Small business owners and taxes: What should you know?
Do you run a small company? You're with good people. According to the U.S. Small Business Administration, 99.9% of businesses in the country are categorized as small businesses (SBA).
Taxes for businesses may conjure up images of corporations. However, the majority of small businesses don't actually pay business taxes. Because they are not treated as separate corporations, sole proprietorships, partnerships, and limited liability companies (LLCs) pay taxes at the owner's personal rate.
Depending on the type of small business, taxes are paid at a rate of 19.8% on average by small businesses. According to Fundera, small businesses with a single owner pay an average tax rate of 13.3 percent, while those with multiple owners pay an average tax rate of 23.6 percent. C corporations are currently subject to a 21% federal corporate income tax rate. They will also be responsible for paying state corporate taxes, which can be anywhere between 0% and 11.5%. In the tax year 2021, this could lead to a combined average top tax rate of 25.8%.
All businesses are required to pay a variety of taxes, some of which are simpler to comprehend than others. There are several types of taxes for businesses, including federal, state, and local taxes.
Additionally, there are various tax types based on various business activities, such as the sale of taxable goods or services, the use of equipment, the ownership of commercial real estate, the presence of employees, and, of course, the realization of a profit.
If your business is just getting started, you need to be aware of the taxes you'll have to pay. If your business has changed—for instance, if you've purchased property or begun hiring staff—you'll also need to be aware of the taxes associated with these actions.
What is the tax burden on small businesses?
According to the SBA, the average federal tax rate for small businesses of all stripes is estimated to be 19.8%. Small S corporations average 26.9%, small partnerships average 23.6%, and sole proprietorships average 13.3%.
The state in which a small business is located and the way the company is set up are two additional factors that influence the tax rate. For more information on small business income taxes, continue reading.
1. State tax rates for small businesses vary.
State tax laws vary greatly from one another. In fact, there may be no income tax in some states. There are no or very little personal income taxes in Wyoming, South Dakota, Alaska, Florida, Montana, New Hampshire, Nevada, and Indiana. Furthermore, neither South Dakota nor Wyoming levies a gross receipts tax or a corporate income tax. On the other hand, Louisiana, Iowa, Maryland, Vermont, Minnesota, California, and New York have higher sales, property, individual income, and other tax laws.
2. Tax laws depend on the way your business is set up.
Small businesses should consult an attorney and an accountant to determine how their businesses should be classified because tax laws vary depending on business structure. A sole proprietor is an individual who owns an unincorporated business by themselves.
Partnership: In a partnership, each partner's share of the business's net income is subject to tax.
Limited liability company: LLCs must pay taxes on their portion of the company's net income. LLCs with several members are taxed as partnerships.
Corporation: Only businesses that pay federal taxes independently based on net earnings are corporations. Currently, they pay a flat tax of 21%.
3. Payroll, sales, and other taxes are paid by small businesses.
NerdWallet states that small businesses should set aside about 30% of their income after deductions to cover federal and state taxes because small business owners are subject to both income tax and self-employment tax.
Small businesses also pay the following taxes:
Payroll tax: Per The Balance, once an employer has determined and deducted the correct amounts from employee paychecks for federal income tax withholding and FICA (Federal Insurance Contributions Act) taxes, they are required to:
Calculate and set aside the amount required for FICA taxes that the company as a whole must pay.
b. Based on their total employee payroll, make either monthly or semi-weekly payments to the IRS.
c. Submit a quarterly payroll tax report via Form 941 or electronic filing.
Income tax: Since the reported income of the business's owner(s) determines the small business (non-corporate) tax rates, owners should anticipate paying both their personal income tax and a self-employment tax.
Self-employment tax: Also known as FICA tax, this charge covers Medicare and Social Security taxes. Small business owners are both the employer and the employee, as opposed to salaried workers, who split these costs with their employer. They must cover the entire cost, therefore. Need assistance with tax calculation? Try our calculator for self-employment taxes.
Capital gains tax: If your business investments grow in value or you sell business assets for a profit, you'll probably need to pay tax on the difference, which is known as a capital gain. The capital gains tax rate is determined by how long-term or how short-term your gain is.
Property tax: This refers to taxes owed on "real property" that your company owns, such as buildings or land. Local organizations make the assessments for property taxes, which are then spent locally.
Dividend tax: Dividends, which are a portion of a company's profits paid to shareholders, are taxed in accordance with the manner and timing of the investor's ownership of the dividend. The IRS states that if a sole proprietor or independent contractor's net self-employment income for the year was $400 or more, they are required to file an income tax return.
What Amount Should a Small Business Reserve for Taxes?
30 to 40 percent of your income should be set aside to pay your federal and state taxes. Keep in mind that you'll be paying these taxes quarterly, so budget money accordingly. Depending on the type of small business you run, you might be able to save less money.
How well-established your business is will determine when you should start saving money for taxes.
New to the world of small business? Try saving at least 30% of each payment you receive.
Previously made a profit? Put away your 30 percent every month.
Profitability, on average, year over year? Take 30% of the net income from the prior year after dividing it by four. If you underestimate the amount owed, don't worry too much. According to the IRS, you are considered to have met the safe harbor rule if you pay the same amount of taxes quarterly as you did at the end of the previous tax year. Thus, you won't face consequences for making a low payment.