The IRS classifies businesses based on tax designations such as LLC, C corp, S corp, partnership, and sole proprietorship. Small businesses can be any of the above, but many choose to be S corporations because of the tax benefits.
Understanding how you are taxed will help you plan better and be more tax-efficient. This guide will help you understand your tax liability as a small business owner, no matter the business structure.
75% of small businesses are classified as unincorporated pass-through entities that attract the personal tax rates of the owners.
Sole proprietorships have no legal entity of their own as other structures do. Tax designations such as C corporations are legal persons and cannot be taxed based on the owner’s income.
The taxation for C corporations is straightforward. These corporations attract a flat rate of 21% as per the Tax Cuts and Jobs Act of 2017. The same act also did away with the alternative minimum tax or AMT for C corporations.
The alternative minimum tax was a mechanism that ensured that some federal taxes are paid in case the tax liability, according to AMT rules, is higher than the normal tax rate. The Tax Cuts and Jobs Act exempted C corporations from these rules.
So, how much would a C corporation pay in taxes? For instance, if you are a C corporation with a taxable income of $100,000, then you would be liable to pay 21% of that, which is $21,000. It’s as simple as that!
Pass-through entities include all business structures other than C corporations. These can include sole proprietorships, partnerships, S corporations, and LLCs.
These companies don’t pay any taxes on their own. However, the taxable income generated is added to the income of the owner and taxed based on tax slabs on the whole.
The rate at which these businesses are taxed depends on which tax bracket the owner falls in. The threshold for these tax brackets depends on whether taxes are filed by an individual, a married couple, or the head of a household.
Take a look at the tax brackets below to see how you would be taxed:
Let's take an example.
Susan is a single business owner with a total taxable income of $80,000 -- $40,000 from her sewing business and $40,000 from other sources.
Here is how she would be taxed:
10% on the first $9,700 = $970
12% on ($39,475 - $9,700) = $3,573
22% on ($80,000 - $39,475) = $8,915.5
The total tax payable for her would be $13,458.5 before factoring in any tax credits or deductions.
You can always ensure your tax estimations are correct by using a small business tax calculator. Check out this press release by the IRS for a detailed understanding of the latest tax brackets.
Many factors go into calculating your tax liability, including your business structure, income, and deductibles.
Whether you enjoy a flat tax rate on your business or attract income-based tax slabs, you can use tax credits to save on the total amount you pay.
Tax credits are awarded for different reasons. They incentivize businesses to promote or engage in an activity such as using renewable energy instead of fossil fuels.
Some kinds of tax credits are listed below:
- General Business Credit
- Work Opportunity Credit
- Disabled Access Credit
- Alternative Motor Vehicle Credit
- Low-Income Housing Credit
- Credit for Increasing Research Activities
You can find a full list of the business credits offered by the IRS here.
Individuals and owners of pass-through entities can also claim tax credits such as:
- Income and Savings Credit
- Healthcare Credit
- American Opportunity Credit and Lifetime Learning Credit
- Family and Dependent Credits
Tax deductions or write-offs are expenses you can deduct from your income to decrease your total taxable income. Your small business taxes can save on paying extra by leveraging this criterion set by the IRS.
For an expense to qualify as a tax deduction, it has to be both ordinary (common for your business) and necessary (helpful for your business).
The IRS does not allow personal expenses to be deducted from your business’s taxable income. However, if you partially use the said funds on your business, that fraction of the expense is considered a business expense and is tax-deductible.
Information about tax travel expenses expenses related to travel anywhere within India can be claimed as tax-deductible.
Here are other expenses that are counted as a business expense when you file taxes:
- Employees' pay
- Saving plans for retirement
- Rent expense
- Business interest
- Federal, state, local, and foreign taxes attributed as a business expense
- Insurance for your business
The IRS explains deductions in taxable income in detail under Publication 535, Business Expenses.
Some states tax business owners for the income earned within the state. The applicable tax rates and laws differ in states. Usually, states use one of the following systems to tax income earners.
- No tax on any income
- Flat tax rate on all incomes
- Successive tax rate on higher incomes
All states impose income tax except for South Dakota, Tennessee, Florida, Alaska, Nevada, Texas, Wyoming, and Washington.
Besides income tax, small business owners may need to file one or all of the taxes explained below.
Individuals who are not associated with an established business and work for themselves have to pay self-employment tax.
The self-employment tax rate is 15.3%. The rate includes two sections:
- 12.4% for social security (old-age, survivors, and disability insurance)
- 2.9% for Medicare (hospital insurance)
The franchise tax is liable to some businesses for the privilege of operating in certain states. It is a state-imposed tax and not a federal tax. A business can be barred from operating in the state for non-payment of these taxes.
You may be liable to pay taxes on the services and goods you sell in the state you live in. Not every state imposes this tax, and it’s advisable to consult a professional accountant to understand how to compute, collect, and pay these taxes to your state’s tax authority.
You may be liable to pay excise small business tax deductions depending on your line of business operations. This is determined by the goods you produce and/or sell and the products you use. Learn more about how IRS regulates excise duty here.
If your business operates from a physical address, you may be liable to pay property tax on the said real estate to the concerned authority.
Understanding different taxes that you may be responsible for paying requires a little homework. While the IRS has detailed the requisites to file different taxes, it’s always recommended to get your taxes reviewed by an expert.
At Fincent, we house a crew of seasoned bookkeeping mavens who can help you save time and money on bookkeeping, so that you can focus on doing what you love and growing your creative business. Get in touch with us today and leave your books with us so that you can focus on a happier and more productive you.
Fincent: Your Business's Personal Financial Wizard - From Bookkeeping to Tax Filing