Taxation Overview for Small Businesses

Filing taxes is a complex exercise. The tax rate a business pays is determined by several different factors. Your business structure and size, your income and the various deductions you qualify for are going to determine your tax bracket and therefore your tax rate. Read on to understand the rates that determine how much small business owners pay in taxes.

Understanding Small Business Tax Rates

How do we determine small business tax? Small business tax is what you pay as a percentage of your earnings from your small business. This percentage will depend on your income and business structure. Following is a summary of the tax rates applicable for each entity.

For purposes of classifying small businesses, there are two broad categories of entities - C corporations and Pass-through entities. C corporations are taxed at a different rate than pass-through entities.

For a small business structured as a C corporation, tax is paid at a flat rate of 21%. This rate was set by the Tax Cuts and Jobs Act (TCJA) of 2017.

A large percentage of small businesses fall under the second category - pass-through entities. These include:

  • Sole-proprietorships
  • Partnerships
  • Limited Liability Companies (LLCs)
  • S Corporations

Owners of pass-through entities do not pay the same taxes as C Corporations. They pay taxes on income from the business on their personal income returns. The tax rate will depend on the owners income tax bracket and can range from 10% - 37%. The progressive nature of income tax rates means that pass-through entities will be subjected to higher tax rates for higher income.

There are 7 Federal Income Tax Brackets for Small Entities. These range from 10% to 37% of your income. Starting from the lowest which is 10% each bracket represents a higher tax rate than the previous one. When your income grows and falls into a higher bracket, you pay a higher rate only on the part of your income that is in the higher bracket.

In addition to income tax, there are other taxes that small business owners may need to pay. These include:

  • Payroll Tax - A small business owner is required to collect payroll tax from employees at a rate of 15.3%. This includes withholding FICA (Federal Insurance Contributions Act), social security and Medicare taxes.
  • Self-Employment Tax - While employees share payment of FICA taxes on a 50/50 basis with their employer, a self-employed small business owner has to pay the whole amount.
  • Excise Tax - A small business involved in certain types of businesses that meet certain IRS requirement will also need to pay excise tax
  • Sales tax - For businesses that sell items or offer services in a state with sales tax, the owners will be required to pay sales tax.
  • Property Tax - You will pay this for any taxable property that your small business holds.
  • Capital Gains Tax - Small businesses that earn an income from investments are required to pay capital gains tax.

The requirements for the additional taxes listed above may vary from state to state. It is advisable to check with state authority which taxes your particular type of business is required to pay for operating within their jurisdiction.

A large number of pass-through entities, mostly sole proprietorships, partnerships and S Corporations make Quarterly Estimated Tax Payments. This is done to avoid paying all the taxes at once especially in cases where the projected amount owed is high. Estimated tax payments are made on earnings that are not subject to Federal Withholding taxes. Due dates for estimated tax fall in January, April, June and September of each year.

Self-Employment Taxes: What You Need to Know

Self- employment taxes are used by the government to pay for Social Security and Medicaid. Those who earn a salary pay half of this amount and the other half is paid by their employers. Business owners have to pay the whole amount for themselves. The self-employment tax rate is currently 15.3% on net earnings.

Strategies for Tax Planning and Compliance

Just as important as understanding your tax rate is being aware of record-keeping best practices for tax purposes. Accurate, clear records give the best picture of your business. These records are also important for tax purposes. Apart from being a record of your transactions, your record will also help you to be compliant with IRS regulations. Some of the most important things to keep in mind is that business accounts and personal accounts should be kept separate. A good record of revenue and expenses is the best way to keep your finger on the pulse of the business and will contribute to your ability to set and measure your goals. Bookkeeping can seem like a daunting task to any small business owner. You may be unable to make the time or you may not want to do the books because you feel someone else may be better equipped to do it.

You should consider utilizing professional accounting services right from the beginning of your venture. This is the best way to be sure that you are doing your bookkeeping right and by extension, complying to IRS regulations. You will also save time. At Wilkins and Co. you will not only find professional accounting services, you will also have the option of utilizing the financial modeling we offer as you work your way to a healthier financial future.

Common Tax Deductions for Small Businesses

Small business owners that reduce their tax liability by applying deductions. Deductions are the best way to reduce your taxable income. Home office deduction is one of the ways that a small business owner can reduce their taxable income. This deduction is applicable for small business owners who use their home for business activities and allows them to write off things like real estate tax and rent.

Another tax deduction applicable to small business owners is depreciation of assets. You can begin depreciating the asset once it is in use and stop depreciating it once you recover its full cost or stop using it. Depreciation is calculated using the straight line method, the accelerated method of applying the Section 179 Deduction which allows you to deduct the entire cost of the asset in the year you acquire it.

FAQs: Tax Considerations for Small Business Owners

1. What factors influence the percentage of tax for small businesses?

The percentage of tax for small business is influenced by its structure and its income.

2. How can small business owners accurately calculate their tax liabilities?

Small business owners can greatly benefit from seeking the services of professional accountants. Contact us at Wilkins and Co for professional accounting services.

Additional Resources and Support for Small Business Tax Issues

More details on IRS guidelines and publications for small businesses can be found on the IRS website. Be sure to study state-specific tax information for your small business as well.