Hear that collective sigh? Yep, it’s tax season again. Time to roll out your receipts, dust off the calculator, and download a stack of forms. But if you’re wondering how to file your business taxes this year, perhaps if it’s your first time, we’re here to help you avoid a colossal headache.
Our comprehensive guide will clarify what taxes you need to file for your business, how to file them, and how to reduce your tax liability. If you’re unfamiliar with all of the terms and concepts associated with business taxes, check out the IRS taxes glossary.
Ready to conquer this tax season? Let’s begin.
The content on this site is not intended to provide legal, financial, or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of a tax advisor before filing your taxes or conducting tax-related operations. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any tax professional.
What Are Business Taxes?
Taxes are required payments to federal, state, and local governments that use that money for public goods and services. In addition to personal income taxes, you must pay taxes on income earned from business profits.
But income taxes won’t be the only kind you encounter as a small or large business owner. Read on to learn about five common tax types and how they might affect your startup.
Federal Income Taxes
Every business owner (except for partnerships) must pay income taxes to the federal government. In 2021, the IRS collected a record-breaking $419 billion in gross income business taxes. How much you pay depends on your business’s net profit (revenue minus expenses) and the company you run.
Curious about how to reduce your taxable income? Check out the section on deductions and credits below.
State and Local Income Taxes
Unlike federal income taxes, not every state or local municipality requires income taxes from your business. To discover exactly how much you owe in state income taxes, hop down to our state income tax section.
Self-Employment Taxes
If you’re self-employed and earned over $400 this year, the federal government requires you to pay self-employment taxes (SE taxes). The current SE tax rate is 15.3 percent and includes your Social Security and Medicare coverage. Contributing to these programs now will secure your well-being in the future by providing health insurance, retirement benefits, disability benefits, and more.
To calculate your SE taxes, use Schedule SE.
Employment Taxes
Got an employee working for you? Then you must withhold income, Social Security, and Medicare taxes from each of their paychecks to send to the IRS.
To withhold the right amount of income tax, use your employee’s W-4 and follow the instructions in IRS Publication 15-T. You can also find the current Social Security and Medicare tax rates in Publication 15, so ensure you withhold the correct amount from each paycheck.
Thanks to the Federal Insurance Contributions Act (FICA), you, the employer, must also contribute to your employee’s Social Security and Medicare taxes. Based on the 2022 tax rates, you must withhold 12.4 percent from each paycheck for Social Security and 2.9 percent for Medicare. You and the employee split the tax rate evenly, each paying 6.2 percent and 1.45 percent respectively.
And don’t forget the Federal Unemployment Tax (FUTA), which covers unemployment benefits nationwide. As an employer, you pay this tax from your income, not your employees, to help those who’ve lost their jobs. For more info on the FUTA tax rate, check out Publication 15.
Estimated Taxes
According to the IRS, most business owners pay SE and income taxes through quarterly estimated payments instead of withholding tax amounts from paychecks. Why? Because underpaying at the end of the tax year results in massive penalties of up to 25 percent of your unpaid taxes. Avoid those crippling costs by calculating your estimated taxes throughout the year as you earn income.
As well as paying estimated taxes on your income, you can also pay quarterly business taxes on your dividends, interest, capital gains, rents, and royalties. For more info on calculating your estimated taxes, check out IRS Publication 505.
Excise Taxes
Excise taxes are due on specific goods or services, usually at the state or local level. Common taxable items include fuel, alcohol, tobacco, heavy trucks, tractors, or trailers. Why these items? Because they extract a “high social cost” from everyday citizens or the environment. You might hear them called “sin taxes” too.
Federal or local governments charge your small business an excise tax for selling these items, and you can pass that tax on to the customer by incorporating it into the product price. These taxes come as fixed percentages or fixed per-unit dollar amounts.
For example, the US government put a 10 percent excise tax on all indoor tanning services. So out of a $60 tanning session, a customer pays $6 toward an excise tax.
And in Ohio, liquor includes a $3.38 per gallon tax. If you own a liquor store and want to sell bottles of Jim Beam, prepare to pay an excise tax per gallon of liquor you stock. To make up for that tax, you can jack up the price of each bottle.
Not sure if the items you sell require excise tax payments? Check out the full list on the IRS’s Publication 510.
How Do You Know Which Business Taxes to Pay?
Now that you’ve learned about the different types of business taxes, let’s explore which ones you’ll have to pay based on your business structure.
Who Has to Pay Business Taxes?
Every founder or owner must pay some form of business tax, but the requirements and additional taxes will vary depending on your startup type.
Corporations, for instance, have to pay a corporation tax on their business profits that non-incorporated businesses aren’t subject to.
We call those non-incorporated businesses pass-through entities since they pass their business income taxes through to the owner and shareholders’ personal income tax returns. Below, we explore the four types of pass-through entities, in addition to corporations.
Sole Proprietorship
If you’re a solopreneur who doesn’t incorporate your small business or share it with partners, you’re considered a sole proprietor. As a sole proprietor, you don’t have to file a separate business tax return – just add a Schedule C form to your personal income tax return.
Schedule C reports how much income your business earned that year. Add your profit or loss to your personal income to determine your total taxable income. The combined total (minus deductions) will determine your tax bracket and how much income tax you owe the IRS that year.
To cover your Social Security and Medicare benefits, though, you’ll have to pay self-employment taxes. And if you hire an employee, you’ll also have to add employment taxes to your to-do list. Finally, ensure you check the IRS Excise Tax page to see if your products or services require an excise tax.
Avoid late fees and penalties by paying your income, SE, excise, and employment taxes quarterly through estimated tax payments.
Partnerships
Like sole proprietors, the IRS doesn’t require you and your business partners to file a separate income tax return for your startup. Instead, partnerships file an information return that reports the income, gains, and losses from that year to the IRS.
Information returns don’t report tax liability, so technically, the partnership doesn’t pay income tax. But each partner must pay their share of the business’s income through a Schedule K-1 form.
Schedule K-1 reports each partner’s share in the business and how much they owe on their personal income tax return based on their share. Two partners who split the business 50/50, for example, would each pay taxes on 50 percent of the income.
In addition to Schedule K-1, partners must submit self-employment, employment, and excise taxes to the IRS.
Corporations
A C corporation is a publicly traded company owned by shareholders. Unlike pass-through entities, corporations must pay income taxes to the IRS directly as their own entities. Every corporation owes a flat income tax rate of 21 percent on all profits, while shareholders pay individual income taxes on their dividends.
Since the IRS taxes your business’s income both when you earn it and when you distribute it to shareholders as dividends, corporations technically pay a double tax. To avoid being double taxed, some founders pass all corporate income through to shareholders and become an S corporation instead.
S Corporations
To qualify as an S corporation, your business must meet the following requirements:
- Reside in the US
- Have less than 100 shareholders
- Have only one class of stock
- Have only allowable shareholders (no corporations, partnerships, etcetera. Only individuals)
If you check every box, you can pass your business’s income onto your shareholders and let them pay income taxes depending on their tax bracket. Like a partnership, you’ll fill out a Schedule K-1 that reports your share of the business, add that to your personal income tax return, and then pay based on where your income falls in the tax bracket.
Shareholders must pay estimated taxes to avoid late fees, and the corporation must pay employment and possibly excise taxes if you sell a qualifying product.
Limited Liability Company (LLC)
LLCs aren’t like your typical startup because you can choose how to structure them. Single-member LLCs (run only by you) are taxed just like sole proprietorships with a Schedule C tax form. But multi-member LLCs can choose to be treated as a partnership or corporation.
Why differentiate between sole proprietorships and LLCs if they’re taxed identically? The only difference is that an LLC legally protects the owner’s assets in case of a lawsuit (hence the limited liability). While both startups pass business income taxes through to their personal tax returns, LLCs are classified as disregarded entities, meaning the business is separate from the owner.
If the LLC can’t pay its debts, for example, the owner’s personal assets are protected and only the LLC’s assets are at risk. Sole proprietors tie their business to their personal assets, increasing their liability in legal situations.
For multi-member LLCs, the IRS will treat your business like a partnership for tax purposes unless you specifically choose to file as a corporation. To elect your LLC as a corporation, fill out Form 8832.
Once you decide which type of business your LLC classifies as for tax purposes, file the proper payments for that type. If you want a refresher on the types of taxes you must file for each business structure, check out the table below.
A table describing the forms you must file based on your startup type (adapted from IRS Publication 583)
How Much Do You Have to Pay?
No two companies will pay the exact same amount in business taxes for a fiscal year. It will vary by your income and personal tax bracket (for pass-through entities). But below, we’ve summarized a few key measurements so you have a rough idea of what to expect for your federal, state, and local taxes.
What You Owe in Federal Income Taxes
On the federal level, corporations must pay a 21 percent flat tax rate on all income or capital earned that year. LLCs that classify themselves as corporations must do the same. So your federal taxes owed will depend on how much you make and how much you can reduce your taxable income through credits and deductions.
Pass-through entities like partnerships, S corporations, sole proprietors, and LLCs pay by their individual tax bracket. For the 2023 tax season, the IRS has released seven federal tax brackets: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent.
A table of the 2022 federal income tax brackets for single filers
Say you’re a single filer who earns $60,000 annually, placing you in the 22 percent tax bracket. The good news is that you don’t pay a 22 percent tax rate on the entire $60,000.
Instead, you pay 10 percent on the first $10,275 of your salary, 12 percent on the amount between $10,276 and $41,775, and then 22% on the remainder up to $60,000.
As you can see from the table above, you don’t need to complete all the calculations yourself. Each bracket starts with the total from the brackets before it (in our example, $4,807.50). To find out how much tax you’d owe for a $60,000 salary, find the difference between 60,000 and 41,776 (18,224), and then multiply that total by 22 percent. In this case, 22 percent of $18,224 is $4,009.28. Add that to the $4,807.50 from the first two brackets, and you’ll owe a total of $8,816.78 in federal income tax.
Don’t feel like calculating your federal income tax return by hand? Use the IRS Tax Withholding Estimator to get a rough estimate.
What You Owe in State Income Taxes as a Pass-Through Entity
State taxes vary even more than federal income taxes. Each state chooses its approach to personal income taxes, though they generally fall into one of three categories:
- No income tax required
- Flat income tax rate has everyone paying the same rate for all income/dividends
- Progressive tax rate has those with higher taxable incomes paying higher taxes
Got that? Now let’s see where your state falls on the income tax spectrum.
US States with the Highest and Lowest Income Tax Rates
Eight U.S. states don’t levy income taxes at all: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Then we have 10 states that tax a flat rate, which you can see in the table below.
A table of the U.S. states with flat income tax rates for 2022
The rest of the states (and Washington DC) use a progressive tax rate so that low-income individuals pay lower tax rates than high-income individuals. Out of the remaining 33 states, those with the highest and lowest tax rates are as follows:
- Delaware, Mississippi, Ohio, and South Carolina all have the lowest starting progressive tax rates at 0 percent.
- California boasts the highest tax rate (12.3%), followed by Hawaii (11%), New York (10.9%), New Jersey (10.75%), Washington DC (9.75%), Oregon (9.9%), Minnesota (9.85%), Vermont (8.75%), and Iowa (8.53%).
- Arizona has the least amount of tax brackets (2) while Hawaii has the most (12)
For more information about your state’s tax brackets, check out Tax Foundation’s breakdown.
What You Owe in State Income Taxes as a Corporation
In addition to a federal corporate income tax, 44 states require you to pay a corporate income tax. Of those, New Jersey boasts the highest rate at 11.5 percent while North Carolina has the lowest at 2.5 percent.
Instead of corporate income taxes, Nevada, Ohio, Texas, and Washington require gross receipts taxes (your gross income without taking out expenses). And three states (Delaware, Oregon, and Tennessee) require BOTH corporate income and gross receipts taxes.
Only Wyoming and South Dakota are income-tax and gross-receipts free for small businesses.
What You Owe in Local Income Taxes
Like state taxes, your local township, city, county, or municipality determines how it will tax you for the upcoming year. To find out your local tax rates, check your local government’s website.
What Can You Write Off on Taxes For Your Business?
At this point, you might wonder how on earth you can afford to pay all these taxes. Luckily, the federal government provides two avenues for reducing your business taxes.
What Are Tax Deductions?
Tax deductions are specific expenses you can write off (claim or deduct) to lower your total taxable income. Here are common examples that you should take advantage of.
- Travel expenses. Whenever you leave your tax home for a trip longer than the workday, you can expense costs like airfares or filling up your gas tank. You can also write off lodging, tolls, meals, Uber rides, car rentals, and more. Just make sure you clearly state the business purpose for these trips.
- Rent and utilities. If you rent an office space and pay for overheads, prepare to deduct those costs from your taxes. Write off electricity, internet, water, trash, and telephone bills if possible.
- Inventory. Ecommerce businesses can deduct the “cost of goods sold” at the beginning or end of the tax season. Include components like the cost of raw materials, storage fees, labor costs, and factory overhead into your deductions.
- Insurance. Want to protect your business without paying a fortune in premiums? Write off those premiums on your tax return. You can claim business insurance as well as health, liability, worker’s compensation, and life insurance.
- Startup costs. While the IRS views startup costs as capital expenses to be deducted over time, you can still claim up to $5,000 for your first year of business. Different startup costs you can write off include advertising, market research, travel, attorney fees, accountant fees, and more. Corporations can deduct an extra $5,000 just for organizational costs like state filing fees or legal fees.
What Are Tax Credits?
You might see tax credits and deductions used interchangeably, but they are NOT the same thing. While tax deductions lower your total taxable income, tax credits are subtracted from the final income tax totals themselves. Credits are split into three categories: nonrefundable, refundable, and partially refundable.
- Nonrefundable tax credits are amounts you deduct from your final income tax total. If you’re able to deduct more than the tax owed, you would NOT be issued a refund for the extra money. These taxes only work for the current tax year and can’t be carried over.
- Say you owe $1,000 but are eligible for a $1,500 credit. The credit would reduce your tax bill to zero but the IRS won’t refund you the remaining $500.
- Examples include the Child Tax Credit, work opportunity credit, and adoption credit.
- Refundable tax credits allow you to claim the full credit amount, even if it surpasses the tax owed. Any extra money will be refunded to you.
- Imagine you owe $2,000 but are eligible for a $3,000 credit. The IRS would reduce your tax bill to zero AND refund you $1,000.
- Examples include the Earned Income Tax Credit and premium tax credit.
- Partially refundable tax credits allow you to claim a portion of the extra money beyond your tax liability.
- With the American Opportunity Tax Credit, for example, eligible students receive a credit of up to $2,500. If that’s higher than their tax bill, the student receives 40 percent of the remaining amount (up to $1,000).
How Do You Reduce Your Business Tax Liability?
While deductions are one of the most effective ways to reduce your tax liability, you can explore other options such as saving for retirement.
Any income you save in a 401k, for example, is pre-tax. The more money you invest, the less income you’re taxed on.
An individual retirement account (IRA) works slightly differently. IRA contributions are added after tax has been taken out, and they’re deducted from your tax returns at the end of the year.
Want to use pre-tax income before retirement? Put money away in a flexible spending account. Employers manage these separate accounts, and you can use them for medical expenses like doctor’s appointments.
How to Reduce Your Taxes While Selling Your Business
Looking to sell your business on a marketplace like Acquire.com but want to avoid heavy taxes? We’ve got you covered.
When you sell your business for more than your adjusted basis, it’s considered a capital gain. But the IRS taxes you on that profit for at least one year after the sale is completed through capital gains taxes.
You’ll pay either long-term capital gains taxes or short-term depending on how long you held the business. Long-term refers to a business you held for at least a year while short-term refers to businesses held for less than a year. Aim for long-term capital gains because the flat rate of 0 percent, 15 percent, or 20 percent tends to be lower than the short-term rates determined by your personal tax bracket.
But short-term or long-term, you still want to reduce your capital gains tax as much as possible. One option is to hold your business for at least a year to guarantee a lower, long-term capital gains tax rate.
Another option is selling your business (specifically, your corporation) through a stock sale rather than an asset sale. If you possess Qualified Small Business Stock (QSBS), you could qualify for a tax exemption of up to $10 million or ten times your QSBS’s adjusted tax basis.
To learn more about QSBS, the benefits of a stock sale vs. an asset sale, and how they affect your business taxes, review our post on minimizing tax liability.
Additionally, use your capital losses to offset the taxes on your capital gains in the future. If your losses exceed your gains up to $3,000, you can deduct that amount from your income and roll it over into the next year to minimize your tax liability.
How Do You File Your Business Taxes?
With tax season officially underway, it’s time to start gathering your materials and preparing the appropriate forms. Whether you choose to file your business taxes yourself or hire an accountant, make sure you have the following items ready:
- Personal Information
- Previous Year’s Tax Return
- Financial Business Reports
- Tax Forms
- Asset Information
- Loan Information
- Income Records
- Expense Records
- Deductible Expense Information
- Payroll Data
- Inventory Total
- Stocks & Bonds Information
You’ll also want your Social Security Number (SSN) or Employer Identification Number (EIN) prepared, depending on your business type. The IRS uses your EIN to identify your company when processing your taxes.
Sole proprietors and single-member LLCs without employees don’t need an EIN to file their taxes because they’re not employers. But every other business type (which often do employ people) must have their EIN on hand to file their business taxes.
How to File Your Business Taxes for the First Time
Once you’ve gathered all your materials, you can start the filing process on your own or with an accountant. While accountants aren’t strictly required to file your business taxes, they can make the process go smoothly and find new ways to reduce your taxes. But if you’re determined to file them yourself, follow these steps.
- Collect and organize all of your materials. Check the list we provided above several times to ensure you account for everything To make filing your business taxes easier in the future, keep all of your records online through programs like QuickBooks.
- Prepare the correct tax forms. Your business structure will determine which tax forms you need to file, so thoroughly check the IRS Business Structures website for the type of tax you owe and which forms to use.
- Fill out your tax forms. Get your calculator ready and plug in all the information required on the tax forms. Some small businesses will have simpler forms than others (sole proprietors’ two-page Schedule C vs. corporations’ six-page Form 1120).
- Pay attention to the deadlines. Not every business tax is due on April 15. S corps and partnerships filing a Form 1120S or 1065 must pay by March 15. Sole proprietors, LLCs, and corporations generally pay in April. But the deadline sneaks up faster than you think, so have all of your paperwork turned in sooner rather than later.
You decide whether to file your business taxes on your own or with an accountant’s help. Weigh the pros and cons of paying for an accountant vs. spending hours hunched over your computer calculating your return. Given that the IRS sends out approximately two million math error notices every year, triple-checking your work is a must. You don’t want the IRS to slap you with penalties later.
What Are the Penalties for Not Paying Your Taxes?
In a best-case scenario, you’d always file and pay your taxes on time. But in circumstances where you don’t, what’s the worst that can happen?
At the absolute worst, you could go to jail for up to five years. But the only taxpayers risking jail time are those who willingly deceive or evade the IRS. For most taxpayers, failure to file or pay your business taxes results in the Failure to File Penalty and Failure to Pay Penalty.
Failure to File Penalty
For every month or part of a month your tax return is late, the IRS charges you five percent of your unpaid taxes (up to 25 percent). If you still haven’t filed your tax return after 60 days, the minimum penalty is $435 plus compounded daily interest.
Failure to Pay Penalty
The IRS will send you a Failure to Pay notice in two circumstances: You haven’t yet paid the tax amount reported on your return or you didn’t report all of your business taxes on your return (and didn’t pay for them).
Once again, for every month or part of a month that you don’t pay your taxes, the IRS charges you 0.5 percent of the unpaid taxes. This penalty also doesn’t exceed 25 percent.
If you happen to have both a Failure to Pay and Failure to File Penalty, you’ll owe 4.5 percent of the unpaid taxes (the IRS subtracts the 0.5 percent Pay penalty from the 5 percent File penalty for a total of 4.5 percent).
You have 10 days from the date of your IRS notice to pay your taxes. Failure to do so will bump up your penalty to 1 percent per month or partial month.
How Much Does a Small Business Have to Make Before Paying Taxes?
If you’re a self-employed business owner, you must file an income tax return once you’ve earned $400 in net profits. If you haven’t earned $400 in net profits but meet another requirement from the IRS Form 1040, then you also have to file income and self-employment taxes.
Is Your First Year in Business Tax-Free?
No, you’re still required to pay taxes after your first year in business. However, for the year that you founded your company, you can write off almost all startup expenses and get a deduction for that tax year. Claim costs like advertising, market research, travel, attorney fees, accountant fees, and more to reduce the amount of taxes you pay in your first year.
How Much Should a Small Business Owner Set Aside for Taxes?
According to The Wall Street Journal, small businesses should set aside 30 to 40 percent of their income for tax purposes. This will cover federal and state income taxes as well as self-employment and potential employment taxes. The amount you set aside will vary depending on your state tax rates, however, because some states don’t even charge income taxes.
Does a Business Pay Taxes on Revenue or Profit?
Profit. When the IRS discusses the various business tax types, it always refers to a business’s “income” being taxed, not its revenue. While revenue is your total company earnings, income (or profit) is revenue minus expenses. Revenue alone doesn’t factor into business taxes at all.
Remember that not all taxes focus on profit exclusively, though. Excise tax rates, for example, come from the value of a specific product or service your business sells.
What Happens If You Have a Business Loss on Your Taxes?
If your business reports more expenses than earnings, you’ve suffered a business loss. Luckily, sole proprietorships, LLCs, partnerships, and S corporations can write off business losses on their personal income tax return. However, there’s a limit to how big a loss you can claim. Single filers can’t deduct more than $262,000, and joint filers can’t deduct more than $524,000, per the IRS excess business losses criteria. Anything above those limits is considered excess and can’t be taken as a loss on your tax return.
The content on this site is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional before any M&A transaction. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any M&A professional.
