Small Business Tax Guide: Tax Rates and Filing Tips
People who own small businesses often juggle many different jobs, but the role of accountant is rarely a favorite. We won’t lie: business taxes can be daunting and get a bit complicated. Things do get a lot easier, however, once you understand a few basics. Here’s a plain English breakdown of the business tax basics you need to know.
What Is a Business Tax?
No one escapes the tax man, including businesses. Businesses pay several different taxes. Just like individuals, businesses pay an income tax on their profits. Businesses with employees must also pay certain types of employment taxes. We’ll talk more about these small business taxes in a bit.
In addition to employment and income taxes, businesses must sometimes pay sales tax. Forty-five states and hundreds of local governments charge sales tax. In these areas, your business will calculate and collect sales tax on every taxable sale. You’ll then submit the sales tax you’ve collected to the appropriate taxing authorities along with a tax return detailing your sales data.
Business owners may also be responsible for excise taxes. Often charged on items such as tobacco, alcohol and fuel, an excise tax is one borne by businesses. Although often passed on to the consumer through higher prices, excise taxes are ultimately the business owner’s responsibility.
If your business owns property such as a retail space or warehouse, the business will have to pay property taxes. If you personally own the property your business operates in, however, the local taxing authority will likely tax you personally rather than the business entity.
Like the federal government, some states and local entities tax business profits. Depending on where your business operates or is headquartered, you may be subject to these additional taxes.
Like individuals, businesses pay tax on the money they make. To keep things simple and easy to understand, we often talk about this tax as an income tax. When dealing with a business, however, this is a bit of a misnomer. Businesses pay federal income tax based on their profits, not on their income.
Some businesses are assessed a corporate tax and dealt with as an individual entity. Depending on the business structure, however, the owner of the business is sometimes responsible for paying small business taxes. This situation occurs when the business is a pass-through entity — a concept we’ll explain in detail soon.
The federal tax is a pay-as-you-go tax, which means you pay your taxes throughout the year as you incur tax liability. if your business expects to owe the IRS more than $1,000 in taxes at the end of the year, you’ll need to make estimated tax payments every quarter throughout the year.
As their name implies, estimated tax payments are based on an estimate of what you expect to make. As the year goes on and you have more information, you can adjust your estimated payments up or down as needed. If you’re ever in doubt, err on the side of caution. If you pay too much into the IRS during the year you can get your money back in the form of a tax refund. If you pay too little, however, the IRS could assess fines and penalties that will unnecessarily increase your tax bill.
There are several different types of employment taxes that business owners must be aware of. The first is self employment tax. In a traditional employment setting, employers and employees split the cost of social security and Medicare taxes. When you work for yourself, however, you don’t have anyone to split the cost with, so you’ll have to foot the entire bill. This is what’s known as self employment tax.
If you have employees, you have to pay different employment taxes. You’ll withhold half of the social security and Medicare tax (often called FICA) from your employees and then you’ll pay the other half.
You’ll also find yourself responsible for paying federal income tax withholding to the government. Businesses don’t pay this tax, but they are responsible for withholding it from their employees and then submitting it to the federal government.
Employers must also pay FUTA tax. This is a federal unemployment tax paid by businesses. For 2020, the FUTA tax rate is 6 percent of the first $7,000 you pay each employee. This amounts to a maximum tax liability of $420 per employee.
Many businesses are eligible for a credit that reduces the FUTA tax rate by 5.4 percent, dropping the rate from 6 percent to 0.6 percent. This in turn reduces the tax liability to $42 per employee. We don’t have time to go into all of the FUTA tax specifics right now, but it’s clearly important to understand whether or not your business is eligible for the discount. If you’re not sure, make sure you do your research or ask a Picnic Tax expert.
What Is the Business Tax Rate for 2020?
For 2020, the basic tax rate for a C corporation is 21 percent. But taxes are never quite that simple, are they? The tax rate for pass-through entities changes based on the business owner’s personal tax rate. I know we’ve said it before, but we promise to explain pass-through entities more in-depth. In fact, let’s do it now.
So what is a pass-through entity? When a business is incorporated as a C corporation, it becomes its own entity separate and apart from its owners. But limited liability corporations (LLCs), partnerships and sole proprietorships don’t work that way. These business structures work as pass-through entities.
When these businesses make a profit (or suffer a loss), it’s passed through the business to the business owner. The owner then pays the tax on the business income at his or her personal income tax rate. For 2020, these rates vary from 10 to 37 percent depending on your tax bracket.
If you’re a sole proprietorship, you report this income on a Schedule C. Other business structures use the Schedule K.
S Corporations are also a pass-through entity, but they’re a little different. To understand them, you must first understand a little more about C corporations. Technically, C corporations get taxed twice. First, the corporation itself is taxed on its profits. Many of these corporations then pay dividends to their stockholders. When they do, the stockholders pay tax on these dividends, resulting in a second taxation of the company’s profits.
S corporations were created to avoid this issue. The IRS allows S corporations to pass their profits through to the owners of the business, avoiding the 21 percent C corporation tax. The generosity of the IRS has its limits though. To qualify as an S corporation, a business must have 100 or fewer shareholders, all of whom must be United States citizens.
Tips to Reduce Your Small Business Tax Bill
You may not be able to avoid business taxes altogether, but you can likely reduce them. As is true on your personal taxes, a well-planned tax strategy can prove quite beneficial. There are many tax credits available to businesses that you may be able to take advantage of.
Tax deductions are another benefit to incorporate into your tax strategy. The Section 179 deduction, for instance, lets businesses deduct the full cost of certain assets all at once rather than depreciating them slowly over time. You can also increase your employee’s benefits in lieu of raises, increasing your expenses without raising your payroll tax.
If your business is a pass-through entity, remember to look at both business and personal tax breaks since one affects the other. You can, for instance, make contributions to a retirement plan to reduce your tax liability. All business owners can benefit from a tax planning session with a CPA, but those operating pass-through entities have an extra incentive to plan carefully as their business taxes greatly impact their personal taxes.
This is where we come in. At Picnic Tax, we thoroughly enjoy tax planning. We can help you figure out the best way to reduce your business taxes, your personal taxes or both. If you’re just getting started, we can also help you choose the business structure that will work best for you. If you’re struggling to understand your business taxes and how they may impact you personally, give us a call today. We’ll be happy to talk you through the more confusing aspects of your business taxes and help you formulate a plan.