How Much Tax Do Small Businesses Pay?
Tax reform means changes in how small businesses pay taxes. The Tax Cuts and Jobs Act, signed in December 2017, comes with several key changes to how small businesses pay taxes and how much tax they pay.
But what does the term "business tax" mean and how does it affect your small business?
What Is a Corporate or Business Tax?
A corporate or business tax is charged on the profits of a company. Federal taxes for partnerships and S-corporations are due on March 15. They may be able to file for a six-month grace period, extending the deadline to September 15. Individual taxes and C-corporation taxes are due on April 15, with a potential extension to October 15. Payments can be made by installments every quarter beginning in April, with the final payment due in December.
Small Business Tax Rate
When you think of business taxes, the first things that comes to mind are probably federal and state 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 owner.
Since small business, or non-corporate, tax rates are tied to the total income of the business owner, we need to look at the income tax rates that went into effect as of 2018 and will continue for eight years.
What is the Corporate Tax Rate?
Larger businesses and those taxed as corporations have the biggest tax cut under the new tax law. The corporate tax rate was cut from a table with the highest corporate taxes to a flat 21%. This change has no expiration date.
What Other Taxes Does a Business Pay?
In addition to income taxes, the largest tax bill small businesses pay is for payroll taxes. These taxes are based on employee pay at the rate of 7.65% on employee gross payroll. Other payroll taxes, like unemployment taxes and workers compensation taxes, increase the amount of tax an employer must pay.
Other taxes your business will be responsible to pay include:
- Capital gains taxes on business investments and on the sale of business assets. Long-term capital gains (held more than a year) are taxed at different levels, depending on the income of the business, Short-term capital gains are taxed as ordinary income.
- Businesses must pay property tax on real property (land and buildings) owned by the business.
- Your business must also pay tax on dividends from business investments.
What About 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.
Some of the tax reform law changes will have a direct impact on your business, depending on the state in which you do business.
How Do Small Business Owners Pay Taxes?
Most small businesses are owned by individuals. As discussed above, partnerships, LLC's and sole proprietor businesses pay no business tax, but the tax is passed through to the owners and is paid by the owners on their personal tax returns. So, asking the question about how much tax they pay gets muddled up in the tax owed by the individual for all forms of income, not just the income of the business.
The only type of business that pays taxes on its own is a corporation. The corporation's owners don't pay any tax 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.
Considering the Effective Tax Rate
Small businesses of all types pay an estimated average effective tax rate of 19.8%. The effective tax rate is the average rate of tax for a business or an individual taxpayer. The effective tax rate is calculated by dividing the total tax paid by the taxable income. The other way to look at tax rates is the marginal tax rate, which is the highest rate paid by the business or individual. The corporate tax rate table, for example, has different tax rates for different levels of corporate income.
Averages don't tell you much of anything about the ends of the curve. You know what they say: If you stick your head in the oven and your feet in the freezer, on average you're just right.
According to the SBA report mentioned above,
Sole proprietorships face a 13.3 percent rate, small partnerships face 23.6 percent, and small S corporations face 26.9 percent. While not directly comparable, the rate faced by small C corporations is 17.5 percent.
Net income differences in types of businesses
What is more interesting in this SBA report is the statistics about net income.
Nearly 60 percent of small sole proprietorships have a net income of less than $10,000, while only 3.1 percent have a net income of at least $100,000. On the other hand, more than 18 percent of small S corporations have a net income of at least $100,000.
The higher income for corporations would be a factor in explaining their higher tax rate.
What about 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 tax liability 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.
Qualified Business 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 C-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 — worth 20%, it's called the Qualified Business Income Deduction. Using this deduction, that means that a business with a taxable income of $100,000 only has to pay taxes on $80,000 of that amount.
The Bottom Line
As a small business, the amount of tax you pay depends on the state in which you do business. The taxes range from federal and state, payroll, unemployment and capital gains taxes. Although the new tax reform gave relief to big corporations, there was some concession handed to the country's small businesses in the form of the Qualified Business Tax Deduction.