What Is the Small Business Tax Rate?
The small business tax rate for the 2019 tax year is a flat 21% for a C-corporation and will remain so for the 2020 tax year. On average, the effective small business tax rate is 19.8%. However, businesses pay different amounts in taxes based on their entities. Generally, sole proprietorships pay a 13.3% tax rate, small partnerships pay a 23.6% tax rate, and small S-corporations face a 26.9% tax rate.
Taxes are complicated, and many small business owners struggle to understand how their tax liability is determined. Many business owners don’t know the corporate income tax rate, what tax cuts they are eligible for, or what terms like pass-through income even mean. Plus, in addition to income taxes, businesses also have to pay payroll taxes, unemployment taxes, and other kinds of taxes.
To make things even more complex, small business tax rates, deductions, and applicable laws can change from year to year, meaning you have to stay up to date on these changes to ensure you’re meeting your tax obligations completely and accurately.
While understanding how small business taxes are calculated and applied can seem overwhelming to any business owner, learning some basics can help you make the right decisions and work with your tax professional. This guide breaks down the types of taxes your company may be subject to, as well as the different small business tax rates applied to your earnings—plus, it also includes updates to tax laws that may affect your business.
In This Article
- Types of Small Business Taxes
- When to Pay Small Business Taxes
- Tax Rates by Type
- State Small Business Tax Rates
- How Deductions and Credits Affect Your Tax Rate
- Determining Your Tax Rate
Types of Small Business Taxes
One of the biggest reasons taxes are so difficult for small business owners is because there isn’t a single “small business tax”—meaning there isn’t a single small business tax rate either. However, when it comes to business taxes, people are typically thinking about federal income taxes and how those rates apply to their business.
This being said though, federal income tax is just one of a number of taxes your business might be required to pay. Ultimately, your company might have to pay one type of tax or several, depending on your business structure, whether you have employees, or what products or services you provide to your customers or use to conduct business.
In general, there are six types of business taxes:
Most people are familiar with income tax—individuals must pay income tax on wages, investment income, and gains from the sale of property they own. A corporation, however, must also pay tax on the net income—income after accounting for expenses—it earns each year.
LLCs, sole proprietorships, and certain other business types, on the other hand, are considered pass-through entities, meaning the business itself does not pay income tax. The owners pay tax on the business income at their individual tax rate and report the business income on their personal tax return.
This being said, it’s important to remember that not all income is treated the same—as an example, shareholders in a C-corporation pay a different small business income tax rate on dividend income versus ordinary net income from the business.
If you have employees, you are responsible for paying employment taxes, also called payroll taxes, on their wages. Employment taxes include federal income tax withholding, social security and Medicare taxes, and federal and state unemployment taxes.
Many businesses hire a payroll company to manage their payroll tax liabilities and file their tax forms on their behalf. Employment taxes can be complicated—plus, failure to file and pay on time can result in stiff penalties and, in rare cases, criminal prosecution.
Self-employed individuals are responsible for paying self-employment taxes, which includes social security and Medicare. You must pay this tax if your net earnings from self-employment last year were at least $400. Most businesses pay half of the total amount of social security and Medicare taxes on their employees’ wages and the other half is withheld from the employees’ paychecks and remitted by the business.
But for self-employed individuals, they pay the entire amount for these taxes on their own. Some special rules apply here, such as those for self-employed individuals who work for a church or on a fishing crew.
If your business is in a certain type of industry or sells certain types of products or services, you might be responsible for excise taxes on these transactions and activities. An excise tax is an indirect tax, meaning it isn’t directly paid by the consumer of the product.
Often, the tax is included in the price of the product or service, as with cigarettes and liquor. Businesses that sell products or services subject to excise tax are responsible for collecting the taxes and sending them to the IRS.
There’s no federal sales tax in the U.S., but 45 states and thousands of localities levy sales tax. Business owners are responsible for calculating, collecting, and reporting sales tax to local and state governments. Customers pay sale tax on goods and services at the point of purchase.
After a recent court decision, even some ecommerce sellers must collect and report sales tax from out-of-state customers. As a small business owner, it’s important to understand your state and locality’s rules on sales taxes.
If you own commercial property, land, or a brick-and-mortar location, then you’ll have to pay a business property tax to the city or county where the real estate is located.
When to Pay Small Business Taxes
Just as important as the types of taxes you pay is when you have to pay them. Most individuals pay taxes one time before a specific deadline set by the IRS. However, most business owners have to pay estimated income taxes and self-employment taxes on an ongoing basis.
Estimated taxes are taxes that you pay throughout the year, based on what you think your taxable income at the end of the year is going to be. Any business owner who expects to owe more than $1,000 in taxes for the year must pay estimated taxes on a quarterly basis. The estimated tax payments you make throughout the year are deducted from your total liability when you file your tax return. Federal income tax is a pay-as-you-go tax and you can incur penalties and interest if you fail to make the required estimated tax payments when they are due.
Small Business Tax Rates by Type of Tax
The Tax Cuts and Jobs Act (TCJA)—which first took effect for the 2018 tax year—reduced the U.S. corporate income tax rate from a maximum of 35% to a flat rate of 21%. Therefore, no matter how much income your C-corporation makes, this means you won’t pay more than a 21% rate on income. If you take a dividend or distribution from the business, that is subject to a different, capital gains tax rate. Since C-corporations pay a corporate tax rate, plus taxes on dividends, many people say that C-corporations are subject to double taxation.
Pass-through entities, including S-corporations, limited liability companies, and general partnerships, have a different type of federal small business income tax rate. Owners of these types of businesses, as well as sole proprietors, report business income on their personal tax return and pay taxes at their individual tax rate. Individual tax rates are determined by your level of taxable income and filing status (single or joint filing). In general, individual income tax brackets are progressive, meaning that people with higher income pay more taxes than those with lower income.
Here’s a summary of the small business tax rates you’ll want to keep in mind:
Income Tax Rate for C-Corporations
As discussed above, all C-corporations pay a flat 21% tax rate on net business income.
Dividend Tax Rates for C-Corporations
Shareholders of corporations must pay taxes on dividends or distributions from the business. The dividend tax rate depends on whether the dividends are qualified or unqualified. Dividends are qualified if you’ve held onto the underlying stock for at least 60 days. As of the 2020 tax year, the rate on qualified dividends ranges from 0% if you earn under $40,000 to 20% if you earn over $441,450 in income. On non-qualified dividends, sometimes also called ordinary dividends, the dividend tax rate is equal to the shareholder’s regular income tax rate.
Income Tax Rates for Pass-Through Entities and Sole Proprietorships
The federal small business tax rate for pass-through entities and sole proprietorships is equal to the owner’s personal income tax rate. For the 2019 (and 2020) tax year, personal income tax rates range from 10% to 37% depending on income level and filing status. For example, a single filer who reports $100,000 in net business income will pay a 24% tax rate.
It’s important to note, however, as of the 2018 tax year, sole proprietors and owners of pass-through entities can deduct up to 20% of their business income before their tax rate is calculated. In the above example, the tax filer could deduct up to $20,000 from the net business income. Then, they’d only have to report $80,000 in income, reducing their tax rate to 22%.
There are limits, however, on this small business tax deduction based on income and type of business. In general, you must earn less than $157,500 (single filers) or $315,000 (joint filers) to qualify for the full deduction. Additionally, professional service businesses, such as law firms and doctor’s offices, typically can’t claim the full deduction either.
Employment Tax Rates
As we mentioned briefly above, employment taxes include social security taxes, Medicare taxes, and unemployment taxes. These small business tax rates break down as such:
- Social Security Tax: 12.4% on wages paid up to $137,700 for 2020 (up from $132,900 in 2019). Employers pay half of this amount (or 6.2%), while the other half is deducted from the employee’s wages. If you’re self-employed, then you pay the full amount as part of your self-employment taxes.
- Medicare Tax: 2.9% of all wages paid to an employee (no wage threshold), with the tax split between employer and employee. There are additional Medicare withholding requirements for employees who make over $200,000 per year.
- Federal Unemployment Tax: 6% of the first $7,000 you pay to an employee. You can usually take a credit against this tax if you’ve paid state unemployment taxes. If you’re entitled to the maximum 5.4% credit, the federal unemployment tax rate is reduced to 0.6%.
- State Unemployment Tax: Each state charges its own state unemployment taxes. The rate typically depends on the size and age of your company, the industry, the historical rate of turnover at your company, and how many of your former employees have applied for unemployment benefits.
Excise Tax Rates
Once again, excise tax rates vary greatly based on the specific type of product or service that you’re selling. You can read more about the different types of excise taxes and rates in IRS Publication 510. It’s important to note that some states also charge excise taxes.
Sales Tax Rates
Sales tax rates vary greatly based on state and locality. The first thing you should do to determine the sales tax rate for your small business is to find out if you’re in an origin-based state or a destination-based state.
In origin-based states, like Texas and Pennsylvania, sales tax rates are based on where the seller or business operates. In destination-based states, like Florida and New York, sales tax rates are based on the customer’s location. Within states, rates might also differ based on which locality you’re in and what types of products you’re selling.
Property Tax Rates
Like sales taxes, property taxes vary greatly based on city and county. When you purchase property, the property will be registered with the local tax authority. This agency will send you information about property tax rates and deadlines. Property taxes are levied on the property’s assessed value, not on the purchase price or fair market value.
State Small Business Tax Rates
In addition to federal taxes, your business is also responsible for complying with state and local tax obligations. With the exception of South Dakota and Wyoming, all states levy a tax or charge of some sort on business income. There are three main models for state small business tax rates:
- Corporate Income Tax: In most states, C-corporations must pay a corporate tax rate of 4% to 9% on net business income.
- Gross Receipts Tax: A few states, including Texas and Washington, charge a gross receipts tax instead of a corporate income tax. Gross receipts tax is levied on a business’s gross sales, instead of net income. A business usually can’t take deductions before this tax is calculated.
- Franchise Tax: Some states charge a franchise tax in addition to or instead of a gross receipts tax or income tax. A franchise tax is calculated on the value of a business’s stock or assets and usually ranges from 0.1% to 0.9%.
All of this being said, you should keep in mind that even if a state doesn’t charge individual income tax, your businesses might still have tax obligations. For instance, New Hampshire doesn’t levy an individual income tax, but it does have a corporate income tax and a franchise tax. In addition, states might charge their own equivalent of payroll taxes and excise taxes. Sales taxes are exclusively at the state and local levels.
For more information about state business tax rates, you can contact your state’s business tax agency. You can also see the most and least business-friendly states from a tax standpoint, in the graphic below.
How Deductions and Credits Affect Your Small Business Tax Rate
As we explained in regard to the 20% deduction sole proprietors and other pass-through entity business owners can take, figuring out your final small business tax rate isn’t as easy as multiplying your net income by your tax rate. Instead, there are several factors that could affect your final tax bill:
- Tax Deductions: Many business owners take advantage of tax deductions (like home business tax deductions) on business expenses to lower their taxable income. Some deductions can make a huge difference to your bottom line. For example, the Section 179 deduction lets businesses deduct the total cost of an asset, like a vehicle or machinery, in the year of purchase.
- Net Operating Losses: Other companies might have net operating loss deductions carried forward from a prior year that reduce the amount of the current year’s taxable income.
- Tax Credits: Your business could also be eligible for tax credits that can reduce the amount of tax you pay and your effective small business tax rate. Tax credits are better than deductions because they allow you to subtract the amount of taxes you owe on a dollar-for-dollar basis. For instance, businesses that use alternative sources of fuel or alternative sources of energy might be eligible for a tax credit.
Ultimately, because of deductions and credits, two businesses with the same net income for the year could end up paying different amounts of federal income tax.
How to Manage Small Business Taxes
Now that you know the different small business tax rates and what your business can expect, you’re probably wondering how you can prepare so that you won’t be caught off guard when it comes time to pay your taxes. Given that no two businesses will end up paying the same amount of tax, every business’s approach will be slightly different.
However, the best thing any business owner can do is put money aside ahead of time. You may want to allocate as much as 40% of your income to cover state and federal taxes each quarter, in accordance with your small business tax rate. This is especially important when you just start your business since you won’t yet have a complete understanding of your business’s tax liabilities.
A best practice is to set aside money to pay taxes in a bank account separate from your business’s day-to-day finances. This way, you won’t accidentally spend money that was earmarked for the IRS. You can even set up automatic transfers from your business bank account into a separate account, so that you know you’re always putting away money to cover your tax bill.
If you miscalculate and end up underpaying what you owe, don’t worry. Most business owners can avoid the underpayment penalty if they pay as much in taxes each quarter as they did the previous year. You can read more about this rule on the IRS website.
At the end of the day, understanding and meeting your tax requirements are some of the most complicated parts of running a business. There are a number of reasons why business taxes are so complex—there are a variety of taxes to consider, your small business tax rate will differ based on your entity type, and there are deductions and credits to incorporate as well.
Therefore, the best thing you can do for your business is to work with a qualified tax professional, like a CPA, enrolled agent, or tax attorney. Their expertise can help you understand the types of taxes your business is responsible for and make sure you are paying the correct small business tax rate.