If you own a small business, you’ll be responsible for a number of business taxes and must navigate several tax laws. Your taxes can influence decisions about how you organize, staff, and run your businesses. Tax considerations also guide your pricing strategy for goods and services.
Below are seven types of taxes you might be responsible for.*
1. Income Taxes
Income taxes are based on your business profits. The way business profits are taxed depends on how you organize and operate the enterprise. In choosing the type of entity, you should consider issues such as double taxation and tax rates.
If you’re a sole proprietor, you own the business yourself and in your own name (or an assumed name that you register). The profits from the business represent part of your income and are taxed at the same rates as salaries, wages and other ordinary income.
A corporation is a separate legal entity from its shareholders. By default, corporate profits face taxation at the corporate level and when the corporation distributes it to the shareholders. With an “S” corporation election, qualifying corporations can avoid this double taxation and have profits taxed only when distributed to the shareholders.
A partnership forms from two or more people engaged in business for a profit. The partners pay taxes on their share of the profits, but the partnership entity itself does not pay. Each partner gets a “K-1” to report the partner’s share of profits.
Limited Liability Company
LLCs allow the owners to avoid personal liability for business debts and avoid double taxation. How profits pass through the LLC depends on the number of owners, or “members.” A single-member LLC is treated by the IRS as a sole-proprietorship, while profits from a multi-member LLC get treated the same way as those for partnerships.
2. Self-Employment Taxes
Generally, you must pay Social Security and Medicare taxes even if you work for yourself. Again, your choice of business entity affects whether you pay self-employment taxes. The IRS treats partners, sole proprietors and members of LLCs as self-employed individuals.
By choosing to incorporate rather than form an LLC or partnership or operate as a sole proprietor, you avoid the self-employment tax. Instead, the corporation withholds the Social Security and Medicare taxes only from employee’s wages.
If you organize especially as a closely-held corporation, you might pay yourself or others -- including employees -- as salary. Of course, you and other employees pay income tax, but it might eliminate the self-employment taxes.
3. Unemployment Taxes
Businesses pay federal unemployment taxes and state unemployment taxes to fund an unemployment insurance program. Unemployment insurance affords benefits to those who lose jobs through reasons such as a layoff, a resignation for health reasons or a termination otherwise through no fault of your own.
Your unemployment tax rates can increase as former employees collect unemployment benefits. Thus, you should exercise care when you decide to fire an employee. As a general rule, most employees fall in the at-will category. If you fire an employee who hasn’t engaged in misconduct or incompetence, the employee can receive unemployment compensation. This gets charged against you, with your taxes increasing.
4. Payroll Taxes
You must withhold from your employees’ wages and salaries federal, state and (where applicable) local income taxes. As to the Social Security and Medicare taxes, your responsibilities include contributions as well as withholding from the employees.
You can avoid payroll taxes by using independent contractors over employees. You don’t withhold anything from wages or face payroll taxes for the latter. For vendors or service providers who you treat as independent contractors, you will issue them Form 1099s so they can report your payments.
However, the mere fact you call someone an independent contractor or send them a Form 1099 might not keep you away from the payroll taxes. If you control the manner, method and other details of the work, that “independent contractor” may actually be treated as an employee. Whether your payee has his or her own equipment, staff and the right to have other jobs also factors into the independent contractor analysis.
For more information about contractors vs. full-time employees, review this article: Hiring Help: Do You Need an Employee or Independent Contractor?
5. Sales Taxes
Most states and many local jurisdictions impose a sales tax on purchases of goods and services. If your small business entails lodging or is located in a resort locale, you’ll see variants of sales taxes. These may be called hotel or other tourism taxes.
Some jurisdictions do not tax groceries, reasoning that such a tax would impact low income consumers.
However, you might find the exemptions do not apply to products such as soda or candy. In fact, some cities have imposed separate taxes for these products to make them more costly and discourage their use.
Technically, your customers pay the sales tax. You collect it at the time of sale. It represents an indirect tax on your customers because you pass the tax to your customers in the form of higher prices.
6. Excise Taxes
With an excise tax, a government collects a percentage of the price or value of certain goods (such as alcohol, fuel, tobacco, health devices), services or activities. Health care services and airline tickets are also subject to these taxes.
Unlike sales taxes which are imposed at the point of purchase, excise taxes arise at the time of manufacturing or production. Thus, if your small business is engaged manufacturing, production or wholesale distribution of these items, you directly pay the tax.
Retailers or others who provide these goods and services to customers do not pay the tax directly. Instead, they see the tax indirectly in the prices they pay from the manufacturer or distributor. That cost (tax) is passed down to the consumer.
7. Property Taxes
Small businesses that own land and equipment pay property, or sometimes called ad valorem, taxes. These property taxes are calculated based upon the tax value of the property. Since property taxes come from local governments, your business can claim them as a business expense.
If you have a home office, you can claim tax breaks for at least a portion of property taxes on your home. This applies when you meet clients, patients or customers in the home on a regular basis. Additionally, separate buildings such as a studio, barn or a salon upon which you might pay property taxes count for deductions on property taxes. For in-depth information on the home office deduction, read this article from the SmartBiz Blog: How to Take the Home Office Tax Deduction.
For additional information about small business taxes, review this article from SmartBiz University, Identifying Potential Tax-Related Issues.
*This information is provided for educational purposes only. Hiring a tax professional is the best way to manage and understand all your obligations, especially when there are changes in legal requirements.
About the Author
Alice Bell is a freelance writer from Los Angeles. She contributes to several business and finance blogs including Tax Crisis Institute. Also, Alice is a yoga enthusiast and avid reader.