What Factors Affect How Much Your Business Pays in Tax

Shiloh Johnson
By Shiloh Johnson

One of the most common pain points for business owners is dealing with tax headaches. There are many tax deadlines to meet that are constantly changing and it can be confusing to understand how you’re actually being taxed based on your business activities. Here, we are going to break down the key things to know about tax and your business. 

What to know #1: Entity type affects how you’re taxed 

When it comes to business tax, it really depends on the type of business entity you’ve set up. For example, sole proprietors are liable for self employment tax while corporations are not. The majority of business owners set up entity structures that fall within the pass through category where the tax is paid at the member level via a K-1 or Schedule C (if single member). 

According to the Tax Policy Center, “Most US businesses are taxed as pass-through (or flow-through) entities that, unlike C-corporations, are not subject to the corporate income tax or any other entity-level tax. Instead, their owners or members include their allocated shares of profits in taxable income under the individual income tax. Pass-through businesses include sole proprietorships, partnerships, limited liability companies and S-corporations.”

In other words, the majority of business owners are taxed at the individual level. Data from the Small Business Administration shows that the average business owner pays an average effective tax rate of 19.8 percent. Sole proprietors end up paying an average effective tax rate of 13.3 percent while partnerships’ average rate is 23.6 percent. Business owners with S corporations pay the highest average effective tax rate at 26.9 percent. 

What to know #2: Tax brackets matter 

Since most business owners are taxed at the individual level, it’s important to know which tax bracket you’re in. We have a progressive tax system, which means as your income goes up, so does your tax rate. 

There are seven different tax percentages with varying ranges of income. As of the 2021 tax year, here are the individual tax rates based on single and married filers’ income. 

Tax percentageSingle filer incomeMarried couples filing jointly income10% $9,950 or less $19,900 or less 12% More than $9,950More than $19,90022%More than $40,525More than $81,05024%More than $86,375 More than $172,750 32%More than $164,925More than $329,85035%More than $209,425More than $418,850 37%More than $523,600More than $628,300 

Source: IRS 

What to know #3: You’re responsible for different types of taxes 

As a business owner, you may be responsible for various types of income tax. You typically need to pay Self-Employment Tax, which is a flat rate of 15.3 percent and covers Social Security and Medicare as well as pay quarterly estimated taxes. 

In addition, you may be responsible for other tax types such as payroll tax if you have employees, sales tax or excise tax if you sell certain goods, products, and services, plus business property tax, and business license tax based on your city. You’ll want to check with your state department of revenue and municipal finance office to ensure you are up to date on all requirements. ComplYant also helps with this process, we line you up with all of your tax liabilities based on what you do, and where and how you are doing it. (Psst – You can try us free here!)

What to know #4: Where you live matters 

On top of the various taxes listed in tip #3, you’re likely going to have to pay state income tax depending on your state. Keep in mind that there are a few states that don’t have any state income tax, such as Washington and Texas. And your state may be calling it a different thing instead of income tax they may call it excise or franchise tax. You can check out your state income tax rates via the Tax Foundation’s website. 

Bottom line

Being a business owner means that you will be responsible for various types of tax. How you’re actually taxed based on your business depends on a number of factors such as  business structure, where you live, and how you are conducting business. So while there is no one-size-fits-all answer to how you’re taxed, taking all of these factors into consideration can give you a clearer idea of what’s going on with your business tax and keep you on the right side of compliance.

Need help managing your tax deadlines, notices & more? We’ve got you covered. Try us, absolutely free.

Shiloh Johnson
By Shiloh Johnson
Shiloh Johnson is a long-time CPA and founder of ComplYant, a technology platform offering business owners and entrepreneurs a simple way to manage tax rules and requirements.

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