How Much Do Small Businesses Pay in Taxes: A Tax Guide (2024)

11 Min. Read

January 9, 2024

How much do small businesses pay in taxes? It’s a seemingly simple question, but the answer is actually full of nuance and potential determining factors. Understanding how to calculate the taxes you’ll pay on your small business is vital to a good accounting strategy. As a small business owner, whether you run a company with employees or a sole proprietorship, it’s essential that you accurately forecast the income tax you’ll need to pay and adjust your business structure, business expenses, and accounting strategy accordingly. With proper knowledge and planning, paying your federal income tax doesn’t have to be a blow to your business cash flow.

The average small business owner pays 19.8% of their business’s gross income per tax year. However, this figure can vary widely depending on the type of company in question. Small businesses with one owner pay an average tax rate of 13.3%, while companies with multiple owners pay an average rate of 23.6%.

Under current business tax laws, C corporations pay federal income tax for corporations at a rate of 21%. They’ll also need to pay additional state corporate taxes, with a rate ranging anywhere from 0% to 11.5%. Combined, this could result in a tax rate with a potential maximum of 25.8%.

How do you determine how much will your small business pay in taxes this year? Let’s have a look.

Key Takeaways:

• With the proper knowledge of tax laws, business structure planning, and financial planning regarding your net business income, you’ll be well-prepared to pay your federal income tax when the time comes.
• The key to effective tax preparation for small businesses is organized, efficient accounting.

In this article, we’ll cover:

• How Are Small Businesses Taxed?
• What Is the Small Business Tax Rate by State?
• How Much Are the Average Taxes for Small businesses?
• How Much Can a Small Business Make Before Paying Taxes?
• How Much Should a Small Business Set Aside for Taxes?
• Conclusion
• Frequently Asked Questions

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.

How Are Small Businesses Taxed?

You might be surprised to learn that most small businesses don’t pay the corporate rate for their federal income tax.

In fact, 75% of small businesses aren’t considered corporations but something called “unincorporated pass-through entities.” This means that they pay the owner’s personal income tax rate rather than the rate that would usually be dictated by business income alone.

Owners include income from their small businesses in their personal taxes, so their income tax rates are calculated based on the business owner’s total earnings.

Use the current Federal Income Brackets to see what percent tax you’ll owe based on your income:

• For example, if you make $40,526 to $86,375, you’ll be charged $4,664 plus an income tax rate of 22% of the amount over $40,525. The average small business owner makes $64,474 per year. A $4,664 base fee plus $5,268.78 (22 percent of $23,949) means an owner making $64,474 will be taxed $9,932.78.

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 of $64,474 would be $3,262.18.

So in New York, you’d be taxed $13,194.96 (total federal and state taxes) on $64,474 per year, meaning your net earnings after tax would total $51,279.04. 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 (over 70% in the U.S.) are actually classified as sole proprietorships. Sole proprietorships have one owner and are not officially set up as a business with the state. This means that small business owners running a sole proprietorship will report their business income on their personal taxes.

Partnerships are businesses with multiple business owners, and the owners would each individually report their income on their personal taxes.

Corporations are legal business structures that give companies many of the rights commonly enjoyed by individuals. In this case, the business pays taxes as an entity; the owner does not report the business’ income on their personal taxes.

The corporate tax rate is now 21%, down from 37%, 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% is a flat rate and has no expiration date.

A Limited Liability Company’s (LLC) tax rate depends on its business structure: sole proprietorship, partnership, or corporation.

What Taxes Do Small Businesses Pay?

Small business owners can expect to pay several different taxes based on their business income—even if they file those earnings at their personal income tax rate. These taxes for small business owners include:

• Income tax. First and foremost, you’ll need to pay federal and state income tax, as applicable in your region.
• Self-employment taxes. This covers social security and Medicare. Most small businesses will need to pay this, which is currently at a tax rate of 15.3%.
• Payroll tax. Small businesses must pay 7.25% of an employee’s gross payroll earnings. Unemployment and workers’ compensation taxes may also apply.
• Capital gains taxes. This is taxation on investments or the sale of your assets. Assets held for more than a year are taxed at a capital gains tax rate of 0%, 15%, or 20%, depending on total income, with higher rates applying to higher business income. Assets held for less than a year are considered part of the business’ income and are taxed as ordinary income according to personal income brackets.
• Property tax. Any buildings or land owned by the small business will be subject to property tax. Property tax rates can vary from 0.18% to 1.89%, depending on the state in which the small business is located.
• Dividend tax. Dividends resulting from investments made by a small business are considered income and are taxed according to the owner’s tax bracket or the corporate tax rate, depending on the company’s business structure.

What Is the Small Business Tax Rate by State?

State income tax and other state taxes have changed thanks to the Tax Cuts and Job Act. Not all states have an income tax—in fact, some states have business taxes that are more favorable for small businesses than others.

For example, Florida is one of the best states for small business owners 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 for small businesses.

On the flip side, the least favorable states for small business tax purposes include New York, California, and New Jersey, with their common factor being 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 poorly-structured individual income taxes.

How Much Are the Average Taxes for Small Businesses?

Differences between states aside, how much do small business pay in taxes on average? Small businesses of all types pay an average tax rate of approximately 19.8%.

Small businesses with one owner pay a 13.3% tax rate on average, and ones with multiple business owners pay 23.6% on average. Small business corporations (known as “small S corporations”) pay an average of 26.9%.

Corporations, whether C corporations or small S corporations have a higher tax rate on average because they earn more income. This is easy to understand when you consider that over 18% of small S corporations report net earnings of at least $100,000 per year, while almost 60% of small businesses with one owner have an annual net income of less than $10,000.

How Much Can a Small Business Make Before Paying Taxes?

All businesses must submit an annual income tax return according to tax laws laid out by the IRS. The exception to this rule is partnerships, which must submit an information return instead of an annual income tax return. And if you have employees, employment taxes (such as social security taxes and payroll taxes) are mandatory.

Business owners who earn a net income of less than $400 can skip paying the self-employment tax, but that’s the only tax that small business owners can avoid.

Thankfully, the IRS probably won’t be interested in auditing your small business until you turn a profit. But it’s still essential to file your taxes, even if you’re sustaining losses, in order to take advantage of deductions and avoid legal issues down the line.

How Much Should a Small Business Set Aside for Taxes?

As a small business owner, it’s up to you to prepare to pay your federal income taxes. We recommend setting aside 30 to 40% of your net income per year 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 and the business structure you have in place.

The best time to set aside money for taxes depends on your business’s establishment.

1. New to the small business game? Try setting aside at least 30% of your business income every time you’re paid.

2. Recently turned a profit? Sock away your 30% on a monthly basis.

3. Is your profit fairly stable year by year? Take last year’s net income, divide it by four, then take 30% of that number. Plan on saving that amount quarterly.

Setting aside funds for tax time in a separate business bank account is a good idea. 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.

With countless features, automated systems, and seamless integration with dozens of useful apps, FreshBooks is a trusted accounting software for small business owners everywhere. It offers invoicing, expense tracking, time tracking, and reporting features that can simplify the process of calculating and tracking tax-related information. Click here to get started.

Conclusion

As a small business, understanding your tax liability is absolutely essential to long-term financial success. It’s important that you do adequate research to ensure you’re well-prepared for costs that will pop up down the line and to stay informed on all write-offs and deductions you can take advantage of.

Searching for intuitive accounting software to help make tax prep simpler for your small business? FreshBooks can help. Our cloud-based accounting platform is simple yet powerful and offers all the organizational and reporting tools you need to approach tax season with confidence. Click here to get started.

FAQs on How Much Do Small Businesses Pay in Taxes

More any questions on business taxes, average income taxes for different types of businesses, or anything else to do with ensuring a smooth tax year? Here are some of the most frequently asked income tax questions—answered.

Do small businesses pay taxes every 3 months?

Yes. Small businesses are expected to pay estimated taxes at the end of each quarter. Unlike individual income taxes, which are paid annually in April, it’s up to businesses to calculate their estimated taxes and pay them every three months. If you miss these quarterly payments, your business could face a hefty fee later on.

How do I calculate taxes for my small business?

First, you’ll need to determine the applicable income tax rate for your business. This is based on your location, business structure, and annual net income. Then, you can do the math manually or use one of the many business income tax calculators available online. Alternatively, you could use an all-inclusive accounting and tax prep software, such as FreshBooks, to simplify tax calculation.

What are the tax benefits of owning a small business?

While small businesses can be subject to higher tax rates, tax deductions also have a much higher potential. Available tax deductions for small businesses include advertising, communications (internet service, cell phones), utilities, business insurance, and more. The IRS website has more information on available tax deductions for small businesses.

What percentage does a small business pay in taxes?

On average, small businesses in the United States pay an annual income tax rate of 19.8%. However, this tax rate can vary drastically depending on how many business owners there are, the structure of the company, its location, and its net annual income.

Are there any tax breaks for small businesses?

Yes—small businesses can take advantage of several tax breaks, depending on the type of expenses they incur throughout the year. From deductions for rent and utilities to travel and communication, there are numerous tax breaks and deductions you should be aware of.

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