Based on an SBA study, small businesses pay an average tax rate of 19.8%. The actual tax rates that apply to small businesses vary significantly based on business entity, income, deductions, tax credits, and rates in effect for the year. Small C-corporations have the lowest average tax rate at 17.5%.
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What the Average Small Business Tax Rate Is
According to a study published by the Small Business Administration (SBA) in April 2009, small businesses pay an average tax rate of 19.8% on all income. Sole proprietors pay an average tax rate of 13.3%, partnerships pay 23.6%, S corporations (S-corps) pay 26.9%, and small C corporations (C-corps) pay about 17.5%.
The overall average tax rate of 19.8% reflects the average of effective tax rate paid by small businesses, based on an analysis of IRS data for tax year 2004. While the data is over a decade old, this is the most recent study of small business tax rates published by the U.S. government. It’s important to understand the difference between marginal tax rate and effective tax rate.
Marginal tax rate and effective tax rates are defined as follows:
- Marginal tax rate: The marginal tax rate is the percentage of tax applied to your income for each tax bracket in which you qualify. It’s the percentage taken from your next dollar of taxable income above a predefined income threshold.
- Effective tax rate: The effective tax rate for individuals is the average rate at which their earned income is taxed, and the effective tax rate for a corporation is the average rate at which its pre-tax profits are taxed.
In Small Business Tax Rates Complexity, the National Federation of Independent Business (NFIB), does a great job of breaking down the different tax rates for small businesses. Per this resource, nearly 75% of small businesses are organized as pass-through companies, which means the business owners pay the taxes personally and so their personal tax rates apply.
How Small Business Tax Rates Differ by Tax Type
The tax rates a small business pays vary significantly depending on the type of business entity. Small businesses organized as taxable C corporations pay a flat tax rate of 21% on their corporate profits for the year. The profits of S corporations, partnerships, and sole proprietors are taxed at personal tax rates ranging from 10% to 37%.
Small businesses can pay six different types of taxes at the federal and state levels:
1. Federal Income Tax Rates
Federal income taxes vary by income and type of business entity. Small businesses organized as C corporations pay tax at the corporate income tax rate. Small businesses organized as S corporations, partnerships, limited liability companies (LLCs), and sole proprietors pay tax at the personal income tax rates. This is because these taxes are passed through and reported on the owner’s personal tax return.
The corporate tax rate is a flat rate, meaning that the same tax rate applies no matter how large or small the amount of taxable income. Personal tax rates, however, are progressive rates. This means that the tax rate gradually increases as a person’s taxable income increases. Taxable income is what’s left over after tax deductions are subtracted from total income for the year. A lower tax rate applies to capital gains and dividends earned by individuals.
The small business tax rates by entity type are:
Corporate Tax Rate
The federal tax rate for C corporations is a flat 21% of taxable income. This 21% tax rate took effect starting with the year 2018, and will last until another tax law changes the rate. For previous years up to 2017, corporate tax rates varied from 15% to 39%, based on taxable income for the year.
Corporate profits potentially can be taxed twice at the federal level. The corporation’s taxable income is subject to the 21% corporate tax. If the corporation pays out any of its after-tax earnings as dividends, those dividends are taxed again at personal tax rates of 15% or 20% on the owner’s personal tax return plus 3.8% tax on net investment income. The marginal tax rate on dividends can be as high as 39.8% after combining the corporate and personal tax rates.
Sole Proprietor, S Corporation, and Partnership Small Business Tax Rates
The profits of sole proprietors, S corporations, and partnerships are taxed at personal tax rates. Business owners pay personal income tax at ordinary rates, which range from 10% to 37%. Additionally, S corporation and partnership earnings are subject to the 3.8% net investment income tax, which applies to owners with incomes over $200,000 (single) or $250,000 (married). The combined marginal tax rate on S-corp and partnership earnings can be as high as 40.8%.
Personal Income Tax Rates for the Year 2018 for Singles & Married Couples
LLC Small Business Tax Rate
LLCs are usually taxed at personal tax rates, as owners of the LLC report their share of the LLC’s income on the owner’s personal tax return. Under the default rules, LLCs with one owner are treated as sole proprietorships, while LLCs with two or more owners are treated as partnerships. Alternatively, owners can choose to treat their LLC as an S corporation or C corporation.
2. Self-Employment Tax Rates
The self-employment tax is how sole proprietors and partners pay into Social Security and Medicare. The 15.3% self-employment tax rate is composed of 12.4% Social Security tax on the first $128,400 of net earnings plus 2.9% on all net earnings.
Net earnings for self-employment tax purposes means the net income (after deductions) from sole proprietorships, partnerships, and LLCs taxed as sole proprietors or partnerships. S corporations do not pay self-employment taxes on net income.
The self-employment tax rates for 2018 and 2019 are:
- Self-employment tax rate for 2018: The first $128,400 of self-employment earnings are subject to 12.4% Social Security tax.
- Self-employment tax rate for 2019: The first $132,900 of self-employment earnings are subject to Social Security tax.
3. Payroll Tax Rates
Payroll, or employment taxes, are how employees pay into Social Security and Medicare. Small businesses pay 7.65% in employment taxes on compensation paid to employees. This 7.65% rate is composed of 6.2% Social Security tax on the first $128,400 of wages or salary paid to an employee in 2018, plus 1.45% Medicare tax on all compensation paid to employees.
In addition to the contributions made by employers, each employee is also responsible for a portion of the taxes. Employees are responsible for paying 7.65% for Social Security and Medicare taxes. This means employers and employees pay a combined total of 15.3% in payroll taxes.
4. Sales Tax Rates
Small businesses pay sales tax on purchases they make for their business, such as equipment and supplies. Additionally, small businesses may need to collect sales tax from their customers, especially in retail businesses. Sales tax rates vary by state, county, or municipality. Sales tax rates range from a low of zero in states without a sales tax, to a high of 10.02% in Louisiana, according to a February 2018 study by the Tax Foundation.
5. Excise Taxes
Small businesses operating in certain industries may need to collect and pay excise tax at the federal or state levels. Federal excise taxes apply to alcoholic beverages, tobacco products, firearms, tires, gasoline, and indoor tanning salons, as well as other goods and services. The excise tax rate is based on the type of product. For example, beer is taxed at a flat rate of $18 per barrel, while cigarettes are taxed at an average flat rate of $69 per 1,000 units.
6. State Tax Rates
Small businesses pay tax in the state or states where they conduct business. Each state sets its own tax rates. Hawaii’s state tax rates range from 8.25% to 11%, for example. These nine states do not impose income taxes: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Some states impose separate taxes on S corporations and LLCs, even though the income from such businesses is taxed on the owner’s state tax return. California, for example, has a 1.5% flat tax rate on S corporations with an $800 minimum. Texas, to give another example, imposes franchise taxes on LLCs: 0.375% (for retailers and wholesalers) and 0.75% (for other LLCs).
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How to Reduce Your Small Business Tax Rate With Deductions & Tax Credits
Deductions and tax credits are the two main ways small businesses can reduce their tax rates. Deductions reduce taxable income, and lowering taxable income results in a lower tax bill. After the tax due has been calculated, certain types of expenses can reduce the tax liability even further; these reductions are called tax credits. You can also carry over losses (which may be created by deductions and credits) to reduce your tax rate in future years.
Common tax deductions, tax credits, and carryover losses that reduce SMB tax rates are:
Small Business Tax Deductions
For the most part, deductions represent expenses related to running a small business. A small business earning $100,000 in revenue with $40,000 of deductions, for example, pays tax on their net taxable income of $60,000. While deductions don’t reduce taxes dollar-for-dollar, they will lower your tax liability. For example, if your average small business tax rate is 37%, every $100 of deductions reduces your tax liability by $37.
Six common small business tax deductions include:
- Travel deduction: Businesses can deduct business travel expenses such as airfare, car rental, and hotels when the owner or employees need to travel for work-related activities.
- Home office deduction: Represents the portion of rent, mortgage payments, and utilities related to a small business home office. The office space must be used regularly and exclusively for business purposes.
- Depreciation on equipment: Computers, furniture, signage, and other big-ticket assets are deducted either all at once or over several years through depreciation deductions.
- Car mileage deduction: The cost of driving a car or truck for business can be deducted by taking the standard mileage rate deduction (54.5 cents per mile for 2018). Alternatively, the business owners can deduct the actual costs of driving their vehicle.
- Employment taxes: Businesses can deduct the 7.65% payroll tax on wages paid to employees. They can also deduct unemployment insurance taxes.
- Qualified business income tax deduction: This is a brand-new deduction for 2018. Small business owners can take a deduction of up to 20% of their net business profits. This is a straight deduction, not related to spending on specific items. The actual percentage of the deduction varies based on the owner’s income for the year.
Besides these common deductions, small businesses also can deduct a wide range of business expenses. Examples include supplies, telephone service, software, professional education, advertising, and many other expenses directly related to running a business. Some types of expenses are eligible for federal tax credits, which can be more advantageous compared to taking a deduction.
Small Business Tax Credits
Some business expenses can generate a tax credit, which reduce the total tax liability dollar-for-dollar. A $100 tax credit, for example, reduces tax by $100. This makes tax credits sometimes more beneficial than deductions, which only reduce tax based on the tax rate percentage. However, you can take both tax credits and tax deductions when appropriate.
Three common tax credits for small businesses include:
- Work Opportunity Tax Credit: Businesses that hire veterans, welfare recipients, people with disabilities, and other demographics can claim a tax credit for 25% or 40% of first-year wages.
- Credit for Retirement Plan Costs: Fees to set up a small business retirement plan, such as a 401(k), generate tax credits in the first three years of the plan. The maximum credit is $500 per business.
- Credit for Employment Tax on Tips: Restaurants, bars, and other businesses that serve food and beverages can claim a tax credit for the 7.65% FICA employment tax paid on tips earned by employees.
Businesses can reduce their tax through both tax deductions and tax credits. Deductions reduce how much income is taxed, while tax credits further reduce the tax liability. If a business loses money in a year, the business won’t pay income tax, and there are special rules for how to handle the loss.
Carryover Net Operating Losses
Sometimes a small business will lose money, meaning its tax-deductible expenses for the year exceed its revenue. For C corporations, these net operating losses (NOLs) will reduce taxable income for the business, whereas this will reduce the amount of the taxable income on the owner’s personal tax returns for pass-through entities. Beginning with 2018, the amount of the NOL is limited to the lower of amount of the carryover loss or 80% of next year’s taxable income.
For businesses organized as C corporations, the net operating loss (NOL) from one year carries forward to the following year. By carry forward, we mean that the loss amount from year one is deducted in year two. Let’s say a C corporation has an operating loss of ($500) in year one, followed by a net profit of $1,500 in year two. The $500 NOL carryover from year one reduces taxable income to $1,000 for year two ($1,500 – $500).
For businesses taxed as sole proprietorships, S corporations, or partnerships, however, the operating losses of the business pass through to the owners. Business owners claim the loss deduction on their personal Form 1040 which will reduce the owner’s other income subject to tax. When business losses exceed the owner’s other income, the individual has a net operating loss for the year. Individuals carry forward their NOL to the following year.
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How Small Business Owners Pay Federal Income Taxes
How small business owners pay their taxes depends on how the business is organized. The process involves estimating how much tax is due on the business income, and paying that amount throughout the year, at least quarterly. These payments of estimated tax are applied to the actual tax liability for the year, which is figured out when the owners prepare their tax returns.
Any remaining tax is due by the filing deadline, which is April 15 for sole proprietors and single-member LLCs. Most pass-through entities must pay their taxes no later than March 15, unless they operate on a fiscal year and not a calendar tax year.
Paying estimated tax differs for sole proprietors, pass-through businesses, and C corporations:
1. Sole Proprietorship Taxes
Sole proprietors pay income taxes and self-employment taxes throughout the year using the estimated tax process. Any tax not paid through estimates is due by the April 15 deadline and can be paid with an extension or with the tax return.
Estimated tax payments are due four times a year (quarterly) and must be reported on IRS Form 1040-ES. Any tax not paid through estimates is due on April 15 and must be reported on Schedule C for sole proprietors. There’s a similar process for state taxes.
The federal government operates two free services for electronic payment of tax: IRS Direct Pay and the Electronic Federal Tax Payment System. Taxes can also be paid via debit card or credit card through third-party payment processors, all of which charge transaction fees. Alternatively, sole proprietors can mail their tax payments with checks or money orders or can pay in person at a local IRS taxpayer assistance center (appointments are usually required).
2. Small Business ‘Pass-Through’ Taxes
The owners of S corporations and partnerships pay estimated tax personally on their pass-through business income. Similar to sole proprietors, estimated tax payments are due four times a year and must be reported on IRS Form 1040-ES. Any tax not paid through estimates is due on March 15 and must be reported on IRS Form 1120S for S corporations and IRS Form 1065 for partnerships.
S corps and partnerships may need to pay their own state and local taxes. For example, S corps pay corporate or franchise taxes in California, the District of Columbia, Louisiana, New Hampshire, and Texas. Partnerships and LLCs might be subject to franchise taxes in California and Texas. Additionally, business owners will need to make state estimated tax payments personally based on their share of the business income.
3. Corporate Taxes
C corporations pay their own corporate estimated tax payments. The IRS requires corporations to report estimated tax payments on IRS Form 1120-W and pay electronically via the Electronic Federal Tax Payment System or through a local bank or tax firm.
Estimated taxes are due on the fifteenth of the fourth, sixth, ninth, and twelfth month of the business tax year. Any tax not paid through estimates must be reported on the corporate tax return, IRS Form 1120, and paid by the fourth month after the end of the business tax year.
Partnerships, S corporations and C corporations may use a fiscal year that is different from the normal calendar year end, January through December. For example, a C corporation that has a fiscal year of July 1 to June 30 would pay estimated tax payments in October, December, March, and June.
The estimated tax payment schedule for a C-corp with a tax year of July 1 to June 30 is:
- Estimated Tax Payment #1: Due October 15 (fourth month of business tax year)
- Estimated Tax Payment #2: Due December 15 (sixth month of business tax year)
- Estimated Tax Payment #3: Due March 15 (ninth month of business tax year)
- Estimated Tax Payment #4: Due June 15 (twelfth month of business tax year)
Who pays which taxes, how much, and when is a lot to keep track of. The professional bookkeepers at Bench can keep your books up to date and provide you with clean financials so you can accurately forecast your tax payments.
When to Pay Your Small Business Taxes
Individuals and small businesses typically pay their taxes throughout the year. Pre-payments for the current year’s estimated tax are due four times during the year. Final payments for last year’s tax are due by April 15 for individuals, sole proprietors, and single-member LLCs. S corporations, LLCs, C corporations, and partnerships whose tax year is January through December must submit payments no later than March 15. Payments made after the deadline could be subject to interest and late penalties.
Specific due dates for paying small business taxes in the year 2019 include:
- Federal income taxes for 2018: Final payments for tax year 2018 are due by April 15, 2019 for individuals, sole proprietors, and single-member LLCs. Pass-through entities must make final payment no later than March 15.
- Federal income taxes for 2019: Estimated tax payments for tax year 2019 are due by April 15, June 17, September 16, 2019, and January 15, 2020.
- Self-employment taxes: These taxes are paid along with any estimates or final tax payments on the same due dates as federal income tax (above).
- Payroll taxes: Due either once per month by the fifteenth of the month or every other week, based on the amount of employment taxes paid in the past. Small businesses pay monthly in 2019 if they paid $50,000 or less in payroll taxes in the four quarters from July 2017 to June 2018.
- Sales taxes: Due dates vary by state and by the amount of sales tax collected. Depending on the state, small businesses may need to pay sales tax monthly, quarterly, or annually.
- Excise taxes: Due dates are semi-monthly or quarterly, depending on the amount and type of excise tax being paid. Federal excise taxes paid to the IRS are due quarterly on April 30, July 31, October 31, and January 31. Excise taxes paid to the TTB are due quarterly if less than $50,000 for the year.
- State taxes: State estimated taxes are due quarterly, and final tax payments for the previous year are generally due by the April 15 deadline, although some states have slightly different due dates. In Virginia, for example, tax payments for 2018 are due by May 1, 2019.
Knowing when to pay is crucial to avoid late penalties and interest. The IRS charges interest (currently at 6% for the first quarter of 2019) on estimated tax not paid by the due dates. Additionally, tax payments made after the April 15 federal tax deadlines are subject to a late payment penalty of .5% per month, plus interest.
The key to avoiding penalties and interest is paying the right amount of tax at the right time. Basing your tax calculations off the most up-to-date financial numbers helps you avoid expensive penalties and unexpected tax bills. The professional bookkeepers at Bench can keep your finances up to date so you can make more accurate decisions about how much tax to pay.
Small Business Tax Rate Frequently Asked Questions (FAQs)
By now, you should have a good idea of the different types of taxes and tax rates that apply to small businesses.
Common questions small business owners ask about tax rates include:
What percentage does a small business pay in taxes?
Small businesses will pay different percentages of tax depending on their income, deductions, and entity type. Small businesses taxed as C corporations pay 21% of their net income in federal tax. S corporations, partnerships, and sole proprietors pay tax at the personal tax rates.
What is the tax bracket for a small business?
C corporations have a single tax bracket: 21% on all taxable income. The net income from S corporations, partnerships, and sole proprietorships are taxed at personal tax rates. There are seven personal tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Where each personal tax bracket begins and ends depends on a person’s filing status.
How much are small business taxes?
Small businesses pay 19.8% in tax on average. Keep in mind that the actual tax rate paid is based on a number of factors, such as income and deductions for the year, the type of business entity, whether the business has employees, and whether the business pays excise tax or sales tax.
How do small businesses pay less taxes?
Deductions and tax credits are the essential tools for paying less taxes as a small business. How much tax a small business pays depends on net income for the year. Deductions for business-related expenses reduce the amount of net income subject to tax. Tax credits, such as for hiring veterans, can further reduce business taxes dollar-for-dollar.
What taxes does an LLC pay?
Owners of limited liability companies (LLCs) generally pay income tax and self-employment tax in the same way that sole proprietors and partnerships pay taxes. Optionally, LLCs can elect to pay tax as C corporations or S corporations. Some states, such as California and Texas, charge franchise taxes on the gross receipts of LLCs.
Small business tax rates vary significantly depending on the income and deductions of the business, the business entity type, and the types of taxes that apply. C corporations pay their own tax at corporate tax rates. The owners of S corporations, partnerships, LLCs, and sole proprietorships pay taxes at personal tax rates. Additionally, business earnings might be subject to employment or self-employment taxes, excise taxes, and state taxes.
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