Taxes. This word alone has the power to strike intense anxiety in even the most stalwart small business owner. Still, paying taxes is a necessary evil when it comes to owning and operating a business.
It’s easy to adopt the mindset of “I’ll worry about it when it gets here,” or “I’ll let my accountant handle all this tax stuff when the time comes.” However, failing to anticipate your tax responsibilities can put your business in a difficult financial situation. You need to understand these numbers (even in a very basic sense) to make critical business decisions big and small.
As if taxes weren’t confusing and difficult enough, there’s not simply a single “small business tax” we can define for you. You’ll have to fulfill several different federal and state financial obligations—these range from federal income taxes to sales taxes to property taxes and more.
It’s a lot to digest—we get it.
That’s why we’re breaking it down to help you understand exactly what types of small business taxes you’re expected to pay. Below, we’ll walk through the 7 most common taxes and highlight nuances to help make your tax burdens a bit more manageable.
But first, we need to identify your business type—because your tax obligations (which ones, how much, when they’re due, etc.) will differ depending on your legal entity type.
Business Taxes by Entity
Corporations, limited liability companies (LLCs), partnerships, and sole proprietors all have different tax responsibilities. You’ll need to understand your business type to ensure that you pay your taxes appropriately.
Here’s a high-level overview of the tax obligations you can expect based on your business structure:
- C Corporation: Due to the Tax Cuts and Jobs Act of 2017, the tax rate (starting in 2018) dropped to a flat 21% for C corporations. C corporations pay their own taxes, meaning the owner doesn’t report this income on their personal taxes. However, shareholders must pay taxes when they receive a dividend or sell stock—this is why C corporations are said to pay “double taxation.”
- S Corporation: The company passes through income to its shareholders, meaning that each shareholder will take a portion of the profits to report on their personal tax returns.
- Sole Proprietor: Sole proprietors simply report their business’s net income on their personal tax returns. Sole proprietors are usually a 1-person show, so they don’t have to pay payroll taxes. But if this is your full-time business, you’ll have to pay self-employment taxes.
- Partnership: Each member of the partnership takes their portion of the profits to report on their personal tax returns.
- LLC: Single-owner LLCs are treated as sole proprietorships for tax purposes, while multi-owner LLCs are treated as partnerships. However, an LLC can elect for corporate taxation if they regularly retain a substantial amount of profits in the business.
Businesses that avoid taxes by passing income to business owners are known as “pass-through” entities. These include LLCs, sole proprietorships, partnerships, and S corporations.
If you’re a freelancer and have never officially registered your business, then you’re operating as a sole proprietor—and that means taxes are as easy as taxes can be. In the eyes of the government, you and your business are one and the same, meaning you’ll simply pay business taxes on your personal tax return.
Types of Small Business Taxes
We’ve already thrown around a few tax terms like self-employment taxes, payroll taxes, and dividend taxes—in this section, we’ll explain what they all mean.
1. Income Tax
Income tax is just what it sounds like—a tax on your business’s income. C corporations pay income tax at the corporate rate (21%), while pass-through entities pay income tax at the individual’s personal rate.
Keep in mind that this tax is on your business’s net income—not on revenue. So if your business suffered a loss (or if your company’s tax deductions exceed the taxable income), then you can reduce your business’s future tax liability.
Thanks to the Tax Cuts and Jobs Act, businesses can now carry forward their net operating loss (NOL) indefinitely until they recover the loss completely. Before, this was limited to a 2-year carryback provision.
Sole proprietors and other owners of pass-through entities may deduct up to 20% of their business profit before tax is calculated. However, your business’s income must be below $157,500 when filing alone or below $315,000 when filing jointly with your spouse.
Curious about your tax rate? Here’s a quick reference to 2020 tax obligations for pass-through entities:
|Tax Rate||Income Level – Individual||Income Level – Married Filing Jointly|
|10%||< $9,875||< $19,750|
2. Payroll Tax
If your business pays employees, you’ll have to withhold certain taxes from their paychecks. Payroll taxes (or employment taxes) are the taxes you pay on your employees’ wages. These taxes include federal income tax withholdings, FICA taxes for Medicare and Social Security, and federal unemployment taxes.
When you’re calculating payroll taxes, remember that all types of wages constitute payroll: salary, commissions, tips, bonuses, overtime, and sick pay.
Here’s a quick breakdown of the federal payroll taxes:
- Federal income tax withholding: You’ll need to withhold a portion of your employees’ paychecks for federal income taxes. Use the latest federal income tax tables, amount of wages, and exemptions (declared on your employee’s W-4) to determine how much to withhold.
- FICA tax (Medicare and Social Security): Both employees and employers are required to pay FICA taxes to help fund Medicare (2.9%) and Social Security (12.4%) programs. You’ll need to withhold FICA taxes from your employees’ paychecks (6.2%) and pay your share, too.
- FUTA (Federal Unemployment Tax Act) tax: You’ll be fully responsible for paying FUTA taxes if you paid any employees at least $1,500 in a calendar quarter.
Your state and local governments also require payroll taxes. Here’s a breakdown of the 3 main types of state and local payroll taxes:
- State income tax withholding: You’ll need to withhold a portion of your employees’ wages for state income taxes, except for in Alaska, Florida, South Dakota, Texas, Washington, and Wyoming.
- State Unemployment Tax Act (SUTA) tax: You’ll need to pay state unemployment taxes as well.
- Other taxes: Some state and local governments may require additional taxes, like family leave payments, disability insurance payments, and more.
You’ll withhold these taxes from your employees’ paychecks to pay to the IRS. You also have to pay your own portion of FICA taxes.
3. Self-Employment Tax
Sole proprietors, partnerships, and LLC owners must pay self-employment taxes for Social Security and Medicare. This is the same tax (at the same rate) as FICA taxes, but it’s paid a little differently. Self-employment taxes are only paid on net earnings. If your business doesn’t have any net earnings, then you don’t have any self-employment taxes.
Self-employment taxes are calculated based on your net income. The amount you owe for self-employment tax is added to your personal tax liability—and it’s also something you need to calculate when doing your estimated taxes.
Business owners must withhold income tax and self-employment tax to pay the IRS throughout the year. Each quarter, you must pay estimated taxes. If you’ve recently switched from being an employee, this is different—because there’s no one automatically taking your tax obligations out of your paycheck.
4. Sales Tax
The federal government doesn’t have a sales tax, but 45 out of 50 states (and thousands of local governments) do. These taxes are used to improve things like roads, public safety, schools, and more. It’s your responsibility to collect this amount from your customers at the point of purchase and then to report and pay that tax to your state.
If you sell a single product in a single state, then calculating, collecting, reporting, and paying your taxes will be pretty straightforward. However, if you have several products and services and operate in multiple states, things will become tricky.
Remember, selling in different states includes e-commerce businesses, too. Certain states require you to collect and pay sales taxes for the digital goods you sell, even if your customers are located in different states.
Below, we’ll break down the process for calculating, collecting, and paying sales tax:
1. Register for a Sales Tax Permit
You’ll need to register for a sales tax permit in each state that you do business. Usually, this is a relatively free and straightforward process.
2. Check to See if Your Product or Service is Sales-Tax Eligible
Whether or not your product or service is taxable is determined by your state. Check out this helpful article from The Balance Small Business to decide whether you need to pay sales tax.
3. Determine Your Sales Tax Rate
Most states have a destination-based sales tax, which means that the sale is considered to happen where the buyer uses the product. So if you live in North Carolina but sell a T-shirt to a customer in West Virginia, you’ll have to calculate, collect, and pay West Virginia’s sales tax.
A few states have an origin-based sales tax, which means the sale is considered to happen in the state where you (the seller) are located.
4. Collect the Sales Tax at the Point of Purchase
Use your point of sale (POS) software—or add it automatically or manually via your digital invoices—to include the necessary state and local sales tax rates.
5. Make Sales Tax Payments to the State
You’ll need to submit your sales tax return and payments to the state at the frequency your state requires. Some require monthly reporting and payments, while others demand quarterly or annual.
5. Excise Tax
Certain products or services require an extra tax—as if there weren’t enough already, right? An excise tax (also known as a “sin tax”) is usually charged on particular commodities like gambling, gas, tobacco, and alcohol.
Excise taxes seek to raise prices to discourage the use of these products—and the money collected usually funds large projects like social programs. For example, an excise tax on gas increases liabilities for gas stations, which then bumps up the prices for consumers—and this hopefully discourages the excessive use of gasoline, which helps alleviate pollution and address sustainability issues.
Businesses usually increase their prices to accommodate excise taxes, effectively passing off the tax obligation to customers. Federal, state, and local governments have the jurisdiction to establish excise taxes—and they can do so by charging by percentage (ad valorem) or by specific amount (cost charged by unit).
6. Dividend Tax
Shareholders of a corporation must pay income taxes on any income they receive from dividends. Dividends aren’t considered earned income, and that’s why they’re taxed differently and separately. This dividend tax isn’t paid through the business—it’s paid through each shareholder’s personal tax return.
This dividend tax is referred to as “double taxation.” First, the corporation must pay income tax on the business’s profits that are distributed to shareholders—then, shareholders have to pay taxes on those dividends. Thus, double taxation.
7. Property Tax
If your business owns real estate (like a brick-and-mortar store, land, or warehouse), then you’ll need to pay property taxes to the local government.
The value of your real estate determines the cost of your business’s property tax. And the value isn’t determined by fair market value—a property assessor determines it.
Once you purchase real estate and get it registered with the local authorities, you’ll receive an assessment regarding your tax obligations.
Managing Your Small Business’s Taxes
If you’ve finished reading about the different types of small business taxes and find that your heart rate is up, don’t panic! You don’t need to understand every term and tax nuance—that’s why professionals exist.
Here are a few things that you can do now to get your taxes in order:
- Hire a professional: Work with a qualified tax professional to ensure that all your ducks are in a row. These experts can make sure you’re calculating, collecting, and completing tax payments appropriately. They also can help you to find and claim valuable tax deductions.
- Put money aside ahead of time: Don’t wait until tax season to start thinking about your obligations. Put your accumulated tax money in a separate bank account to prepare for the future. Set up automatic transfers to deposit money into your tax obligation account so you don’t even have to touch it—out of sight, out of mind.
- Pay more rather than less: When in doubt, pay more. You’ll avoid trouble and possibly end up with a pleasant tax return surprise.
Sunrise Tax Assist Can Help
More than 40% of small business owners spend over 80 hours a year on tax preparation. Whistle…that’s a lot of time. How much is your time worth? If you estimate it’s worth $50/hr or $100/hr, then how much would you be willing to spend to make sure your taxes get done the right way (the first time)?
Fortunately for you, you don’t have to spend a dime to access Sunrise Tax Assist. While Sunrise Tax Assist doesn’t replace the need for a professional accountant, it does streamline all of your tax preparations:
- Tax Checklist: As you’ve seen above, you’ve got a lot of taxes to remember. Use Sunrise’s handy-dandy expert checklist to make sure you’ve got everything covered.
- Tax Documents: Keep all your employee contracts and tax documents in one place for simplified tax filing.
- Tax Estimator: Get a good idea of how much you’ll owe well before you have to make your payments.
Plus, it’s free when you use Sunrise’s bookkeeping software (which is also free).
Prepare for Tax Season
Now that you’ve seen all the various small business tax types, you probably have a different reaction when you hear “small business tax.” It’s a broad term that covers a lot, but now you know the basics of what it all means.
Armed with this knowledge, you’re ready to sort your books to make next year’s tax season a breeze. While taxes will never be “fun” (unless you’re one of those strange, wonderful people we call accountants), you can certainly make them less miserable by regularly reviewing these business taxes.
Sunrise makes bookkeeping a breeze with customized invoicing, simple expense management, and a mobile app that lets you manage your books wherever and whenever you need to. Learn more (and get started) for free now!