Tax reform means changes in how small businesses pay taxes. The most recent (2017) tax reform law, the Tax Cuts and Jobs Act, included several key changes to how small businesses pay taxes and how much tax they pay.
What Is a Corporate or Business Tax?
A corporate or business tax is charged on the profits of a company. The figure used as a basis for taxes varies, depending on the business type.
- Small business owners pay tax on Schedule C as part of their personal tax return.
- Partners in partnerships and LLC owners are taxed on their share of business net income.
- Corporations are taxed on net earnings.
Profit, net income, and net earnings mean essentially the same thing. Profit and loss is an accounting concept calculated as income minus expenses. Net income is a tax term indicating the difference between the gross income of the business and its deductible business expenses. Net earnings is a sum used to calculate income tax for corporations.
What Is the Small Business Tax Rate?
When you think of business taxes, you may be thinking about the federal business income tax rate. But the National Federation of Independent Business says most small businesses don't pay income tax at a business rate.
That's because about 75% of small businesses are not corporations. This large percentage of small businesses are considered "pass-through" entities, which means they pay tax at the personal tax rate of the owners.
Since small business (non-corporate) tax rates are tied to the total income of the business owners, we need to look at the current individual income tax rates.
The 2021 tax tables show that the top federals income tax rate is 37% on $523,601 of taxable income for individuals and heads of households and $628,301 for married individuals filing jointly. A small business owner with income this high, whose company is a pass-through entity, would be taxed at this rate.
What Is the Corporate Tax Rate?
The only type of business that pays taxes on its own is a corporation.
The corporation's owners don't pay any tax strictly on the corporation's profits, but they are taxed on their income if they work as employees. They are also taxed on dividend income they receive—the so-called "double taxation" issue.
Corporations have the biggest tax cut under the new tax law. The corporate tax rate was changed from a table of tax rates to a flat 21%. This change will continue indefinitely.
How Do Small Business Owners Pay Taxes?
Most small businesses are owned by individuals.
Partnerships, LLCs, and sole proprietorships pay no business tax, but the income is passed through to the owners, who report it on their personal tax returns. Because of this, it can be difficult to separate the tax paid on business income from the tax owed by the individual for all forms of income.
To figure your income tax rate, you must calculate your taxes for Form 1040 or 1040-SR, by adding up all your sources of income, including your business's net income. You'll also have to include tax credits and deductions to compute a net taxable income.
When you have your total taxable income, you can use these IRS tax tables to figure out your tax.
An easier way to figure how much income tax you owe is to use a tax preparation software program. Look for the small business version with Schedule C included. These companies also have programs for figuring partnership/LLC and corporation/S corporation taxes.
What Other Taxes Does a Business Pay?
In addition to income taxes, the largest tax bill that small businesses pay is for payroll taxes. These taxes are for FICA taxes (Social Security/Medicare taxes).
Other taxes your business will be responsible to pay include:
- Capital gains taxes on business investments and on the sale of business assets. The capital gains tax rate is based on how long you owned the asset.
- Property tax on real property (land and buildings) owned by the business
- Tax on dividends from business investments
Don't Forget Self-Employment Taxes
Small business owners don't have income tax and Social Security/Medicare taxes withheld, so they must pay these taxes as self-employment tax. The tax rate is 15.3%, based on your business's net income for the year.
You can use the business version of tax preparation software programs to calculate this tax or use Schedule SE. Add the total taxable amount to your other taxable income on your personal tax return.
As a small business owner, you will probably need to pay quarterly estimated taxes to the IRS to avoid underpayment penalties. The payments are due April 15, June 15, and September 15 of the current year, and January 15 of the following year. However, in 2021, individuals and businesses affected by winter storms in Texas and neighboring states may delay paying quarterly estimated until June 15. This delay applies to filing annual tax returns, as well.
Income Taxes for LLC Businesses
If you are wondering why limited liability companies (LLCs) are not listed, remember that the LLC business type is not considered a tax entity by the IRS. An LLC with one owner is taxed as a sole proprietorship, with taxes calculated on Schedule C of the owner's personal tax return.
Multiple-member LLC's are taxed as partnerships. In both cases, LLC taxes are passed through to their owners.
Some LLCs elect to have their businesses taxed as corporations or S corporations. In these cases, the LLC operates the same as usual, but it pays taxes as a corporation or S corporation.
State Taxes for Businesses
For states that have an income tax, the new tax law also affects state income taxes and other state taxes. Some states have a better business tax climate than others; the Tax Foundation rates states on their business tax situation, with all taxes taken into account.
Qualified Business Income Tax Deduction
Although the new tax reform gave major corporations a big tax cut, that didn't apply to small businesses. That's because most small businesses don't identify themselves as corporations, and because the tax can be passed through to the owner.
In order to make the playing field somewhat level for small businesses, Congress came up with a new tax deduction called a Qualified Business Income (QBI) deduction. The new deduction is for 20% of the owner's net income from the business, in addition to the normal deductible business expenses.
It isn't available for owners of corporations or S corporations, and there are specific limits and detailed calculations involved. Your business tax software program or your tax professional can calculate this deduction for you.
For More Information
This publication by the Small Business Administration has more information on tax planning for small businesses, including how each business type pays taxes.