Taxes might not be the most exciting task on a small business owner’s list of priorities, but they’re something you’ll need to think about, plan for and pay on a regular basis.
Learning how different tax issues can impact your business — whether they involve corporate income tax, small business tax rates, tax law changes, tax credits or something else — will help you be more prepared when it comes time to file your returns. This, in turn, will make for more efficient and successful operations.
Here’s your guide to taxes as a small business owner:
One step you’ll want to take before preparing your business tax return is to find out whether you qualify as a small business taxpayer. The Internal Revenue Service defines a small business taxpayer as one that:
- Has average annual gross receipts of $25 million or less for the three prior tax years AND
- Is not a tax shelter
This definition is important when it comes time to claim certain deductions and credits.
Beyond that, you should educate yourself on the various taxes, rules, timetables, tax rates and deductions for different business structures, legal structures and localities. Read on for a comprehensive guide to small business taxes.
How Taxes Affect Different Business Structures
The type of small business structure you operate under will determine when you file taxes and the types of taxes you’re required to file. It can also impact how much you’ll pay.
One thing all structures have in common is they’re required to make quarterly tax payments in the form of estimated taxes. These are designed to ensure businesses pay most of their estimated tax liability during the course of the fiscal year rather than in a single payment when tax returns are filed.
Here are the main types of business structures and how federal taxes affect each one:
Under this structure, the owner operates as an individual with no separation or distinction between personal and business finances. From a tax standpoint, this also means there is no distinction between your personal and business taxes. You’re entitled to all of the profits and responsible for all debts, losses and liabilities. Sole proprietors fill out IRS Form 1040 (Schedule C). They’re also responsible for paying self-employment tax for Social Security and Medicare withholding.
Partnerships are similar to sole proprietorships in that there is no separation between personal and business finances. The main difference is that each partner is liable for the debts and obligations of all other partners.
There are three main types of partnerships:
- General Partnerships
- Limited Partnerships
- Joint Ventures
All partners must file information returns using Form 1065 based on the business’ income. They also must file personal tax returns on their share of income or net operating losses.
Limited Liability Company
A Limited Liability Company, commonly referred to as an LLC, is a pass-through entity, meaning profits and losses pass through to the owners. It’s formed by one or more individuals or entities, called members, through a written agreement that details the company’s organizational structure, including management provisions and how profits and losses are distributed.
The IRS typically classifies LLCs with at least two people as partnerships, though LLCs can also elect to be treated as corporations. An LLC classified as a partnership doesn’t pay taxes itself — members pay them the same way partners do. Partnership income is reported on Form 1065. Additionally, LLCs file Schedule K-1, which outlines the individual share of income to each member. Members also report earnings data from Form 1065 on Schedule E and file it with Form 1040. Another option is to file Form 8832, which lets an LLC elect for the IRS to treat it as a corporation. An LLC set up as a C Corporation reports the corporate income on Form 1120. One that operates as an S Corporation reports corporate income on Form 1120S. Individual S Corp members report their income shares on Schedule-K1 of Form 1120S.
A C Corp is allowed an unlimited number of shareholders, each of whom is protected from the corporation’s liabilities. C Corps are taxed on their profits, while shareholders are taxed on the distributions they receive.
Profits might be subject to two taxes:
- A tax on the profit itself
- Another tax on dividends paid to shareholders
S Corps are not allowed more than 100 shareholders and can only issue a single class of stock. An S Corporation’s profits and losses are distributed to shareholders based on each shareholder’s interest in the business. To qualify as an S Corp, you’ll need to file Form 2553 with the IRS.
S Corporation owners treat taxes as they would for a partnership or sole proprietorship, with shareholders taxed when dividends are paid. Any remaining income paid to owners as distributions are taxed at a lower rate. S Corps file Form 1120-S.
Types of Taxes for Small Businesses
When it comes to taxes paid by small businesses, most of the attention is focused on income taxes because they take such a large chunk of profits. But income taxes are far from the only taxes that businesses have to pay so it’s important to be informed of all possible taxes.
Most businesses are also responsible for paying property taxes and payroll taxes. Some pay excise taxes and franchise taxes as well. Businesses in all but a handful of states must collect sales taxes from customers and then report and pay them to the proper authorities.
Your own business’ tax responsibility depends on a number of factors, including its location, business type, corporate structure and industry. Different states and municipalities have different tax requirements, as do different industries and business setups.
Here are a few taxes that many small businesses have to pay:
All businesses are required to file either a federal annual income tax return or information return. The federal income tax is a pay-as-you-go tax, meaning you pay it as you earn or receive income during the year. If your business is not required to make estimated tax payments, you can pay when you file your return. Most businesses in the U.S. are also required to pay state income taxes, and some might be required to pay local income taxes as well.
If your business has paid employees you’ll be responsible for paying and filing employment taxes. This includes Social Security and Medicare taxes, federal income tax withholding, Federal Unemployment Tax (FUTA) and State Unemployment tax.
For 2020, Social Security taxes are 4 percent on wages paid up to $137,700, according to the Social Security Administration. Employers pay half of this amount, 6.2 percent, and the other half is deducted from the employee’s wages. The Medicare tax is 2.9 percent of wages paid to employees, with no wage threshold. This tax is split between employer and employee. The FUTA rate is 6.2 percent of the first $7,000 you pay to an employee.
State unemployment tax rates vary by state as well as by the size of your company, its age, its industry, its historical turnover rate, the state’s employee tax rates and how many employees have applied for state unemployment benefits.
This is a Social Security and Medicare tax primarily for individuals who work for themselves. Payments of this tax are the same as for other companies, though there is no split between employer and employee so you’ll be responsible for the full amount.
Federal excise taxes are imposed for the sale or production of certain types of products or services such as motor fuel, airline tickets, tobacco products, alcohol and health-related goods and services. Federal excise taxes reported on IRS Form 720 consist of several broad categories, including environmental taxes; communications and air transportation taxes; fuel taxes; taxes on the initial retail sale of heavy trucks, trailers and tractors; and manufacturing taxes on the sale or use different articles.
Depending on the business, other excise tax forms you might have to fill out include Form 2290, Form 730 and Form 11-C. Excise tax rates vary depending on the type of business, and only businesses that deal with affected products are subject to excise taxes.
This is the tax you pay on properties your business owns or is in the process of purchasing. The amount you pay in property taxes depends on where your business is located. Contact your local tax authority to find out about its property tax rates. Property tax bills are typically sent out once a year. This tax does not apply to businesses that rent office space and/or do not own property.
Some states charge a franchise tax to corporations and other businesses for being allowed to do business there. According to Nolo, these taxes are separate from — and owed in addition to — state income taxes. Check with your state’s tax authority to see if a franchise tax applies to your business.
Like property taxes, the amount of sales tax your business is responsible for collecting, paying and filing depends on the state and locality. A lot depends on whether you’re in an origin-based state or a destination-based state. In origin-based states, such as Texas and Pennsylvania, the sales tax rate is based on where the seller or business operates.
In destination-based states like Florida and New York, the rate is determined by the customer’s location. Check with your state and local tax authorities to learn more.
Tax deductions, also known as a “write-offs,” are expenses your business pays that can be deducted from its taxable income. Deductions can lower your tax bill considerably. Just be sure the ones you claim meet the IRS criteria.
According to the IRS website, to be deductible a business expense “must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
Some expenses are considered capital costs because they’re a part of your investment in the business. The IRS looks at these costs as assets, meaning they can’t be deducted. Examples include business startup costs and costs to improve the business.
Common Small Business Tax Deductions
Here are some of the more common deductions claimed by businesses:
- Business Use of Your Home: If part of your home is used for business purposes you might be able to deduct the costs associated with its business use. These might include mortgage interest, insurance, utilities, repairs and depreciation. For more information, refer to IRS Publication 587. To claim this deduction, use Form 8829.
- Business Use of Your Car: Just like with your home, you can deduct car expenses if the vehicle is used for business purposes. If it’s used for both business and personal purposes you have to divide the expenses based on actual mileage. Refer to Publication 463 for more information. A list of mileage rates can be found on the IRS’s Standard Mileage Rates section.
- Employee Pay: The IRS notes that you can “generally deduct” the pay you give employees for services they perform for your business.
- Retirement Plans: Businesses can deduct contributions and certain other expenses associated with retirement plans that offer tax advantages for your own and your employees’ retirements.
- Rent Expense: The rent you pay for the property you don’t own can be deducted as long as the rent is for property used in your trade or business. It’s not deductible if you have or will receive equity in or title to the property.
- Entertainment and Travel: You can deduct certain travel and entertainment expenses as long as they are reasonable and directly related to business, such as taking a client to dinner or traveling to an industry trade show. In many cases, you’ll only be able to deduct part of the cost. It’s important to keep meticulous records to ensure you have plenty of proof that the expenses were directly related to business should you be audited by the IRS.
- Interest: A business interest expense is any amount charged for the use of money you borrowed for business activities. These expenses are deductible.
- Taxes: Federal, state, local and foreign taxes can be deducted if they are directly attributable to your trade or business as business expenses.
- Insurance: You can deduct the ordinary and necessary cost of insurance as a business expense as long as it is for your trade, business or profession. Make sure to double check the rules about deducting business insurance to ensure your costs truly are deductible.
- Depreciation: Depreciation and amortization can be deducted as a business expense. Use Form 4562 to claim your deduction for depreciation and amortization.
Personal, living and family expenses are not usually deductible, so be very careful about separating business and personal expenses. An example would be if you borrow money and use 70 percent of it for business purposes and the other 30 percent to pay for a family vacation. In this case, you can deduct 70 percent of the interest as a business expense but the other 30 percent is considered personal and is not deductible.
Not all tax deductions apply to every business, so if you’re unsure of whether you can deduct something, contact a tax professional.
State Taxes for Small Businesses
In addition to federal taxes, small businesses across the U.S. are required to pay various state and local taxes. All states impose property and unemployment insurance taxes. Beyond that, taxes at the state level vary from one state to the next. In some states, you’ll be required to pay franchise and sales and use taxes, for example, while others have no such requirements.
Janelle Cammenga, a Policy Analyst with the Tax Foundation’s Center for State Tax Policy, noted in an article on the organization’s website that Nevada, Ohio, Texas and Washington impose gross receipts taxes rather than corporate income taxes. South Dakota and Wyoming are the only states that don’t levy a corporate income or gross receipts tax, she wrote.
Check with your state tax authority to find out what taxes you’re responsible for paying.
The state your business operates in will have a big impact on the amount of tax you’ll be required to pay. According to Cammenga:
- Of the 44 states that levy a corporate income tax, the rates range from 2.5 percent in North Carolina to 12 percent in Iowa.
- Six states — Alaska, Illinois, Iowa, Minnesota, New Jersey, and Pennsylvania — impose top marginal corporate income tax rates of 9 percent or higher.
- Eight states — Arizona, Colorado, Kentucky, Mississippi, North Carolina, North Dakota, South Carolina and Utah — have top rates at or below 5 percent.
If your business has employees, it will be responsible for paying state employment taxes, which varies by state. According to the U.S. Small Business Administration (SBA), employment taxes “often include workers’ compensation insurance, unemployment insurance taxes and temporary disability insurance. You might also be responsible for withholding employee income tax.”
Only nine states don’t withhold income taxes:
- New Hampshire
If you sell products or services, you might be responsible for collecting and reporting sales taxes. A sales tax is considered a trust tax, according to the website of LumaTax, a provider of sales tax solutions and services. This means that as a business owner, you’re obligated to collect tax from customers on all taxable sales, hold those funds in trust until the end of the tax period and then file and pay them to the appropriate tax authority.
Businesses that operate in certain states don’t have to worry about collecting, reporting or remitting sales taxes because these states don’t impose a sales tax. The five states that don’t have a sales tax are:
- New Hampshire
If your business is not ready to file its annual tax return on the due date and you need more time to prepare it, the IRS can grant an extension. Even with an extension, however, you’ll have to estimate how much money you owe (if you owe any) and send in that amount by the tax due date, according to the TurboTax website. Otherwise, the extension might be invalidated.
Extensions give you an extra six months to file your returns. You need to request the extension on or before your original tax due date using IRS Form 7004. This form can be e-filed through the IRS’s Modernized e-File (MeF) platform.
Keep in mind that extensions are not the same as amended returns. Amended returns are filed when you make a major error on a previous return that will affect your tax liability, or when you receive new information that should now be included on the return. For more information, visit the IRS section on Amended and Superseding Corporate Returns.
Federal Tax Filing Deadlines for Small Businesses
The tax due dates for federal income tax returns and extensions don’t change much from year to year, with the most relevant dates typically occurring in the middle of January, March, April, June, September and October.
Use the following tables to note tax deadlines for 2019 through 2022. Official dates for 2021 and 2022 have not been released yet by the IRS, though they’re likely to follow the same pattern as previous years. Keep in mind that individual companies might file taxes on different schedules, depending on when their fiscal year ends. Note also that although LLCs can be taxed as partnerships or corporations, the following tables lump them in with partnerships.
The Bottom Line
There’s no hard and fast answer to the question, “How much do small businesses pay in taxes?” Taxes are both complex and ever changing, whether you’re talking about income tax, sales tax or payroll tax. Plus, every business is different.
Mistakes can cost a lot of money — and create a mountain of headaches trying to correct them. That’s why it’s always a good idea to work with a qualified tax professional such as a CPA, enrolled agent or tax attorney. These professionals can help you identify the types of taxes your small business is responsible for and ensure you file the right returns and pay the right amounts.