What Is the Small Business Tax Rate?
The small business tax rate for 2019 is a flat 21% for a C-corporation. On average, the effective small business tax rate is 19.8%. However, businesses pay different amounts in taxes based on their entities. Sole proprietorships pay a 13.3% tax rate, small partnerships pay a 23.6% tax rate, and small S corporations face 26.9% tax rate. C corporations pay 17.5%, though it’s hard to compare the rate faced by this type of entity to other small business entities.
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 complicate things even more, 2019 is the first year that tax reform—the Tax Cuts and Jobs Act—goes into effect. Many small business owners are confused about how the new law will impact their tax bill and change their reporting responsibilities.
While understanding how small business taxes are calculated and applied can seem overwhelming to any business owner, learning some basics can help you while making decisions and working with your tax professional. This guide breaks down the types of business taxes your company may be subject to, the different rates applied to your business earnings, and how the new tax law will affect your business.
Types of Small Business Taxes
There are several types of federal income taxes that a business must pay to the Internal Revenue Service (IRS). Your company might have to pay one or all of them, 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 must also pay tax on the net income it earns each year. Net income means income after accounting for expenses.
LLCs, sole proprietorships, and certain other business types 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.
Not all income is treated the same. For instance, shareholders in a C-corporation pay a different 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—failure to file and pay timely 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 pick up half of the tab for Social Security and Medicare taxes on their employees’ wages, while 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 for self-employed individuals who work for a church or on a fishing crew.
If your business engages in certain types of industries 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 e-commerce 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 property taxes 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 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) reduced the U.S. corporate income tax rate from a maximum of 35% to a flat rate of 21%. 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 include S-corporations, limited liability companies, and general partnerships. Owners of these types of businesses and 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 small business tax rates:
Income Tax Rate for C-Corporations
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. In 2019, the rate on qualified dividends ranges from 0% if you earn under $38,601 to 20% if you earn over $425,800 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 tax rate for pass-through entities and sole proprietorships is equal to the owner’s personal income tax rate. For 2019, 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.
The catch is that, for the first time in 2019, 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 on this 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. And professional service businesses, such as law firms and doctor’s offices, typically can’t claim the full deduction either.
Employment Tax Rates
Employment taxes include all of the following:
- Social Security Tax: 12.4% on wages paid up to $128,400 for 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 paid above $200,000 per year.
- Federal Unemployment Tax: 6.2% 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
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’s Publication 510. 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 is determine 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 where 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, businesses also are 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%.
Keep in mind that even if a state doesn’t charge individual income tax, businesses might still have tax obligations. For instance, New Hampshire doesn’t levy an individual income tax, but does have a corporate income tax and 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, contact your state’s business tax agency. Or, visit Tax Foundation, which annually maps out the most and least business-friendly states from a tax standpoint.
Deductions and Credits Affect Your Small Business Tax Rate
Figuring out your small business tax rate isn’t as easy as multiplying your net income by your tax rate.
There are several factors that could affect your final tax bill:
- Tax Deductions: Many business owners take advantage of 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 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.
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.
Determining Your Small Business Tax Rate
Ultimately, the truth is that the tax code is complicated. It’s complicated for individuals, but especially so for businesses due to the different types of tax obligations. It’s wise 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.