The average small business pays 19.8% of its annual gross income in taxes.1 But every dollar counts when you’re running a small business, and dollars spent on taxes are no exception. Imagine planning for things like payroll and other operating costs without knowing what percentage of your revenue will go to taxes – you simply couldn’t do it. That’s why it’s crucial for every small business owner to understand the numerous factors affecting the taxes they’ll owe.
When you think about business taxes, you might picture a corporation. But in reality, most small businesses don’t pay business taxes. That’s because sole proprietorships, partnerships and limited liability companies (LLCs) pay taxes at the owner’s personal rate — not as a separate corporation. You can see this illustrated in the average tax rate disparities for different business types. The average for all small businesses may be 19.8%, but for sole proprietorships, it’s 13.3%, for small partnerships it’s 23.6%, and for small S corporations it’s 26.9%.1 There are other factors that affect a small business’s tax rate as well, such as the state where it’s located and how the business is structured. Keep reading to learn more about small business income tax.
1. Small business tax rates vary by state
Not all state tax laws are created equal. In fact, some states don’t have income tax at all. Wyoming, South Dakota, Alaska, Florida, Montana, New Hampshire, Nevada and Indiana have no or very low taxes on individuals. Plus, neither Wyoming nor South Dakota have corporate income tax or a gross receipts tax. On the flip side, states with higher sales, property, individual income tax and other tax laws include: Louisiana, Iowa, Maryland, Vermont, Minnesota, California and New York.2
2. Tax rules are based on your business structure
Because tax rules differ based on business structure, it’s important that small businesses consult with an attorney and accountant to determine how their businesses should be classified.
Your business will likely fall into one of four structures:
- Sole proprietorship: A sole proprietor is someone who owns an unincorporated business by him or herself. According to the IRS, a sole proprietor or independent contractor, has to file an income tax return if net earnings from self-employment were $400 or more in the year.
- Partnership: In a partnership, individuals are taxed on their share of business net income.
- Limited liability corporation (LLC): LLC’s are taxed on their share of business net income. Multiple-member LLC's are taxed as partnerships.
- Corporation: Corporations are the only entities that pay federal taxes on their own based on net earnings. They are currently taxed at a flat 21% rate.
3. Other types of taxes for small businesses
According to NerdWallet, because small business owners pay both income tax and self-employment tax, small businesses should set aside about 30% of their income after deductions to cover federal and state taxes.
Other taxes small businesses pay include:
1. Payroll tax: After an employer has calculated and withheld the appropriate amounts from employee paychecks for federal income tax withholding and FICA (Federal Insurance Contributions Act) taxes, they must:
a. Calculate and set aside the amount they, as a business, must pay for FICA taxes.
b. Make payments to the IRS either monthly or semi-weekly, based on their total employee payroll.
c. Report on payroll taxes quarterly using Form 941 or through e-file.
2. Income tax: Small business (non-corporate) tax rates are tied to the reported income of the business’s owner(s), so business owners should expect to pay both their income tax and a self-employment tax.
3. Self-employment tax: This is your FICA tax and includes both Social Security and Medicare taxes. Salaried employees split these costs with their employer, but small business owners are both the employee and the employer. That means they have to pay it all. Need help calculating your tax? Try our self-employment tax calculator.
4. Capital gains tax: If your business investments appreciate or you make a profit on the sale of business assets, you’ll likely pay tax on the difference, known as capital gains. The capital gains tax rate is based on whether your gain is long-term or short-term.
5. Property tax: This is taxes paid on land or buildings, or “real property,” your business owns. Property taxes are assessed by local entities and used for local purposes.
6. Dividend tax: Dividends are a portion of a company's profits that it pays to shareholders and are taxed based on how and when you own an investment.
Learn more about how to file business taxes. and running a small business at the Nationwide Business Solutions Center.
Sources:
[1] “How Much Do Small Businesses Pay in Taxes?”, https://www.freshbooks.com/hub/accounting/how-much-do-small-businesses-pay-taxes (Accessed Aug. 2023)
[2] “The Best and Worst States for Business Taxes in 2023”, https://thebalancemoney.com/best-and-worst-states-for-business-3193240 (Accessed Aug. 2023)
