Tax liabilities can differ depending on business structure, location, and several other factors. Sole proprietors, for example, may face a 13% federal tax rate, while small partnerships and S-corporations (S-corps) pay nearly 24% and 27%, respectively.
Knowing where your small business stands with tax rates is crucial to filing the proper taxes at the right time. Not only must you be concerned with income tax but other costs such as self-employment and excise taxes. With legal implications for your business, taxes can make or break your success.
Here are several things to be aware of for your small business’s taxes, including how to file and what to pay.
How Do Small Businesses Pay Taxes?
No two small businesses are alike, and that makes for a unique structuring of business tax liabilities. Business structures account for the primary reason behind different tax rates and payment options for small businesses.
According to the Small Business Administration, nearly 87% of all non-employer businesses in the U.S. are sole proprietorships, in which a business and business owner are not considered separate entities. This type of business structure passes through tax liabilities to the personal returns of the owner, who reports income and losses on the return and pays a personal income tax rate.
Similarly, partnerships and limited liability companies (LLCs) can enjoy pass-through taxation with profits taxed on the owner’s returns. Small businesses operating as these structures must:
- File Form 1065 to report business income, losses, deductions, and credits for informational purposes
- Pass through profits or losses to all partners with their respective shares
Ninety-five percent of all businesses in the U.S. are recognized as pass-through businesses. However, the remaining 5% are C-corporations (C-corps) with a very distinctive means of taxation. C-corps go through a double taxation process, paying income tax on profits before individual shareholders are taxed on dividends recorded on personal returns.
Want to avoid double taxation? Though S-corps reap the advantages of a corporation, they are treated as pass-through businesses. S-corp owners use the pass-through method and have shareholders report profits and losses on personal returns.
What Taxes Do Small Businesses Pay?
Though many small businesses are taxed differently from corporations, the list of taxes is similar across business structures. What changes is how the small business pays and the rate at which it’s taxed.
A shortlist of tax liabilities small businesses must account for include:
- Income tax: Federal, state, and local taxes on income earned during the tax year which can be passed through to personal returns depending on business structure
- Self-employment tax: Important for sole proprietors and those who work for themselves to cover government-mandated Social Security and Medicare taxes
- Employer tax: Federal taxes to cover Social Security, Medicare, federal unemployment, and income tax withholding for any employees
- Estimated tax: Federal tax on income not subject to withholding or if withheld taxes will not cover how much you will owe in the tax year
- Excise tax: Federal tax for businesses meeting requirements outlined by the IRS, such as manufacturing certain products or using special equipment.
Your small business may have a different list of taxes, depending upon your location, product or service, and holdings. Some additional taxes include property tax (buildings or land owned by the business) and dividends tax (investments made by the business that produced income in the form of dividends).
How Much Taxes Do Small Businesses Pay?
How small businesses are taxed depends on the structure and federal, state, and local taxes. Yet with the current tax laws, small business owners can estimate rates and ensure they are paying the proper quarterly amount. Here is what you should be prepared for:
Sole proprietorships, partnerships, LLCs, and S-corps use the pass-through method, wherein profits and losses are reported on the business owner’s and shareholders’ personal tax returns. This means that profits (i.e income) are taxed at the personal rate.
You can use the IRS income tax brackets in Publication 15-T to see what percentage you owe based on income.
For example, let’s say you make the average small business owner's income in 2021, which, according to Payscale, is $66,725. According to the IRS Publication 15-T bracket, because you make between $44,475 and $90,325, you would owe $4,664 plus 22% on income over $44,475. The flat tax rate plus $4,916.12 (the 22% additional income charge) means you would owe $9,580.12 to the IRS for that specific tax year.
Income tax brackets are specific to federal tax but do not account for state income tax. You should be prepared for the amount you owe to be larger than the result from using the bracket calculation. Estimated taxes will make it easier to cover the cost by separating it into four manageable payments throughout the year.
C-corps exist as a separate entity from the business owner and are taxed outside of the owner’s tax return. The C-corp tax rate is currently 21%, which is the flat rate used to tax this type of business on any profits made.
Small business owners need to cover more than federal and state income tax. Additional liabilities to prepare for are self-employment tax and employer tax (i.e. payroll tax).
For sole proprietors, the IRS mandates a 15.3% self-employment tax and filing Form 1040 if net earnings are $400 or more. This covers 12.4% for Social Security and 2.9% for Medicare.
Meanwhile, small business owners with employees need to pay 7.65% for payroll (or FICA) taxes, covering Social Security, Medicare, and unemployment insurance for employees. The employees match the 7.65% tax contribution to reach the 15.3% amount.
Small Business Taxes at the State Level
State income tax is a separate cost small businesses must account for. However, this cost is much harder to identify on average as each state has a very different rate.
The Tax Foundation has released its 2021 state business tax report, which outlines the states with the highest and lowest income tax rates. The more tax-friendly states for small businesses to operate in would include those without a corporate or individual income tax such as Wyoming and South Dakota.
On the other end of the spectrum, states with the highest tax rates include New York and New Jersey. In fact, New Jersey ranks at the very bottom of the Tax Foundation’s report with one of the highest corporate tax rates at 9% and individual income tax rates.
Frequently Asked Questions (FAQs)
What do you need to give your accountant for small business taxes?
Working with an accountant is the best way to submit taxes correctly and on time. You’ll want to bring an income statement, expenses statement, business registration, tax forms, and payroll information to start the process.
What percentage does a small business pay in taxes?
The amount you’ll pay in small business taxes depends on many factors, most importantly business structure and location. The average pass-through business owner ranks within the 22% personal income tax bracket. A C-corp, though, will pay a flat tax rate of 21%.
When are quarterly taxes due for small businesses?
Quarterly taxes are a great way to handle significant tax bills by using estimated taxes and paying in four equal amounts. Estimated taxes are due April 15, June 15, September 15, and January 15 of the following year.
How much do accountants charge for small business taxes?
Tax preparation for business taxes can vary depending on the IRS forms required. According to the National Society of Accountants, business tax preparation can vary from $174 for Form 1040 Schedule C to $778 for Form 1120S for S-corps.