In 2009, the Small Business Administration estimated that the average effective tax percentage rate for small businesses was 19.8% from whatever sources it derives income. This amount includes ordinary income, capital gains and excise taxes, but does not include sales tax, property, estate taxes or state income tax. Tax rates vary widely on federal income tax, so the more money your small business makes, the more it will pay in taxes.
While this generally answers the question: what percentage does a small business pay in taxes, it is only a good guide to determine the actual amount your business will pay. The higher your income, the higher percentage you pay. Federal income tax brackets for 2020, for a married couple are:
Table of Contents
Taxable Income Tax Rate
$0 – $19,750 10%
$19,751 – $80,250 $1,975 + 12% of the amount over $19,750
$80,251 – $171,050 $9,235 + 22% of the amount over $80,250
$171,051 – $326,600 $29,211 + 24% of the amount over $171,050
$326,601 – $414,700 $66,543 + 32% of the amount over $326,600
$414,701 – $622,050 $94,735 + 35% of the amount over $414,700
$622,051 or more $167,307.50 + 37% of the amount over $622,050
Small businesses generally are not taxed like corporations. Limited Liability Companies have been created as a form of entity in all 50 states to allow business owners to “pass through” income from their businesses and then to pay the tax at the individual, rather than the corporate level. This means that the tax will be paid after all of the personal deductions for charitable gifts, mortgage interest, real estate taxes, etc., are deducted from their business income. For this reason, many small business owners maximize their mortgages to keep the deductible level of interest high and lower their overall taxable income.
The Internal Revenue Service (IRS) agency does not recognize the legality of a sole proprietorship, partnerships, limited liability companies and limited liability partnerships as taxable corporation — they are instead considered “pass through” entities.
A limited liability company (LLC), the most common form of small business entity used today, is considered a pass-through tax entity. In these types of companies, profits pass through the company to individual members. Individual members rather than the company itself must report the members’ share of the profit on their personal tax returns.
The percentage a small business pays in taxes is important to the owner’s cash flow, and it is a complicated formula to determine all of the taxes that must be paid. When you come to a point you want to sell your small business, you will be able to add back the amount of taxes you have paid, along with other expenses, to determine the income your company should be valued on.
In many cases, you can download tools from a site like TurboTax to be sure you’re calculating your small business taxes correctly. For more difficult circumstances, a skilled tax or valuation expert, like the team at Landmark Advisors can assist you to help ensure you don’t pay a higher percentage in taxes than you need to.
Contact a trained specialist at Landmark today to be sure you are planning for your small business tax issues in the best way to save money and protect your business value each year.