Most small business owners say they started their business for autonomy, flexibility, freedom to innovate and to help their community.1
Not on the list? Taxes.
To help keep your business in good legal standing and avoid penalties, you must meet federal, state and local (where applicable) tax obligations. The IRS charges penalties for incorrect or late returns and payee statements.
Payroll taxes are just one type of taxes small businesses must pay. Read on for an overview and links to resources about other tax responsibilities.
What Determines How Much Taxes Small Businesses Pay?
Businesses pay different tax rates based on how they are structured, where they are located, their income, and any tax deductions and tax credits they are eligible for.
Small businesses must pay federal income taxes to the IRS. Businesses may also owe state and local taxes, depending on the type of business, the products and services provided, and whether they have employees.
Business Structure
Business structure plays an important role in determining tax obligations. Each structure comes with unique tax implications.
Sole proprietorship is the simplest structure. It doesn’t require separate business tax filings. The business owner uses Schedule C (Form 1040) to report their business income and expenses on their personal tax return. The owner’s income is then subject to individual income tax rates.
Limited Liability Companies (LLCs) offer some flexibility. Depending on the setup, the IRS will treat an LLC as either a sole proprietorship, partnership or corporation.
Corporations, such as C corporations, pay taxes at the corporate level. They file a separate tax return using Form 1120, U.S. Corporation Income Tax Return.
S corporations pass income, losses and deductions to partners. Partners then report their share of a partnership’s profits, losses, deductions and credits on their individual tax returns using Schedule K-1 on Form 1065, U.S. Return of Partnership Income.
Federal Tax Rates
Sole proprietors and partnerships use individual federal income tax rates and brackets, which range from 10% to 37%. This means business profits are added to other income, such as wages and investments, to determine the correct tax bracket. Income from pass-through entities, like S corporations, is also taxed at personal rates.
By setting a flat 21% corporate tax rate, the Tax Cuts and Jobs Act (TCJA) simplified taxes for corporations.
Related to the TCJA, the Qualified Business Income Deduction (QBI) allows eligible businesses to deduct up to 20% of their qualified business income, reducing their taxable income. The deduction is complex, with many rules and limitations. It’s best to consult with a tax professional to learn the nuances and decide if it is right for your business.
Revenue Levels
When you realize how revenue is taxed, you’re better positioned to help plan and manage your business finances. Bottom line, revenue directly impacts the amount of taxes a business owes.
Different thresholds can trigger additional taxes or move a business into a higher tax bracket. Small business owners should work closely with financial professionals to help direct growth effectively.
Revenue also affects eligibility for certain tax benefits and tax credits. For example, small businesses with revenue below certain levels may qualify for specific small business tax credits, which would reduce their overall tax liability.
Location & Industry
Where you do business and the type of business you are in also influences the taxes you pay.
For example, some states do not impose an income tax on select types of small businesses. Other states, however, may have higher rates or additional taxes. Depending on your industry you may also pay sales or excise taxes.
Employees
Small businesses with employees must also pay their share of federal and state employment taxes and taxes withheld from employee pay.
Types of Small Business Taxes
Businesses with a firm handle on their tax responsibilities are better positioned to make informed financial decisions. Effective planning can help ensure you have sufficient funds to meet tax liabilities, which will help avoid costly penalties and interest charges.
Federal Income Taxes
Income taxes are based on a business’s net income, which is gross income minus expenses.
How your business reports and pays income tax depends on how it’s structured. Sole proprietorships, partnerships and some LLCs report business income on personal tax returns. The income is then subject to personal tax rates, which can affect the final tax amount.
Corporations pay taxes at the corporate level. This leads to what is commonly called double taxation, where income is taxed at both the corporate level and again as personal income when dividends are distributed.
Becoming familiar with these terms can help you manage your tax obligations.
- Gross Revenue. Total earnings before any deductions.
- Business Expenses. Costs incurred in the operation of a business.
- Taxable Income. Revenue after deducting expenses.
- Tax Deductions and Tax Credits. Allowances to reduce taxable income or tax owed.
State Taxes
State and local taxes have a direct impact on the overall small business tax burden. Unlike federal taxes, local rates and rules vary widely by location.
The two most common types of state and local small business taxes are income taxes and employment taxes, according to the U.S. Small Business Administration. The business structure typically determines state income tax.
Local taxes further complicate tax calculations, with cities and counties potentially imposing additional taxes on businesses. These can include business license taxes, personal property taxes, and gross receipts taxes.
Some states and local governments offer tax incentives and tax credits to help ease the burden and support small business growth.
Consulting with a local tax professional can help small business owners navigate this tricky area.
Payroll Taxes
As an employer, you are responsible for withholding, depositing and reporting employment taxes, including:
- State income tax and local income taxes, where applicable
- Employees' share of Social Security and Medicare taxes (called FICA)
You must also pay and report the employers’ share of:
- Social Security (part of FICA), which is a flat 6.2% of employee compensation up to a set wage base limit for each employee
- Medicare (part of FICA), which is 1.45% of all compensation subject to the tax for each employee
- Federal unemployment taxes (FUTA), which is capped a the first $7,000 in wages paid to each employee
- State unemployment taxes, also known as state unemployment insurance (SUI). SUI tax rate ranges and unemployment tax wage bases vary by state and industry.
Failure to properly withhold and deposit these taxes can result in significant penalties.
Automating payroll, tax calculations and payments with a payroll service like SurePayroll® By Paychex is one of the easiest ways for small business owners to save time and simplify payroll and payroll tax management.
Self-Employment Taxes
Generally, self-employed individuals must file an annual income tax return and pay estimated taxes quarterly, according to the IRS.
Taxes for Social Security and Medicare are handled differently for people who work for themselves. In a standard employer-employee setup, these taxes are shared between the business and the worker.
When you are self-employed, you must cover both the employer and employee portion. Self-employment tax totals 15.3%, which is made up of 12.4% for Social Security and 2.9% for Medicare. This is calculated based on net earnings from self-employment.
These terms can help you manage self-employment taxes.
- Net Earnings. Gross income minus business expenses.
- Tax Threshold. Apply to income over $400 annually.
- Quarterly Payments. Plan to pay estimated taxes four times a year.
Filing estimated taxes quarterly can help you avoid a large one-time payment. It can also help prevent interest penalties for underpayment. It’s important to keep careful records of your earnings and expenses to help accurately calculate your self-employment taxes.
Sales Tax
Most states require businesses to collect sales taxes from customers who buy taxable goods and services. If you make out-of-state purchases for your business for which you did not pay sales tax, you might also owe use taxes.
Excise Taxes
Businesses in industries like manufacturing, transportation and alcohol should be aware of what type of activities trigger excise taxes.
These taxes can be imposed on the federal or state level. Rates differ depending on the type of product or activity. Consulting with a tax professional can guide you in effectively managing these taxes.
Strategies to Help Manage Taxes
Proactively managing taxes can help small businesses find and plan to take advantage of available tax deductions and tax credits.
Not all tax breaks apply to every business, so make sure to talk with a tax professional. It’s also important to keep detailed records and all receipts. This way you can take full advantage of the tax breaks for which you qualify.
Tax Deductions
Tax deductions, or tax write-offs, can help reduce your taxable income. To qualify for a write-off, the IRS says the business expense must be ordinary and necessary to your business.
These tax breaks usually fall into specific reporting categories such as business travel, advertising and marketing, and business meals and entertainment. See our list of top tax deductions for small business.
Tax Credits
Unlike a tax deduction, which reduces your taxable income, a tax credit can lower the amount of tax you owe.
Some to check out:
- Work Opportunity Tax Credit. The Work Opportunity Credit can be claimed by employers who hire individuals facing barriers to employment.
- Retirement Plan Startup Costs Tax Credit. Eligible small businesses can take advantage of tax credits for starting retirement savings plans for their employees thanks to the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 and SECURE Act 2.0.
- Empowerment Zone Employment Credit. Businesses that hire and retain employees in empowerment zones may be eligible to claim up to $3,000 per employee.
See the IRS list of business tax credits or check with your tax advisor for information about more tax credits.
How to Pay Small Business Taxes
Most small business owners must make quarterly estimated payments to cover income tax, and employment and self-employment tax liabilities. Failure to make the quarterly estimated payments can result in penalties and interest.
Quarterly Payment Due Dates
These quarterly payments are generally due:
- April 15
- June 15
- September 15
- January 15
How to Estimate Quarterly Income Tax Payments
One way to calculate your estimated quarterly payments is:
- Estimate Your Taxable Income. Use your previous year’s income and adjust for expected changes.
- Calculate Estimated Tax Liability. Apply the current tax rate to your estimated taxable income to estimate your tax liability.
- Determine Quarterly Payments. Divide the estimated tax liability by four to estimate your quarterly payments.
How to Make Quarterly Payments
Small businesses are encouraged to use the U.S. Treasury’s Electronic Federal Tax Payment System (EFTPS) to make tax payments. The IRS offers a variety of other payment options on its website.
If you have employees, you will also use Form 941. The employer’s quarterly federal tax return reports income taxes and Social Security and Medicare withheld from employees’ paychecks. You use this form to pay the employer’s portion of Social Security and Medicare as well.
You don’t have to tackle payroll and payroll tax management alone. SurePayroll can help your small business with automated payroll, tax calculations, filings, deposits and more.
6 Tips for Effective Tax Planning
The following tips can help small businesses streamline their tax planning process. Consulting with a financial professional can help refine your approach.
- Regularly review tax laws. Stay informed about changing tax laws and regulations to uncover opportunities to save.
- Separate business and personal expenses. This simplifies accounting and helps ensure business expenses are recorded accurately.
- Schedule quarterly reviews. Regular financial reviews, ideally with a financial expert, can help track performance against plans and find areas to adjust.
- Leverage technology. Consider using accounting software to automate calculations and generate reports.
- Plan for major purchases. Time large purchases to favorably impact your taxable income.
4 Common Small Business Tax Errors
According to the IRS, these four tax errors can be costly for small business owners:
- Underpaying estimated taxes.
- Depositing employment taxes incorrectly or late.
- Filing late.
- Not separating business and personal expenses.
Frequently Asked Questions
How much do small businesses usually pay in taxes?
If your small business is a sole proprietorship or partnership, the graduated personal income tax range of 10% to 37% will apply. If your small business is set up as C corporation, you will pay 21% corporate income tax.
How much should I set aside for taxes for a small business?
Conventional wisdom suggests setting aside 30-35% of your income to cover tax payments. You should check with a tax expert for advice on your specific business.
Why do small businesses pay so much tax?
Businesses pay different tax rates based on how they are structured, where they are located, the amount of income they have and any tax deductions and credits they are eligible for.
Small businesses must pay federal income taxes to the IRS. Businesses may also owe state and local taxes, depending on the type of business, the products and services provided, and whether they have employees.
Simplify Your Success
You’re an expert in your field. You don’t need to be one in payroll and payroll tax management. The right payroll service provider can help you stay focused on your business, customers and employees.
1 Small Business Facts, Reasons for Running a Business, U.S. Small Business Administration, Office of Advocacy, November 2022.
