Figuring out all the taxes for your small business can be tricky. With different federal, state, and local business tax rates depending on your business structure and location, it’s easy to get overwhelmed. 

But don’t worry! This guide breaks down federal, state, and local income taxes, sales taxes, and employment taxes. You’ll also learn some creative tax deductions for small businesses to lower your tax bill.

Federal income tax rates and requirements for small businesses

As a small business owner, you’ll need to pay federal income taxes for your company. The amount depends on your business structure. Sole proprietors and partnerships are taxed based on the owner’s federal income tax bracket. For 2020, the top bracket is 37% for income over $518,400. Sole proprietors report business income on their individual income tax return. Partnerships and S corporations pass through income to partners and shareholders, while corporations pay corporate income tax rates.

For LLCs (limited liability corporations), it’s a little more complicated. You can choose how you classify your LLC for tax purposes: 

  • As an S corporation, you’ll pay taxes according to your income tax bracket, just like for sole proprietorships and partnerships
  • As a C corporation, your business will pay a federal tax rate of 21%. 

You’ll need to use the right form to file your income tax return:

In addition to income taxes, you may owe self-employment tax (for sole proprietors) and employment tax (if you have employees). Self-employment tax includes social security and Medicare taxes, and the rate is 15.3% on the first $137,700 of net earnings. Employment tax includes social security, Medicare, and federal unemployment taxes.

Your business may also be subject to employment taxes like Social Security, Medicare and unemployment. Businesses may also pay excise taxes, sales taxes, use taxes, gross receipts taxes or franchise taxes depending on your location and industry.

State tax rates and regulations for small business owners

You’ll also need to figure out your state’s tax rates and regulations. State tax policies vary significantly, so do your research to understand how your state taxes businesses. Many states tax business income similar to the federal government, with graduated tax brackets based on taxable income. Some states have a flat tax rate for all businesses, and a few states don’t have a corporate income tax at all. State income tax rates range from 1% to 11%.

States may also charge gross receipts taxes on total revenue, sales taxes on goods and services, franchise taxes, and employment taxes for employees, depending on your type of business and location.

The type of business structure you choose also impacts your state tax obligations. Sole proprietorships and partnerships are usually taxed at the owner’s individual income tax rate, while limited liability companies and corporations may pay corporate tax rates. Certain business structures like S corporations may avoid double taxation.

Whatever your tax structure, you’ll have to pay estimated state income taxes quarterly and file an annual state income tax return. It’s best to work with an accountant to determine your tax liability, file the proper forms, and take advantage of any opportunities to reduce your state tax burden legally. Staying compliant with state tax laws is essential to avoiding penalties and ensuring your business’s success.

Sales tax, gross receipts tax, and other local taxes

As a small business owner, you’ll need to pay attention to local taxes in the city, county and state where you operate. Local taxes vary significantly based on city and county, but two of the main local taxes for small businesses are sales tax and gross receipts tax.

Sales tax

Sales tax applies to retail sales of tangible goods and sometimes services. The tax rate varies in each state, county and city, so you’ll need to register with the appropriate tax agencies where your business is located. Once registered, you must collect sales tax from customers and remit it regularly to the proper tax authorities. The type of business structure you choose does not affect how sales tax applies to your small business.

Gross receipts tax

Gross receipts tax is a tax on the total revenue or gross receipts of a business. It’s similar to a sales tax, but applies to all revenue received by a business, not just retail sales. The tax rate depends on where your business is located and the type of business. Some states exempt certain types of businesses from gross receipts tax, or have lower tax rates for small businesses under a certain revenue threshold.

How your business structure affects your tax rate

The type of business structure you choose for your company will significantly impact your small business tax rate. The four most common structures are sole proprietorships, partnerships, corporations, and limited liability companies (LLCs).

Sole proprietorship

As a sole proprietorship, your business income is taxed based on your individual income tax rates. You’ll need to report your business income and expenses on Schedule C, filed with your individual income tax return. Your tax rate will depend on your total taxable income for the year.

Partnership 

Partnerships also pass through income to the individual partners, who pay taxes at their individual income tax rates. The partnership will file an informational return, and each partner will report their share of income and deductions.

Corporations 

Corporations pay corporate income taxes on their profits. C corporations pay corporate tax rates, which are often lower than individual rates. However, shareholders also pay taxes on corporate dividends. S corporations pass through income to shareholders, who pay individual income tax rates.

LLCs

LLCs can choose to be taxed as partnerships, sole proprietorships or corporations. Most small LLCs elect to be taxed as partnerships or sole proprietorships to take advantage of pass-through taxation.

As a small business owner, you should weigh the tax implications of each business structure. You may be able to take advantage of lower tax rates and creative tax deductions for small businesses to maximize your profits. By understanding how taxes apply to your type of business, you can make the choice that benefits you most.

Tax deductions and strategies to lower your small business tax rate

As a small business owner, you want to keep as much of your hard-earned money as possible. Luckily, there are several clever and legal ways to reduce your small business tax burden, like small business tax deductions and credits. 

First, make sure you’re taking advantage of all the tax deductions you’re entitled to. Things like business expenses, office supplies, business travel, vehicle expenses, rent and utilities, and employee benefits are often tax deductible.

You should also consider your business’s structure. Sole proprietorships and partnerships are taxed based on the individual income tax rates of their owners, corporations are taxed at corporate tax rates, and LLCs can choose to be taxed as corporations or based on the individual income tax rates of their owners. The structure you choose can significantly impact your tax bill.

Another strategy is to time income and expenses strategically. For example, delaying billings or payments until after the new year can shift tax liability to the next tax year. You might also prepay certain business expenses at the end of the year to get additional deductions.

Some states offer tax incentives or creative tax deductions for small businesses to spur economic growth. Check if your state provides tax credits, exemptions or deductions for research and development, job creation, or other business activities. You might also explore tax credits for hiring veterans, research and development, and providing employee health insurance.

Don’t pay more tax than necessary

As a small business owner, lowering your tax bill should always be a priority. The more money you can keep in your pocket, the more you can invest back into your business. With some creative planning and the help of a tax professional, you can take control of your small business taxes. Make sure you understand how your federal, state, and local business taxes apply, so you can plan accordingly and take advantage of any creative tax deductions for small businesses that you’re entitled to.