What Percentage Does a Small Business Pay in Taxes

What Percentage Does a Small Business Pay in Taxes?

The percentage a small business pays in taxes varies widely but often falls between 20% and 30% of its net income. The exact tax rate depends on factors like business structure, location, and revenue. 

Owning a small business comes with its share of responsibilities—and taxes are often at the top of that list. Figuring out how much of your income goes toward taxes can get complicated, especially since tax obligations vary depending on your business structure, location, and earnings. Here, we’ll break down the typical tax responsibilities for small businesses and offer strategies for managing your tax burden effectively.

Federal Tax Rates by Business Structure

Your federal tax obligations will depend largely on your business structure. Here’s a closer look at common types of small businesses and how they’re taxed:

1. Sole Proprietorships and Partnerships

• Tax Rate: With sole proprietorships and partnerships, the business income is generally taxed at the individual rate of the owner or partners, so tax percentages depend on personal income levels.
• Self-Employment Tax: On top of income tax, owners are usually responsible for additional self-employment taxes to cover Social Security and Medicare contributions.

2. Limited Liability Companies (LLCs)

Single-member LLCs are typically taxed like sole proprietorships, with profits reported on the owner’s personal tax return, including self-employment taxes.

Multi-Member LLCs: Multi-member LLCs are taxed similarly to partnerships, where income “passes through” to each member’s individual tax return.

3. S Corporations

S Corporations are pass-through entities, so shareholders pay taxes on their individual returns based on their income level.

Self-Employment Advantage: S Corp owners have flexibility to pay themselves a salary, while other income can often be taken as distributions, potentially lowering self-employment taxes.

4. C Corporations

Unlike pass-through entities, C Corporations are subject to a flat corporate income tax rate on their profits.

Double Taxation Consideration: If profits are distributed as dividends to shareholders, these distributions are also subject to tax at the individual level.

State and Local Taxes: An Added Layer

Federal taxes aren’t the only taxes your business may face—state and local governments can impose taxes as well. Here are some typical state-level obligations a small businesses CPA in Columbus, Ohio can help you identify:

• State Income Tax: Some states impose a corporate income tax, which is usually calculated based on revenue or income and varies widely.
• Franchise Tax: Certain states require a franchise tax, essentially a fee for the right to do business in that state.
• Sales and Use Tax: If your business sells products or certain services, you may be responsible for collecting and remitting sales tax, which varies by state and locality.

Payroll Taxes if You Have Employees

If you employ staff, additional payroll taxes will apply, including contributions for Social Security and Medicare as well as federal and state unemployment taxes. Each year, income caps and contribution rates are subject to adjustment, so payroll taxes should be reviewed regularly as part of your tax planning.

Typical Tax Rates Small Businesses Face

With federal, state, and payroll taxes combined, many small businesses see an effective tax rate that falls within a common range, often influenced by eligible deductions, credits, and the business structure itself. To maximize tax efficiency, it’s important to consult with a tax professional who can provide guidance on structuring your business in a way that aligns with your financial goals.

Practical Ways to Manage Your Tax Burden

Here are some strategies that can help keep your business taxes manageable:

1. Maximize Deductions and Credits: An accountant can categorize many common business expenses that qualify for deductions, from equipment to home office use. Certain credits, like the Qualified Business Income (QBI) deduction, can also reduce taxable income for pass-through entities.
2. Choose the Right Structure: The structure of your business affects how much you pay in taxes, so it’s worth evaluating options like LLC, S Corp, or C Corp to identify the most tax-efficient setup for your needs.
3. Strategize Payroll for S Corps: If your business operates as an S Corp, paying yourself a reasonable salary and distributing additional income can help reduce self-employment tax obligations.
4. Stay on Top of Estimated Tax Payments: Making estimated tax payments quarterly can prevent penalties and help you avoid a large, unexpected tax bill at year-end.

Frequently Asked Questions

How can small businesses lower their tax rate?

There are a variety of ways to reduce taxes, from maximizing deductions to choosing the right business structure. Taking advantage of all eligible deductions, credits, and retirement contributions can lower taxable income, while a strategic business structure can minimize certain taxes, like self-employment taxes.

Are S Corporations taxed differently than LLCs?

Yes, there are differences. S Corporations offer flexibility that may allow owners to reduce self-employment taxes by taking part of their income as distributions. LLCs, on the other hand, are generally taxed as pass-through entities, with income reported on individual tax returns and subject to self-employment tax.

What state taxes do small businesses need to pay?

State tax obligations vary based on location, but common requirements include state income tax, franchise tax (a business privilege fee in certain states), and sales tax if your business sells goods or services. Since state rates and rules vary, it’s important to work with a tax professional familiar with your state’s requirements.

Do C Corporations face double taxation?

Yes, C Corporations face double taxation, meaning they pay corporate income tax on profits, and if those profits are distributed to shareholders as dividends, the shareholders pay taxes on those distributions at the individual level.

Final Thoughts

The percentage your small business pays in taxes depends on several factors, including business structure, income level, and location. Working with a tax professional can provide clarity and help you implement strategies to reduce your tax burden. At Hogan CPA Financial Services, we help small businesses make informed financial decisions. Reach out to us today for personalized tax guidance and a strategy tailored to your needs.