Own/operate a business based in the US? Your business will subject to tax in various forms. Most of these are taxes on income, but some are based on certain kinds of sales. There may even be taxes based on top line revenue.
Your taxes that you are likely to have to pay can be broken down into:
- corporate income tax. This is at the federal level and most states impose it as well
- estimated tax. You can think of this tax as a prepayment of income tax throughout the year. You will pay the difference between it and income tax at the end of the year. You’ll receive a refund if you paid more than your assessed corporate income tax
- self-employment tax. If you work for yourself, you can face this tax
- employment taxes. These apply when you have employees. You will deduct monies from your employee salaries and pay to the IRS
- excise taxes. This applies to certain sales or types of businesses
- sales and use taxes. These apply to most physical products that you sell at retail
Corporate income tax
Corporate income tax is a proportion of your net business income. Income is profit. Profit is your business revenues less expenses.
- The starting point for calculating your net business income is your gross receipts
- You are able to deduct allowable deductions from your gross receipts. These means your net income will be less than gross receipts
- Purchases of items that will last significantly more than in the year you purchases need to be treated as assets. You can’t deduct the full purchase price but have to depreciate them instead. Depreciation allows a proportion of the item’s value to be deducted based on the expected life of the asset
- Private expenses generally cannot be deducted
Your taxable income, in simple terms, is the remaining income after you have deducted your allowable deductions.
You can find more detail in IRS Publication 583. This document is rather long. Use it as a reference rather than trying to read it from beginning to end.
Complex rules apply to meals, travel and entertainment, which is discussed in detail here.
Types of company structures and tax
Different company or corporate structures are taxed differently on their income.
- “C Corps” are taxed on all business income (less deductibles). Shareholders also pay tax on any dividends distributed. This means you may pay business tax on income twice
- “S Corps” are only taxed on certain capital gains and passive income. Each shareholder declares their share of the corporation’s income on their own tax return. Effectively, this moves the tax obligation from the corporation to the shareholder
- LLCs are a special type of company structure. LLCs are not a full corporation but are a hybrid structure. They can elect to choose how they are taxed, subject to some constrains. They can be taxed as a partnership, a C Corp or a S Corp.
Your company will pay business income tax throughout the year. You; however, only know your income at the end of the year. The IRS will apply formulas based on last year’s income to determine your ‘expected’ income for this year. You then pay tax throughout the year based on this expected business income. These in year payments is your “estimated tax”.
You need to file for estimated tax if you expect to pay tax of $500 or $1,000 depending on your situation. Even individuals who are expecting to pay $1,000 or more are subject to estimated tax. If you are in this situation, you can request your employer deduct more from your salary instead of paying estimated tax.
Self employment tax is a tax that funds social security and medicare. It applies to people who work for themselves. It is a substitute for the normal social security and medicare taxes that are paid by ordinary salary and wage earners.
- Essentially all of your gross income is taxed at 2.9% for Medicare. In addition, certain high income earners pay a surcharge
- All income below a threshold ($137,700 in 2020) is taxed at 12.4% for social security
- For the purposes of income tax you may be able to deduct the amount of a notional employer contribution of your self-employment tax. You also can deduct the cost of health insurance
Self employment tax applies to self employed persons earning more than $400 a year. If you are a church employee, it applies if you earn $108.28 (in 2020) or more.
You can find out more information about self-employment tax from the IRS here.
If you employ people, you will need to make deductions from their take home pay to account for their taxes:
- Federal income tax. The IRS publishes withholding tables that apply to W2 employees.
- Social security and Medicare. Social security payments are made up of an employee contribution and a matched employer contribution. The Medicare component is funded by the employer and comprises of a base amount applying to all income and a surcharge amount above an income threshold
- Federal Unemployment Tax (FUTA). This is an amount funded by the employer and is paid separately from other employment taxes
This tax applies to certain situations and businesses such as wagering business, heavy transportation, communication businesses and air transport. More information can be found on the IRS web site.
State income and employer taxes
Many states impose various taxes. These apply to both corporations and individuals. For instance, California imposes income taxes on most companies. This includes business tax directly on LLCs. Because of this, based on your state, you will need to prepare for state income taxes, state franchise taxes, payroll taxes and sales and use taxes (see below).
- income taxes: If your state imposes corporate tax, then the amount or rate of tax will depend on your corporate structure. Your state will impose this tax on business income that is derived from that state. If you operate in multiple states, you may be liable for income tax in different states. The way to calculate this tax is based on the federal system in some states. However, other states impose their own methods, exceptions and what are allowable deductions. Some states don’t have an income tax, but a flat revenue based tax instead. There are some situations where, even if you have no or negative income, you still pay income tax. .
- franchise taxes: Where these are payable, they are generally a replacement for income taxes. For example, S-Corps in California pay a franchise tax. This is levied at a minimum of $800, even if there is no or negative business income
- payroll taxes: These taxes, again varying by state, are a state version of employment taxes. They incorporate payments for various state taxes. Some must be paid from business resources, while others can be deducted from employee pay. Examples of what is included are unemployment insurance, training taxes, disability taxes and personal income tax withholdings
It is important to realize that state taxes and federal taxes are separate. State taxes are effectively in addition to federal taxes.
Sales and use taxes
Sales tax is a tax on retail sales, i.e. the final supply of goods to consumers. It does not apply on wholesale or intermediate sales. Most US states impose it and it is generally a percentage rate on the final value of the sale. The final rate of sales tax depends on a few factors. For simple retail businesses, it is where the seller is based. The rate can incorporates the state, county, city or even special zones where specific sales tax loadings have been applied. The rate cannot be distinguished merely using a ZIP code.
Sales tax used to be based on a physical “presence” or nexus. Before 2018, you did not need to collect sales taxes for states where you did not have physical presence. This was broadly interpreted. Physical presence could have been as little as having a remote worker based in the state. Now states can require you to collect sales taxes where you sell to a consumer based in that state. After 2018, states have authority to require you to pay sales tax if you sell to a customer based in their state.
Use taxes are based on where an item is first used, or where delivered, or even where ordered from. Many states require customers to pay use taxes if they have not already paid sales tax. There are some arrangements where you may be required to collect use taxes on behalf of customers that otherwise avoid sales taxes. As a result of the 2018 expansion of states’ powers to collect sales taxes, use taxes may become less common in the future.
Buyers may be exempted from paying sales tax in specific situations. For instance, they are a business buyer. If you are making sales to an exempted buyer, then they will need to provide you with an exemption certificate. Furthermore, it is your responsibility to ensure that the exemption certificate is valid. In addition, exemption certificates are valid only for certain types of sales. This is because they are not a blank exemption from all sales taxes. If you do not collect sales tax from a buyer who should have paid it, you remain liable to pay it to the state authority yourself.
Keep all exemption certificates that you receive and for any situation where you don’t charge sales tax. This is because you will need them if you are subject to a sales tax audit.
This article gives you an overview of taxes your business is likely to need to pay. If your tax affairs are complex, then you should seek advice from a CPA member.
Being in business in the United States means you may need to pay various business taxes. These could include:
- federal income tax
- estimated tax on business income
- self employment taxes
- employment taxes, some of which you deduct from employee salaries, some you fund yourself
- state income taxes or franchise taxes
- state payroll taxes and insurances
- state/county/city/district sales taxes and use taxes