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Why Small Business Tax Rates Matter

September 19, 2019
Small Business

Small businesses are liable to pay an average 19.8% tax rate. However, the suitability of each tax rate may vary depending on your total business income, tax credits, and deductions. As of now, small C-corporations enjoy the lowest tax rate of 17.5%. But the flat tax rate for C-corporations is set at 21%.

That said, the comparison of the tax rate for different small business entities often confuses taxpayers. Similarly, small business owners’ unfamiliarity with the current income tax rate and eligibility criteria makes it even more complicated.

But 2019 takes a center stage as the new Tax Cuts and Jobs Act is put into place. Consequently, small business owners need to figure out how the new tax bill will affect their filing and reporting throughout the year.

The calculation of tax rates for small business owners can be overwhelming. It’s only wise to learn basic mechanics to make sound business decisions. For this article, we’ll focus on numerous dynamics of tax rates in terms of your business earnings and structure.

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The Nature of Average Small Business Tax Rate

As of now, sole proprietorship's pay a 13.3% tax rate while the small partnerships pay approximately 23.6%. A small S corporation, on the other hand, pays a 26.9% tax rate. The average tax rate of 19.8% is set forth by the IRS on the understanding of marginal and effective tax rate.

Marginal tax rate, for instance, refers to a specific tax percentage applied to your annual income. The same percentage is used for your next taxable income for another year. Effective tax rate, on the other hand, points to the calculation of your income based where pre-tax profits are taxed. Also, make a note that amalgamated marginal tax rate for the S corporation and a partnership is set at 40.8%.

Moreover, breaking down different tax rates is of utmost significance when it comes to small business owners who separate personal from business taxes. Keeping that in mind, your small business may be required to pay some or all of the tax rates depending on the type of your business.

Tax Rate Bracket for Small Businesses

The tax bracket for C corporations is set at 21%. But tax rates for small S corporations, partnerships, and sole-proprietorship are calculated on personal tax rates. However, there are seven tax brackets i.e. 10%, 12%, 22%, 24%, 32%, 35%, and 37% that you need to watch out for. Why? Every single one of this tax bracket could start and end on the filing status of your business.

In essence, your personal income tax rate can go from 10% to 37% based on your total income and filing status. If you earned a business income of, say, $100,000, that means you’ll have to pay a 24% tax rate as a filer.

Starting from 2019, however, pass-through entities as well as sole-proprietors have the opportunistic flexibility to deduct more than 20% of the business income prior to the calculation of tax rate. For example, if you can bring down up to $20,000 of your business income and report $80,000; you’ll decrease the tax rate to 22%.

Remember, your limitation to use deductions will invariably depend on your small business structure and income. However, the minimal amount for single filers is set at $157,000 and $315,000 for joint filers to get the most out of the deduction.

How Tax Rates Apply to Small Businesses
 Federal Income Tax Rates

Whether you have a small or large business income, the same flat rate would be enforced on your taxable income. You should think of personal taxes as progressive taxes. Consequently, the higher the taxable income, the higher the tax rate will be for a small business. Similarly, a lower tax rate is applicable to earned dividends and other capital gains.

 Your Employment Tax Rates

Social Security & Medicare Tax

The tax is split between the employer and the employee once the 2.9% Medicare tax comes into the equation on paid wages. If an employee is paid more than 200,000 per year, there may be more Medical tax rate requirements to follow.

State & Federal Unemployment Tax

If you paid an employee under $10,000, there is a federal tax rate of 6.2% on the first $7,000. If you have been paying unemployment taxes, you can avail maximum tax credit of 5.4%. This will reduce your federal tax rate to 0.6%.

The unemployment tax is regulated differently for each state. This rate can be decided based on your small company’s size, industry type, turnover ratio, experience, and total employees that have already agreed to get unemployment benefits.

Self-Employment Tax Rates

The self-employment tax rate is essentially a combination of Medicare and Social Security for small business owners. However, the self-employment tax rate does not apply to sole-proprietorships, partnerships, and S corporations.

A 12.4% tax rate would be applicable if you are paying more than $132,000 in wages to your employees. Furthermore, the amount is deducted from employees’ wages and employers who pay 6.2%.  You will, however, have to pay the full amount as a self-employed individual.

To be blunt, employers and employee share the 15.3% tax rate to pay payroll taxes. Additionally, the responsibility to pay 7.65% of Social Security and Medicare taxes lies strictly on employees.

Sales Tax Rates

Small businesses often don’t indulge in extraneous purchase habits. However, rudimentary items such as equipment and supplies are subject to the collection of sales tax from the customers. The collection of sales tax, however, can change from one state to another.

A state may not force, for example, retailers to collect any sales tax while a state like Louisiana imposes a collection of sales tax as high as 10.02%. The criteria of a sales tax for a small retail business in New York and Florida depends on the customer’s geographical location. Meanwhile, the sales tax in Texas and Pennsylvania is based on the operational activities of a business.

Excise Tax

A small business can operate in a number of industries. And just like the collection of sales tax, an excise tax is paid on federal or state requirements. A multitude of products and services can be subject to an excise tax. Ultimately, it comes down to the type of product your business is selling. A root beer, for example, has a flat excise tax rate of 18% per barrel.

Tax Rates on Your Property

The selection of tax rate for your small business property is calculated on the geographical specificity. Comparatively, a city, for instance, will have a higher tax rate than a county. You can only apply the right property tax rate when your small business entity is registered. The purpose of registration is to get the first-hand information about your property’s tax rates and stated deadlines. Also, don’t think of the rate in terms of market value. Instead, the assessed value is used to get the finalized tax rate of your property.

State Tax Rates for Small Businesses

Apart from South Dakota and Wyoming, every single state charges a specified tax on your small business income. A corporate income tax is a primary model in a given state to calculate a small business tax rate. Therefore, C-Corporations are required to pay a 4-9% of the tax rate on business income. In addition, Washington and Texas charge a gross receipt tax that’s added in your gross sales.  More importantly, some states use franchise based method to calculate 0.1-0.9% tax rate on the value of your business.

It is imperative to remember that a state may have different tax obligations for small business to fulfill. Just takea New Hampshire for example. This state does not impose any tax rate on individual taxable income, but it collectively incorporates franchise tax and corporate income tax. Small businesses should assume the same rules for employment or excise taxes as states may charge their own tax rate.

How Deductions and Credits Tie into Small Business Tax Rate

The truth is that multiplying your taxable income to numerous tax rates can get tricky. Deductions and tax credits eventually turn out to be the deciding factors for your tax rate. Sure, some deductions can make a huge difference for your small business while some may just turn out to be the wasteful opportunities.

It is true – tax credits are mathematically proven to be more beneficial for small business than deductions.  That’s because you get the instant freedom to subtract your total owed taxes on a dollar-by-dollar valuation.

Find Out Your Small Business Tax Rate

Your small business may have the exact same federal income tax as another business, but you may end up calculating different tax rates based on availed deductions and credits.  Though that’s not the end of it all, the types of taxes paid throughout the year can also determine different tax rates.

In simple terms, C corporations go for the corporate tax rates that are calculated on total taxable business income. S corporations, partnerships, LLCs, sole-proprietorships, nonetheless, establish tax rates based on personal taxable income. That said, these business earnings are interlinked with employment, self-employment, sales, excise, and state taxes.

Conclusion

To make things simpler for you and your small business, acquire the service of a qualified tax specialist like an enrolled agent, tax attorney, or a qualified CPA who can help you meet all the state tax obligations and navigate through complex tax rate codes. Halon Private Client can always help you make sure that you know your tax rates and help you with strategies.

Tatiana Bashlova

Tatiana is the Junior Vice President at Halon. She has experience in operations, payroll, legal, human resources, and finance in various industries. In her spare time she enjoys reading about new laws, hiking, and fishing. .

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