Small businesses face a number of challenges and obstacles, yet ask 9 out of 10 owners and they’ll all claim the same thing: nothing beats working for yourself and earning every single cent.
Though small businesses work extremely hard, they are often at a disadvantage when dealing with the IRS. Not only are there more tax obligations, but the IRS also scrutinizes small and medium businesses (SMBs) more stringently with audits compared to regular individual taxpayers.
How much should a small business expect to pay in taxes? We get asked this question often, so let’s examine the subject in more detail.
Understanding Small Business Taxes
On average, the effective small business tax rate is 19.8 percent. However, SMBs pay different amounts in taxes based on how their business is structured. For example, on average, a sole proprietorship pays a 13.3 percent tax rate, while a small partnership pays a 23.6 percent.
Taxes can be complicated for small businesses. Many owners struggle to correctly understand their tax liabilities. It’s also hard for small businesses to plan for the correct amount of money to set aside for taxes.
The biggest issue a lot owners face is the wide range of taxes SMBs must set aside. Income taxes, payroll taxes and unemployment taxes are just a few examples of the six primary tax categories SMBs need to set in reserve.
Depending on the type of business, companies may have to pay one or all of the types of small businesses taxes. It depends on the structure of a business, how many employees are on staff and what products or services the business offers. Let’s study the different components of small business taxes:
Income tax is the most obvious tax businesses need to file with the IRS. It is comparable to a regular taxpayer reporting their income, only businesses need to also include other items like income tax on wages, gains from the sale of property, investment income and other forms of income.
Income tax is based on net income, which is income after accounting for business expenses. Sole proprietorships, limited liability companies (LLCs) and other types of businesses are considered “pass-through entities”. This means the business itself does not pay income tax. Instead, the owners of the SMB are required to pay tax on the business income at their individual tax rate. They are also required to report the income on their personal tax return.
Employers are responsible for paying payroll taxes for employees based on their wages. Employment/payroll taxes include federal income tax withholdings, federal and state unemployment taxes, Social Security and Medicare payments.
Payroll taxes get a little complicated, which is why many SMBs hire professional accountants. Failure to file payroll taxes correctly can result in harsh penalties and even criminal prosecution.
Self-employed workers are grouped together with SMBs. So, individuals who earn a gross sum from clients need to reserve money each year for Social Security and Medicare. Anyone that earns more than $400 net profit per year from self-employment income is required to file.
It is important to understand the various components of self-employment earnings, including whether or not paying quarterly tax payments to the IRS is advisable.
The United States does not enforce a federal sales tax. However, 45 of the 50 states, and thousands of local districts, impose their own sales taxes. So, unless a business has its operations based in Alaska, Delaware, Montana, New Hampshire or Oregon, it will need to set aside funds for sales tax.
SMBs are responsible for calculating, collecting and reporting sales taxes to local and state governments. A growing number of e-commerce websites are starting to collect and report sales tax from out-of-state consumers.
The excise tax is relegated to small businesses that operate in certain types of industries or sell certain types of products or services. An excise tax is an indirect tax, which means it is not paid directly by the consumer at the point of sale. Instead, the tax is usually included in the price of the product or service. An example of an excise tax would be what liquor stores are required to pay on each sale.
Small businesses that own commercial property, land or brick-and-mortar shop locations are required to pay taxes associated with the property. The amount they need to set aside is based on the city or county where the real estate is located.
Levy & Associates Partners with Small Business Owners
Levy & Associates helps small businesses understand their tax obligations. We partner with clients to understand their business and help companies make their businesses tax efficient.
For more information, please contact Levy & Associates at 800-TAX-LEVY, or visit www.levytaxhelp.com. We’ve worked with small business owners for decades and are ready to help you.