So, What Percentage Does a Small Business Pay in Taxes?

As a small business owner, few topics are as important yet difficult to understand as taxes. What percentage does a small business pay in taxes? The short answer is that it depends.

If your business is a corporation, then you need to pay the federal corporate tax rate of 21%. However, most small businesses in the United States operate as sole proprietorships, partnerships, limited liability companies (LLCs), or S-Corps, where the rules for business taxes can get blurry. Do not fear! In this guide, we'll help you figure out how much you'll need to pay in small business taxes.

The Basics of Small Business Taxes

There's no one universal tax rate or form for small business tax. Your specific tax obligations depend on your business structure, location, and revenue - among other factors.

The primary types of small business structures are sole proprietorships, partnerships, limited liability companies (LLCs), S corporations, and C corporations. Each business structure comes with its unique tax considerations.

How Much Do Sole Proprietorships Pay in Taxes?

As a sole proprietor, your business and personal finances are intertwined. Unlike corporations or partnerships, sole proprietorships are not separate legal entities. Instead, the business and the owner are considered one and the same in the eyes of the law. This impacts how you pay taxes.

Tax Percentage Overview

Income Tax

As a sole proprietor, you report business income and expenses on your personal tax return using Schedule C (Form 1040).

The taxable income from your business is subject to federal income taxes at individual tax rates, which range from 10% to 37% as of 2023. Depending on your state, you may also need to pay a state income tax.

Source: IRS. You can use this table to determine the rate for your federal income taxes as a sole proprietor.

Self-Employment Tax

One of the unique aspects of sole proprietorship taxes is the self-employment tax. This tax covers Social Security and Medicare contributions for self-employed individuals.

As of 2023, the self-employment tax rate is 15.3%, consisting of 12.4% for Social Security (on earnings up to a certain threshold) and 2.9% for Medicare. Sole proprietors are responsible for paying the entire self-employment tax, unlike employees, who share the burden with their employers.

Estimated Quarterly Taxes

As a sole proprietor, you are generally required to make estimated quarterly tax payments to cover your income tax and self-employment tax liabilities. If you don't pay taxes on time, you may be faced with penalties and interest charges.

Tax Deductions

As a sole proprietor, you can qualify for certain tax deductions on your business expenses, such as home office supplies, rent, and even bank fees. Tax deductions lower your taxable income, which means you pay less in federal income taxes.

How Much Do Partnerships Pay in Taxes?

Partnerships, whether general partnerships or limited partnerships, operate as pass-through entities for tax purposes. This means that partnerships do not pay small business tax at the entity level. Instead, profits, losses, deductions, and credits "pass through" to the individual partners, who report them as part of their personal income taxes.

Tax Percentage Overview

Income Tax

Partnerships file an informational tax return (Form 1065) with the IRS to report income, deductions, credits, and other relevant financial information. However, the partnership itself does not pay income taxes. Instead, the profits and losses pass through to the individual partners, who report their share of business income on their personal tax returns.

Self-Employment Tax

General partners in a partnership are subject to self-employment tax on their distributive share of partnership income. This tax covers Social Security and Medicare contributions for self-employed individuals. Limited partners, however, may not be subject to self-employment tax on their passive income from the partnership. Consult with a tax professional to learn more.

Distributive Shares

Partnerships allocate profits and losses among partners based on the terms outlined in the partnership agreement. Each partner's distributive share of partnership income or loss is reported on Schedule K-1 (Form 1065) and must be included on the partner's individual tax return.

How Much Do LLCs Pay in Taxes?

A limited liability company (LLC) is one of the most popular business structure choices for small business owners and entrepreneurs.

LLCs are unique entities that offer the liability protection of a corporation combined with the flexibility of a sole proprietorship. LLCs are not taxed as separate entities by the federal government. Instead, they are considered "pass-through" entities for tax purposes, meaning that the profits and losses of the LLC pass through to the individual members (owners) of the company.

Tax Percentage Overview

Pass-Through Taxation

LLCs do not pay taxes at the entity level. Instead, the profits and losses of the business flow through to the individual members' personal tax returns. Each member reports their share of the LLC's income or loss on their individual tax returns, regardless of whether the profits are distributed to them.

In essence, the way LLCs pay their small business taxes is very similar to the way sole proprietors pay their small business tax. However, registering your business as a limited liability company means that your business and personal assets are separate, which adds an important layer of liability protection.

Income Tax

The taxable income of each LLC member is subject to federal and state income taxes at the owner's personal tax rate. The federal income tax rates for individuals range from 10% to 37% as of 2023, depending on income brackets.

Self-Employment Tax

LLC members are typically subject to self-employment tax on their share of the LLC's profits. The self-employment tax rate is 15.3% and covers Social Security and Medicare contributions.

How Much Do S-Corps Pay in Taxes?

An S Corporation is a unique tax status that certain small businesses can qualify for to take advantage of potential tax savings. Unlike traditional C Corporations, S Corps do not pay federal income taxes at the corporate level. Instead, S Corps are pass-through entities similar to LLCs. This means that your business income passes through to your personal tax return.

Tax Percentage Overview

Pass-Through Taxation

S Corps do not pay federal income taxes at the corporate level. Instead, profits and losses pass through to individual shareholders based on their ownership percentage. Shareholders report their share of the S Corporation's income or loss on their personal tax returns. This system is similar to how LLCs pay their small business taxes.

Income Tax

Shareholders of S Corps are subject to federal and state income taxes on their share of the corporation's income. The income you generate from your S Corp will be taxed at your personal income tax rate.

Self-Employment Tax

Unlike sole proprietors and LLC owners, who are typically subject to self-employment tax on all business income, S Corporation shareholders only pay self-employment tax on wages and salaries received from the corporation. Distributions of profits to shareholders are not subject to self-employment tax. This can lead to significant small business tax savings.

S Corporation shareholders who are actively involved in the business must receive reasonable compensation for their services. This compensation is subject to payroll taxes, including Social Security and Medicare taxes.

Maximizing Tax Efficiency for S Corporations

Reasonable Compensation

Ensure that shareholder-employees receive reasonable compensation for their services. Setting appropriate salaries helps mitigate IRS scrutiny and potential tax implications.

Distributions vs. Salary

Strategically balance distributions of profits with salaries to optimize tax efficiency. While distributions are not subject to payroll taxes, excessive distributions without adequate salary can raise red flags with the IRS.

Maximize Deductions

Take advantage of available deductions to reduce taxable income. Common deductions for S Corps include business expenses, employee salaries, retirement contributions, and health insurance premiums.

Consult with a Tax Professional

S Corporations offer certain tax advantages, but they also must adhere to compliance requirements and reporting obligations. You'll need to file an annual tax return with the IRS, maintain accurate records of income, expenses, distributions, and shareholder transactions for tax reporting purposes, and more.

Seek guidance from a competent tax professional to develop a strong strategy and stay compliant with the law.

How Much Do C-Corps Pay in Taxes

C Corporations are distinct legal entities separate from their owners (shareholders). Unlike pass-through entities such as S Corporations and LLCs, C Corporations are subject to double taxation, meaning that they pay corporate income tax on their profits, and shareholders pay taxes on dividends received from those profits.

Tax Percentage Overview

Corporate Income Tax

C Corporations are subject to federal and state corporate income taxes on their profits. The federal corporate tax rate in the US is 21%.

Dividend Distribution

When C Corporations distribute profits to shareholders in the form of dividends, shareholders are taxed on those dividends at their individual tax rates.

Double Taxation

C Corporations pay corporate income tax on their profits and shareholders pay taxes on dividends received from those profits. 

This dual taxation can result in a higher overall tax burden compared to pass-through entities such as S Corps and LLCs. Double taxation is one of the biggest reasons why few small business owners choose C Corporation as their business structure.

Tax Planning Strategies for Small Businesses

Maintain Accurate Records

Diligent record-keeping is important for tracking income, expenses, and deductions accurately. Use accounting software or hire a professional bookkeeper to maintain organized financial records throughout the year.

Maximize Tax Deductions

Take advantage of available tax deductions to minimize taxable income. Keep detailed records of business expenses and explore deductions specific to your industry and business activities.

Choose the Right Business Structure

Assess the pros and cons of different business structures in terms of tax implications, liability protection, and operational flexibility. Consult with a tax professional or attorney to determine the best structure for your business goals.

Stay Informed About Tax Law Changes

Tax laws and regulations undergo regular updates and revisions. Stay informed about changes that may impact your business and adapt your tax strategies accordingly.

Frequently Asked Questions

How much does a small business need to make to pay taxes?

It depends on your business structure. C Corporations are subject to the flat 21% corporate tax rate and there's no minimum income to get taxed. For pass-through entities, such as LLCs, meaning that your business income is taxed as part of your personal income, taxable income thresholds determine whether you should file a tax return.

What is a pass-through entity?

A pass-through entity is a business structure in which income, deductions, and credits pass through to the owners for tax purposes. This means that the entity itself does not pay income tax at the corporate level. Instead, the profits and losses of the business are reported on the owners' individual tax returns. Sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations are pass-through entities.

Do small business owners pay self-employment taxes?

Yes, but the specifics depend on your chosen business structure. Sole proprietors, partners in partnerships, and LLC members are typically subject to self-employment taxes to cover contributions to Social Security and Medicare. S Corp shareholders only pay self-employment taxes on their salary.

Does my small business need to pay a sales tax?

It depends on the nature of your business, the products or services you sell, and where you operate. The sales tax rate and regulations vary by state, county, and municipality, so it's essential to research and understand the specific requirements in your area.