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 small business tax reform is one major part of that effort. But 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 business 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. 

The NFIB says that the top individual tax rate is currently 39.6%, while the top corporate tax rate is currently 35%. And don't forget state and local taxes, which can increase the tax rate for small businesses up to 50%. 

Tax reform measures should address both corporate and pass-through taxes for small businesses. 

How Much Tax Do Small Businesses Pay? 

The answer is the question of how much tax a small business pays depends on the type of business and how the business is owned.

The Office of Advocacy of the Small Business Administration shows that average effective tax rates range from 13.3 percent for sole proprietorships to 26.9 percent for S corporations. The effective federal income tax rate, says the SBA, is the actual amount of taxes paid by a firm as a percent of its net income.

 Sole proprietorships have the lowest effective tax rate, while corporations have the highest. 

How businesses owners are taxed  

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. 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.