For businesses, taxes are a once-a-year event. They need to be something we think about throughout the year. Tax implications integrate into everything we do to inform our decisions on how and when we spend the company’s money.
When you first start a company, taxes are probably the last thing on your mind. Perhaps you created a legal entity to protect any personal assets you have, but other than that, building products and services you love monopolizes your time. After all, you can’t pay taxes if you don’t sell anything. Sure, you can deduct losses, but maximizing tax deductions is never why anyone goes into business.
Attitudes about tax rates and income taxes change once a company starts to make money. Owners and managers understand how hard it is to generate revenue, so they want to do what they can to keep more of their hard-earned money in the business. That’s where tax planning comes in. Knowing about taxes and how to tax-optimize a business is important to future growth.
Talk About Different Tax Entities
We’re not going to get into why people select certain tax entities. Just know that sole proprietorships, C-corporations, limited liability corporations (LLCs), partnerships, and S-corporations are all options. They differ in the way they handle taxes on revenue, how equity is treated, and how big an organization can be. If you’re starting a company and want to know which entity is right for you, get in touch with a certified public accountant who can point you in the right direction.
What you SHOULD know, though, is that different entities pay different small business tax rates. For example, C-corporations pay a 21 percent flat federal income tax rate to the Internal Revenue Service (IRS) on corporate profits. S-corps, partnerships, LLCs, and other small business entities pay rates that coincide with personal income taxes. Thus, tax rates will fluctuate based on how much a business makes and which tax bracket it places you in.
Different entities have to pay separate taxes depending on how profits are paid to shareholders in the form of dividends. Dividend tax rates are determined by how long a shareholder-owned their share of the company. If you’ve owned the underlying stock for longer than 60 days, the dividend is classified as a “qualified dividend,” and is subject to lower taxes. The amount you’ll owe on qualified dividends is based on your income and ranges from 0 to 20 percent. Non-qualified dividends (held less than 60 days) are taxed at the shareholder’s normal income tax rate.
Different Small Business Taxes
Business owners quickly learn that income tax isn’t the only money they owe to the government. There are a wide variety of taxes that every company must pay. Here are some of the main ones:
Income tax
We just touched on income taxes earlier, but income doesn’t just come from sales of a product or service. Anything the business does that generates profits is subject to income tax. For instance, it must be paid on any profit from the sale of company property or investment. Corporations also have to pay taxes on any net profit for the year. Net profit is whatever is left over after subtracting business expenses.
Self-employment tax
If your business earnings from a self-employed venture exceed $400 in a year, then you’re probably going to have to pay self-employment taxes. This is the equivalent of a company paying your payroll taxes, except you don’t have a company employing you. This means you are responsible for paying Medicare, Social Security, and unemployment taxes for yourself.
Excise tax
Usually, when someone buys a product, they have to pay sales tax based on the price of what they’re buying. Sales tax varies by state and local community. However, some products have a tax levied on them called an excise tax. This is a special tax that’s included in the product before sale. Cigarettes, alcohol, and other products and services have excise taxes included in their retail price. Companies are responsible for collecting the excise tax and paying it directly to the government.
Payroll Tax
Payroll taxes are often referred to as employment taxes and, are paid on any wages that go to company employees. They include payments to Social Security and Medicare, as well as to unemployment taxes to help people laid off from work as they search for a new job. You’ll want to pay close attention to payroll taxes. The IRS and other authorities treat failure to pay as a serious tax liability that includes fines and other penalties.
Sales tax
Thankfully, the United States doesn’t yet have a federal sales tax. However, states use sales taxes to raise revenue without having to increase things like property taxes. With sales taxes, a percentage of whatever consumers buy is tacked on at the point of sale. Companies are responsible for separating sales tax from their gross receipts and paying them to state tax authorities.
Managing and keeping track of sales tax rates can quickly turn complex, especially if your business operates nationally. Each state, and sometimes each county, charges different sales tax rates that have to be accounted for.
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Property tax
If a business owns a brick-and-mortar location (a physical property), then it will have to pay property tax. Tax rates vary by location depending on where the building is located.
Pass-Through Entities
You may have heard the term “pass-through entity” before. This means that any income or profit generated from the business is passed onto the owner(s), and is taxed at their normal income tax rate. Most small businesses are pass-through organizations. That’s because most small companies in the U.S. are sole proprietorships, LLCs, and partnerships. They have a small number of employees, if any, and don’t have to pay taxes on the business level.
Just recently, the U.S. government dropped the corporate tax rate from 35 percent to 21 percent, a huge decrease. Under the new tax plan, however, the highest individual tax bracket was reduced by only 2.6 percent, from 39.6 percent to 37 percent. The changes to the tax code made understanding whether incorporating or registering as a pass-through business entity is the best choice for you.
Without diving too much into the specifics, the main difference in choosing an LLC, for example, versus a C-corporation, is what you plan to do with profits generated by the business. If you plan on holding them long-term and reinvesting them into the company, then incorporating may be the right move. If you use most of the profit to pay the mortgage and grocery bill, though, then a pass-through entity could be best.
Make sure you consult a tax professional before making any decisions. You can find qualified accountants online who will be happy to walk through your current situation and future goals. They’ll be able to make an informed decision on which path you should take.
One change to be aware of for pass-through entities is that in the 2019 tax year, businesses can deduct up to 20 percent of their business income from their tax rate. It’s a nice incentive that lowers tax bills for entrepreneurs and small business owners.
Remember, the effective tax rate of pass-through entities is also affected by each business owner’s filing status. If they’re married and filing jointly, take the standard deduction, and which personal exemptions they’re eligible to claim to help determine what’s owed.
Don’t Forget About State Taxes
When most people think of taxes, we think of federal tax. What do we owe to Uncle Sam? However, most states charge small businesses taxes on top of what you have to pay to the federal government. The state tax liability isn’t as large, but you need to understand how they work if you’re going to do business in any given state. For example, in Texas, the state charges taxes on gross receipts. That is, they charge based on gross revenue, not net profit after expenses. Some states also charge what’s called a franchise tax. It’s essentially a tax on a business’s assets or stock.
Minimizing Tax Obligations – Deductions and Credits
People enter into business ownerships for different reasons, but most of them center around the belief they can deliver a more superior service or product than what’s currently available on the market. They think they are better stewards over their time than a manager at another person’s company, so they set out on their own.
Most entrepreneurs feel similarly about paying taxes. Yes, with taxes you’re helping to pay for roads, schools, and other public goods, but any money you can save in taxes goes right back into your company, where you feel like you know how to use it best. As a result, most small business owners do what they can to make their companies tax efficient.
Tax -efficiency means operating your company in a way that avoids having to pay more taxes than you have to. It’s about knowing how to maximize deductions and credits in a given tax year.
Deductions and credits are what make it difficult to give a straight answer on small business tax rates. Each business is capable of claiming different credits and deductions, so their tax bills will be very different. Here’s a basic breakdown of each:
Tax credits
Tax credits are the best tool small businesses can use to lower tax bills. Tax credits reduce tax bills on a dollar-for-dollar basis. That means if you owe $10,000 in taxes and can claim $5,000 in credits, then your final bill will be $5,000.
Some tax credits come and go based on the political and economic environment at the time. The government uses tax credits to incentivize companies into some action (like buying solar panels or hybrid vehicles). Whatever you spend (up to a limit) on designated items can be claimed as a tax credit. It’s a smart way for businesses to make strategic investments that fit into their plans while lowering tax liability.
Deductions
Deductions are designated expenses that can be subtracted from taxable income. Say, for instance, that your business purchased some significant assets like manufacturing machines or a truck for delivery. The cost of those large purchases can typically be deducted in the year of purchase from net profit to lower your taxable income.
Other common deductions include employee expenses, like travel and meal costs and equipment purchases. The cost of employee training, benefits, and other expenses are also deductible. If you operate a home business, you can deduct a portion of your mortgage or rent if you use space for an office.
The point of deductions is often to encourage business growth. After all, if small businesses are taxed on the cost of hiring and training employees, they’re likely less inclined to do so, and the result could be higher unemployment.
Losses
Some small companies are pre-revenue. That means they haven’t earned any money. It’s also common for some companies in high-growth areas like technology to operate at a loss for years before they become profitable. They use the money they make from products and services, as well as investor money, to grow rapidly and capture market share.
If a company operates at a loss in a tax year, it’s usually allowed to carry that loss over to the next year. They can deduct the amount of the loss from their tax bill.
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Tax Deadlines – Don’t Miss Them or You’ll Pay Fines
For small business owners, understanding the tax code and how it applies to you is complex enough. What gets a lot of people, though, is that businesses have to file on a different calendar than individuals. Some entities are allowed to pay taxes on a different schedule if they operate on a fiscal year basis rather than a straight calendar year. C-corporations that use a different fiscal calendar for the tax year have to pay estimated taxes on the fourth, sixth, ninth, and twelfth months of their tax year.
Companies that generate a profit and will OWE taxes have to estimate their tax burden and make quarterly estimated tax payments to the IRS. Estimated taxes have to be in the general ballpark of what the actual taxes owed will be at the end of the year. The difference has to be settled before April 15 each year. However, pass-through entities have to complete taxes by March 15. Extensions are available if necessary.
There are other tax deadlines you should know about.
Payroll taxes
Payroll taxes are due every month on the 15th. Companies can also choose to pay them every other week, which helps if that’s the paycheck cadence.
Sales taxes
This depends on which state we’re talking about, but state taxes can be due on a monthly, quarterly or annual basis.
Excise taxes
Excise taxes need to be paid either quarterly or monthly, depending on the product and location.
When to Know You should Contract Out for Help
Tax software can indeed handle anything you plug into it. The software is very robust. All it takes is time and patience to work through it. Most small business owners, though, opt instead for professional tax help. A certified public accountant (CPA) will have years of experience helping small businesses lower tax bills. They know more about the tax code than you likely ever will because it’s their sole focus. That comes in handy when federal, state, and local taxes change regularly.
Whether hiring an accountant full-time or finding a third-party service to track taxes, your business will be better off because of it. A great accountant can work with owners and managers to help them know when the best time is to buy new equipment, sell some property, or install solar panels on the office roof. They’ll take the stress of taxes off your plate so you can keep focusing on doing what you love. Whether it’s making new products, marketing, or managing teams, not having to worry about taxes can help your business continue to grow and thrive. Why not see how a professional can help lower your tax obligations so you can do more with your money?