The taxable income of a small company varies depending on the business structure, location of the business, industry, etc. For example, companies registered under sole-proprietorship might meet a 13% federal tax rate. Businesses registered under a partnership or S-corporation structure might need to pay 24% and 27%, respectively.
The key takeaway is that if you run a small business, it is reasonable to determine the tax rate to file taxes without any penalties. You should consider taxes since they may be critical to your success.
Keep reading the article to learn about average numbers among small businesses, tax rates, etc.
How Small Businesses are Taxed in the US?
The most important thing to understand if you have a small business is that it isn’t taxed at a corporate rate. According to the statistics, 75% of small businesses aren’t registered or considered to be corporations. These companies are categorized under the term “unincorporated pass-through entities.”
In accord with the NNational Federation of Independent Businesses report, such unincorporated pass-through entities pay the business owner’s individual tax rate. When a small company owner is filing personal taxable income, they include revenue from their business. The rate, in this case, mainly depends on the total revenue the owner reports.
Use Federal Income Brackets for a current fiscal year (2021-2022) to figure out the rate based on the total revenue. For taxes due in April 2022, the rates are:
Federal Rates Examples
If a business owner makes $164,926 to $209,425, then they are in the 32% bracket. Let’s say the owner has a $200,000 taxable income. One might get confused and think they have to pay $200,000 x 32%, which is $64,000. But that’s a mistake.
The US has a progressive taxing system. This means that people with higher income are subject to higher federal income rates, and people with lower earnings are subject to lower rates.
In simple words, being in a specific bracket doesn’t mean you have to pay that specific income rate on everything you make.
According to the bracket for 2021-2022, the said business owner has to pay 10%, 12%, 22%, 24%, 32% on each specific portion of income:
- 10% bracket. $0 to $9,950, so 9,950 x 0.1 = $995
- 12% bracket. $9,951 to $40,525, so $40,525 – $9,951 = $30,574, and $30,574 x 0.12 = $3,668.88
- 22% bracket. $40,526 to $86,375, so $45,849 x 0.22 = $10,086.78
- 24% bracket. $86,376 to $164,925, so $78,549 x 0.24 = $18,851.76
- 32% bracket. $164,926 to $200,000, so $35,074 x 0.32 = $11,223.68
In total, the business owner has to pay $995 + $3,668.88 + $10,086.78 + $18,851.76 + $11,223.68 = $44,826.1
Instead of paying $64,000, the company owner pays $44,826.1. It’s in case the filer is single and doesn’t file jointly. Instead of paying 32% on all income, the taxpayer pays around 22% on all income according to federal rates.
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State Rates Examples
There is also the state tax rate. For example, if the said business owner has a business registered in Arizona, they would have to pay an extra state tax of $7,637.62. So, $44,826.1 + $7,637.62 = $52,463.72
Let’s say the business operates in New York. In that case, the state tax payment is $12,108.22, so the owner has to pay in total $44,826.1 + $12,108.22 = $56,934.32. Yes, in some states, taxpayers may pay more. On the bright side, business owners may use various deductions and claim credits to reduce taxable income and save funds.
But different businesses must follow different rules based on the structure. As mentioned, most small businesses in the US are registered as sole proprietorships and have just one owner. In that case, the owner reports business revenue as their personal gains (like in the example).
A small company may register as a partnership, meaning it has at least two owners. Each partner has to report business income on their personal gains. They may file jointly if they are married, so the federal rates should be different from the example above. If not, they use brackets for single taxpayers.
In December 2017, the Tax Cuts and Job Act was signed. In accord with this Act, corporate tax rates decreased from 37% to 21%. This rate affects mainly companies registered as corporations.
The LLC (a Limited Liability Company) reports according to a different tax rate which depends on the business structure.
Other Taxes to Consider
There is also a list of taxes for small businesses owners to consider:
- Income tax. A taxpayer reports income according to federal and state rates.
- Self-employment tax. It includes Medicare and social security. Most small companies must pay this tax according to rates during a specific year.
- Payroll taxes. A small company has to pay 7.25% of an employee’s gross payroll. The company may also have to pay workers’ compensation or unemployment taxes.
- Capital gains taxes. It includes taxation on investments or the sale of a company’s assets. Assets held for more than a year are taxed 0%, 15%, or 20%. The percentage depends on total revenue. According to US laws, a higher percentage applies to higher revenues. Property owned for less than a year is part of the company’s revenue and taxed according to federal income brackets.
- Property tax. If a company owns buildings or land, it will be taxed. Property taxes are between 0.18% to 1.89% depending on the state where a business is registered.
- Dividend tax. If a company makes investments and receives dividends, then it’s income. The owner or partners have to report how much they earn according with their bracket. The rules may be different depending on the business structure.
Now let’s check tax rates per state.
Small Business Tax Rate by State
Different states have different rates and some states are more favorable than others, for instance:
- New Hampshire.
States like New York, California, and New Jersey have higher rates so that a company owner will be taxed more. The state rate is based on different taxes. For example, in New Jersey, a business owner would have to pay taxes according to high property, corporate income, and inheritance tax rates.
If you are only considering registering a company, make sure to do research and find out what states are the most favorable according to your situation.
How Much Taxes Does the Average Small Business Have to Pay?
The Small Business Administration reports an average rate of around 19.8%. A small company with just one owner can pay about 13.3%, whereas companies with more than one owner pay about 23.6%. S corps often pay around 26.9%. Corporations pay more since they tend to have higher revenues.
How Much a Small Business Makes Before its Owner has to Start Filing Taxes?
The IRS states that all registered companies must file an annual income tax return. The exception is a partnership. Partnerships have to report on an information return.
If a company has employees, there is no way to avoid paying taxes no matter how much you make — you have to pay employment taxes, such as Medicare, social security taxes, etc.
If a business earns less than $400, the owner can avoid self-employment tax. But the bottom line is that if you have a registered business, you must report gains and losses to the IRS.
So, it doesn’t matter how much you make. Avoiding taxes is not an option. The good news is that it’s possible to take advantage of claiming deductions or credits.
Planning for Tax Season: How Much to Set Aside when Owning a Small Business
A business has to file federal and state taxes every quarter, so set aside smaller funds quarterly. As for the amount of money, consider 30% to 40% to avoid any trouble.
The best way to plan for the tax season is to create a business plan with an estimated annual income. For example, a company plans to earn $100,000. The owner wants to set aside 35%, which is $35,000 in total. The owner has to make sure they have around $8,750 each quarter.
You may be wondering why not set aside the average rate, which is from 13% to 23%. The reason for that is to make sure you have enough to cover all other potential taxes.
Now you know that the US has federal tax rates according to the incomes earned. But there are other taxes a business must pay. They include state tax rates, employment-related taxes, etc.
The good news is that even if you underestimate the amount to pay when it’s due, a business owner won’t have to worry about penalties as long as they pay as much taxes quarterly as they did in the last year.
Author: Charles Lutwidge