How Much Do Small Businesses Pay in Taxes?
Small businesses pay an average of 19.8 percent in taxes depending on the type of small business. Small businesses with one owner pay a 13.3 percent tax rate on average and ones with more than one owner pay an average of 23.6 percent. Small business corporations (known as “small S corporations”) pay an average of 26.9 percent, according to the Small Business Administration.
In this article, we’ll cover:
- How Are Small Businesses Taxed?
- What Is the Small Business Tax Rate by State?
- How Much Does the Average Small Business Pay in Taxes?
- How Much Can a Small Business Make Before Paying Taxes?
- How Much Should a Small Business Set Aside for Taxes?
NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas, outside of supporting questions about FreshBooks. If you need income tax advice please contact an accountant in your area.
1. How Are Small Businesses Taxed?
You might be surprised to learn that most small businesses don’t pay the corporate rate for income tax.
In fact, 75 percent of small businesses aren’t considered corporations but something called “unincorporated pass-through entities.” This means that they pay the owner’s personal tax rate, according to the National Federation of Independent Businesses.
Owners include income from their small business in their personal taxes, so their income tax rates are calculated based on the business owner’s total earnings.
Use the 2018 Federal Income Brackets to see what percent tax you’ll owe based on your income:
- For example, if you make $38,701 to $82,500 per year, you’ll be taxed $4,453.50 plus 22% of your income over $38,700. The average small business owner makes $59,776 per year. A $4,453.50 base fee plus $4,636.72 (22 percent of $21,076) means an owner making $59,776 will be taxed $9,090.22.
The $59,776 average small business owner salary is reported by Payscale.
Then use this state tax calculator to estimate what you’ll be taxed at a state level.
- For example, in New York the state income tax would be $3,033.35.
So in New York, you’d be taxed $12,123.57 on $59,776 per year. Don’t worry if this number seems high! There are plenty of deductions you can claim.
That said, different tax rules apply based on your business structure. Most small businesses are sole proprietorships—over 70 percent in the U.S. Sole proprietorships have one owner and are not officially set up as a business with the state. The owner reports business income on their personal taxes.
Partnerships are businesses with more than one owner and the owners each individually report their income on their personal taxes.
Corporations are legal structures that give companies many of the rights commonly enjoyed by individuals. In this case, the business pays taxes itself; the owner does not report the income on their personal taxes.
The corporate tax rate is now 21 percent, down from 37 percent thanks to the Tax Cuts and Job Act signed in December 2017. This rate affects larger businesses and those considered corporations for tax purposes. The 21 percent is a flat rate and has no expiration date.
A Limited Liability Company’s (LLC) tax rate depends on their business structure: sole proprietorship, partnership or corporation.
List of taxes for small businesses owners:
- Income tax. Federal and state taxes, as applicable.
- Self-employment tax. This covers social security and Medicare. Most small businesses will need to pay this tax, which is currently 15.3 percent.
- Payroll taxes. A small business must pay 7.25 percent of an employee’s gross payroll. Unemployment and workers compensation taxes may be extra.
- Capital gains taxes. This is taxation on investments or sale of your assets. Assets held for more than a year are taxed 0, 15 or 20 percent, depending on overall income (higher rates apply to higher incomes). Assets held for less than a year are considered part of the business’ income and taxed according to income brackets.
- Property tax. Any buildings or land owned by the small business will be taxed. Property taxes vary from 0.18 percent to 1.89 percent depending on the state.
- Dividend tax. Dividends resulting from investments made by a small business are considered income and taxed according to the owner’s tax bracket or the corporate tax rate, depending on the company’s structure.
2. What Is the Small Business Tax Rate by State?
State income tax has changed, thanks to the Tax Cuts and Job Act, as well as other state taxes. Not all states have income tax. In fact, some states have business taxes that are more favorable to small businesses than others, according to the Tax Foundation.
For example Florida is one of the best states because it has no individual income tax. Nevada has no corporate or individual income tax and New Hampshire has no sales tax. The most favorable states usually lack a major tax.
On the flip side, the worst states include New York, California and New Jersey. The common factor is high tax rates. For example, New Jersey not only has high property taxes but also has the second-highest corporate income tax in the country, an inheritance tax and badly-structured individual income taxes.
3. How Much Does the Average Small Business Pay in Taxes?
Small businesses of all types pay an average tax rate of approximately 19.8 percent, according to the Small Business Administration.
Small businesses with one owner pay a 13.3 percent tax rate on average and ones with more than one owner pay 23.6 percent on average. Small business corporations (known as “small S corporations”) pay an average of 26.9 percent.
Corporations have a higher tax rate on average because they earn more income. This is easy to understand when you consider that over 18 percent of small S corporations earn at least $100,000 net per year while almost 60 percent of small businesses with one owner earn less than $10,000 net.
4. How Much Can a Small Business Make Before Paying Taxes?
All businesses must submit an annual income tax return, according to the IRS. The exception is partnerships, which have to submit an information return instead. And if you have employees, employment taxes (such as social security taxes) are mandatory.
Business owners who earn less than $400 can skip paying the self-employment tax. But that’s the only tax you can avoid.
Thankfully, the IRS probably won’t be interested in auditing your small business until you turn a profit. But it’s important to still file your taxes even if you’re sustaining losses in order to take advantage of deductions and avoid legal issues down the line.
5. How Much Should a Small Business Set Aside for Taxes?
Set aside 30 to 40 percent of your income to cover your federal and state taxes. Remember, you’ll be paying these taxes quarterly, so set aside funds regularly. You may be able to save less depending on what type of small business you own.
When you set aside money for taxes depends on how established your business is.
- New to the small business game? Try setting aside at least 30 percent every time you’re paid.
- Recently turned a profit? Sock away your 30 percent on a monthly basis.
- Profit fairly stable year by year? Take last year’s net income, divide it by four, then take 30 percent of that number. Plan on saving that amount quarterly.
It’s a good idea to put funds set aside for tax time in a separate business bank account. Even better, set up automatic transfers (either monthly or quarterly) to this separate account.
Don’t worry too much if you underestimate the amount owed. The IRS says that as long as you pay as much taxes quarterly as you did the previous year, you fall under what’s referred to as the safe harbor rule. That means you won’t be penalized for underpaying.