The first step to understanding business taxes is knowing what they are and the different types. How do you know if your company needs to file a certain type of tax? How long should you keep those records? This blog post will answer these questions and more!
What exactly is business tax?
Business taxes are federal, state and local taxes that businesses pay on their income, profits and capital gains. There are different types of business taxes, depending on the business structure and location. Businesses may be subject to income tax, self-employment tax, employment tax, excise tax, property tax or sales and use tax.
What are the types of business taxes?
Depending on the type of business you are running, you may need to pay income tax, self-employment tax, employment taxes, or any other type of business tax. How much your company pays depends on how many employees you have and what types of services/products you’re selling!
Here are some of the types of business tax:
- Income Tax
- Employment Tax
- Excise Tax
- Property Tax
- Sales and Use Tax
- Estimated Tax
- Business Corporation Tax
How much tax does a business pay?
Businesses don’t pay taxes in the same way that individuals do. The amount of tax a business pays is calculated by taking the company’s net income for a given year and applying various calculations to it in order to reach a total taxable income amount. This includes accounting for employee salaries in tax laws similar to how an individual will report their W-2 wages when filing their own taxes, according to Forbes.
Rather than paying taxes on gross revenue, which many small businesses do when they deduct what they’ve spent from what they made, big companies might be more interested in finding ways to avoid paying as much tax as possible while still staying compliant with the law. How long should you keep records? It depends on whether your business is catering towards being successful or if you’re just trying to “get by”.
How is business tax calculated?
All businesses have a specific set of laws they must adhere to when preparing annual reports that essentially act as guidelines for taxation.
To prepare the report, businesses are required to tally up their gross revenue or income and subtract expenses. The amount left over is known as net profit (or net income), which is subject to tax rates set by federal, state, and local governments. This amounts to “net taxable income.” How much business you make largely determines the size of this number. For example, if you run an accounting firm with two employees who took home $150K in salary last year while bringing in $200K in revenue, your tax bill would be about $28K (26% based on average federal/state/local taxes). If you
Who is subject to business tax?
A business is subject to the national income tax if it has net profits from either its trade or its business, and an individual is subject if they earn self-employment income.
Generally, sole proprietorships and partnerships are subject to self-employment tax on the income from their businesses.
Corporations are subject to business tax on the income they receive from their trade or businesses.
How to find a tax ID for any business?
Every business needs a tax ID number, whether it’s for filing taxes or hiring employees.
The first step is to go to the IRS website. From there you will be able to find the appropriate tax ID number for your business.
On that page, you’ll be able to apply for an EIN online. The application process is simple and takes just a few minutes. You’ll need some basic information about your company, such as its name and address.
Once you’ve completed the application, you’ll receive your EIN immediately. You can also find your tax ID number by mailing in Form SS-four, which is titled “Application for Employer Identification Number.”
What are the distinctions of income tax against business taxes?
There are many distinctions that separate income tax from business taxes, but one of the largest distinctions is that business taxes will most likely be assessed on lower brackets of gross revenue.
Whereas taxable income is always taxable no matter how low it is, bracketed taxation changes the meaning of lower-taxed gross rates – which are substantially less for small- to medium-sized businesses.
For example, if you make $520k in gross revenue as an individual, then your average federal/state/local rate will be about 35%. Whereas if you run a company with $520k in revenue and two employees making $150K each with benefits before taxes, the amount would be closer to 26% for state and federal income tax purposes.
Another key difference is that business tax rates are not fixed. How much you pay depends on how well your company does in the marketplace with regards to sales, service, and profit margins.
Small Business Taxes for Beginners
What are the tax planning strategies for new businesses?
There are plenty of strategies out there that can work, but it’s important to tailor them specifically for your business.
1. Consider a tax status change
As a business owner, you have many alternatives for organizing your company. You may run your firm as a sole proprietorship, partnership, limited liability company (LLC), S corporation, or C corporation. The way to file taxes for small business owners will depend on their company structure.
If you’ve outgrown your current company structure in the last year, you may be able to convert to one that’s a better fit. LLCs, for example, can opt to be taxed as a C corporation by submitting Form 8832 with the IRS.
Making such a choice was formerly uncommon, as the top corporate income tax rate was 35%, but the Tax Cuts and Jobs Act of 2017 (TCJA) reduced the top corporate income tax rate from 35% to 21%.
2. Take advantage of tax reform
The Tax Cuts and Jobs Act of 2017 (TCJA) expanded the QBI deduction to include 20% of qualified business income. However, it comes with a number of restrictions and requirements.
If the income of owners of specified service trades or businesses (SSTBs) is too high, they lose out on the deduction. SSTBs are any service-based business — other than engineering and architecture firms — that relies on its employees’ or owners’ reputations or abilities to survive.
Examples of these types of SSTBs include:
- Medical practices
- Investment managers
- Consulting firms
- Professional athletes
- Law firms
- Performing artists
- Financial advisers
Your QBI deduction is phased out when your total taxable income reaches a certain amount if you operate a service business that is an SSTB. Those levels are $164,900 if single and $329,800 if married filing a joint return for the 2021 tax year. You must use Part II of Form 8995-A to calculate your deduction; however, if your income is over $214,900 for single taxpayers ($429,800 for married filing jointly), you can’t claim the benefit.
If your taxable income is more than the upper limits but less than or equal to $9,750,000, you can claim the deduction.50% of your share of W-2 wages paid by the business; or
- 25% of those wages, plus 2.5% of your share of qualified property
You might be wondering what this all means. You’re not alone if you’re confused. The QBI deduction can provide a significant tax break for small company owners, but determining who can claim it and then computing the reduction is not simple. If you believe you may qualify, talk to your accountant.
3. Take Advantage of Tax Credits
Tax credits can reduce your taxable income and thus result in a lower tax liability to the IRS. Tax credits are available for going green, employing people, providing disabled employees with public access, and others.
The majority of these credits are part of the General Business Credit, which is quite broad and enables most company owners to take advantage of tax credit possibilities. Small business tax credits might be difficult to understand and manage, but the savings make it worthwhile.
Estimating Your Business Tax
Isn’t it great to be your own boss and set your own hours as a small business owner? You get to be the boss. But, no matter how much fun you have micromanaging everything, there’s one thing that most small-business owners dread.
How Is Your Business Legally Structured?
Before you begin to work with a spreadsheet, it’s critical to understand your company’s legal structure. The IRS classifies your business as one of the following five types: sole proprietorship, partnership, LLC, S corporation, or C corporation depending on its legal structure.
How Do You Calculate Income Taxes for Small Businesses?
When you calculate your personal tax return, do you recall how you arrived at your taxable income? You subtracted deductions and credits from your yearly income to arrive at taxable earnings. The IRS collects taxes based on a taxpayer’s taxable income, which is calculated by subtracting deductions and credits from their yearly revenue.
Small-business taxes are relatively simple to compute, especially if your company is a sole proprietorship, partnership, LLC, or S corporation. C corporations are a little more complicated, so it’s worth taking a few moments to explain them.
What’s the tax rate for C corporations?
The higher corporate rate of 21 percent is charged twice, once at a corporate rate of 21% and again at the individual rates (if any) of shareholders.1
Let’s take a look at an example. You run Money Makeover Inc., which makes $200,000 in profit. Assume your firm turns a profit of $200,000. Finally, let’s assume that after accounting for costs and deductions, you have $175,000 of taxable income remaining.
The first step in our example is to pay taxes at the corporate level, which comes out to a flat rate of 21 percent. Remember: no matter how much money Money Makeover Inc. makes, it will always pay a fixed 21% tax rate. That would be $1,200 (22%*$19).
$175,000 x 21% = $36,750
So, for example, Business Inc. pays $36,750 in corporate income taxes. Now, assume you’re a Money Makeover Inc. shareholder and receive a dividend of $25,000. This is where the issues get a little more challenging; therefore stay focused.
If you hold the stock for more than 60 days, it’s known as a “qualified dividend,” and the IRS will tax it on a sliding scale. That implies that the higher your dividend is, the more taxes you’ll pay. You wouldn’t have to pay taxes if your qualified dividend was less than $38,601 (as in our example
For earnings over $425,800, the rate tops out at 20%. For example, let’s suppose you haven’t owned the stock for more than 60 days. Then it’s referred to as an “unqualified dividend.” Unqualified dividends are taxed using your personal tax rate, which may be found in your tax bracket.
What’s the tax rate if you’re not a C-corp?
Determining income taxes is considerably simpler for sole proprietorships, partnerships, LLCs, or S corporations than it is for C corporations. Whatever earnings you make will be taxed at your tax rate once.
Let’s assume you run a firm called Business Inc. Assume your firm generates $75,000 in yearly income and that after business costs, deductions, and employment taxes (which we’ll discuss next), you’re left with $50,000 in taxable income.
If you’re self-employed and don’t file a joint return with your spouse, you’ll pay $6,900 in taxes if this is your only income and you’re in the 22% tax bracket (which starts at $29,775).
How Do You Calculate Estimated Taxes?
Small companies, on the other hand, face an additional problem. Unlike personal filers, who file their taxes once a year, small business owners are required to pay estimated taxes every quarter. That’s four times a year, in case you were wondering.
Expected annual taxable income is the amount you expect your taxable income to be each year. That may be tough, especially if you’re just getting started with your small business. However, once you’ve got an income figure to work with, things aren’t nearly as difficult. Here’s a step-by-step procedure to assist you to determine these quarterly
- Calculate your taxable income for the current year.
- Determine how much you’ll owe in income and self-employment taxes.
- Divide the total amount of taxes you expect into four equal payments.
- Make an estimated quarterly tax payment to the IRS.
Conclusion
Small business owners are required to pay estimated taxes every quarter, which can be a difficult task. It’s important to stay on top of your taxes so you don’t face penalties from the IRS. If you need help filing your taxes or estimating your payments, consult with an accountant or tax specialist.
