 75% of small businesses are not corporations. This large percentage of small businesses are "pass-through" entities, paying tax at the personal tax rate of the owner. 

Since small business (non-corporate) tax rates are tied to the total income of the business owner, we need to look at the income tax rates that will go into effect beginning in 2018 and continuing for 8 years.  

What is the Corporate Tax Rate? 

Larger businesses and those taxed as corporations will have the biggest tax cut under the new tax law. The corporate tax rate has been cut from a table with the highest corporate taxes at 37% to a flat 21%. This change has not expiration date on it. 

What Other Taxes Does a Business Pay? 

In addition to income taxes, the largest tax bill small businesses pay is for payroll taxes.

These taxes are based on employee pay at the rate of 7.25% on employee gross payroll. Other payroll taxes, like unemployment taxes and workers compensation taxes, increase the amount of tax an employer must pay.  

What About State Taxes for Businesses? 

The new tax law will also affect state income taxes (for states that have an income tax) and other state taxes.

Some changes that may affect you, depending on what state you do business in. States are considering the effects of the new tax law and some are concerned about the negative effect of the increased standard deduction and the fewer taxpayers itemizing taxes. 

How Small Business Owners Pay Tax

Most small businesses are owned by individuals. As discussed above, partnerships, LLC's, and sole proprietor businesses pay no business tax, but the tax is passed through to the owners and is paid by the owners on their personal tax returns. So, asking the question about how much tax they pay gets muddled up in the tax owed by the individual for all forms of income, not just the income of the business. 

The only type of business that pays taxes on its own is a corporation. The corporation's owners don't pay any tax on the corporation's profits, but they are taxed on their income if they work as employees, and they are taxed on dividend income they receive  (the so-called "double taxation" issue). 

Considering the Effective Tax Rate

Small businesses of all types pay an estimated average effective tax rate of 19.8 percent. The effective tax rate is the average rate of tax for a business or an individual taxpayer.

The effective tax rate is calculated by dividing the total tax paid by the taxable income. The other way to look at tax rates is the marginal tax rate, which is the highest rate paid by the business or individual. The corporate tax rate table, for example, has different tax rates for different levels of corporate income.

I don't like averages because they don't tell you much of anything about the ends of the curve. You know what they say: If you stick your head in the oven and your feet in the freezer, on average you're just right. 

According to the SBA report mentioned above,

Sole proprietorships face a 13.3 percent rate, small partnerships face 23.6 percent, and small S corporations face 26.9 percent. While not directly comparable, the rate faced by small C corporations is 17.5 percent.

Net income differences in types of businesses

What is more interesting to me in this SBA report is the statistics about net income.

Nearly 60 percent of small sole proprietorships have a net income of less than $10,000, while only 3.1 percent have a net income of at least $100,000. On the other hand, more than 18 percent of small S corporations have a net income of at least $100,000.

The higher income for corporations would be a factor in explaining their higher tax rate.

What about taxes for LLC businesses? 

If you are wondering why limited liability companies (LLCs) are not listed, remember that the LLC business type is not considered a tax entity by the IRS. LLC's with one owner are taxed as sole proprietorships, with tax liability calculated on Schedule C of the owner's personal tax return. Multiple-member LLC's are taxed as partnerships. In both cases, LLC taxes are passed through to their owners.