Small Business Taxes: The Basics Every New Owner Should Know

Taxes are one of the biggest surprises for new business owners. When you work for an employer, taxes are withheld from every paycheck, and filing a return may be fairly simple. When you run your own business, you take on responsibility for understanding, calculating and paying several types of taxes. Here’s an overview of the main types. Tax rules are detailed and change over time, so check irs.gov and your state’s tax agency, or work with a tax professional.

Income tax

How business income is taxed depends on your business structure.

Sole proprietors and single-member LLCs taxed as sole proprietorships generally report business income and expenses on Schedule C, which is filed with their personal Form 1040 tax return. Net profit is added to other income and taxed at individual income tax rates.

Partnerships and multi-member LLCs taxed as partnerships generally don’t pay income tax at the business level. Instead, they file an informational return, and profits and losses pass through to owners, who report their share on personal tax returns. S corporations work similarly, passing income through to shareholders.

C corporations pay corporate income tax on their profits. Shareholders then pay individual income tax on dividends they receive.

Some business owners may qualify for the qualified business income deduction, which can reduce taxable income from pass-through businesses, subject to limits and eligibility rules.

Self-employment tax

If you work for yourself, you generally pay both the employee and employer shares of Social Security and Medicare taxes, known as self-employment tax. The IRS rate is 15.3% on net earnings from self-employment, made up of 12.4% for Social Security, up to an annual wage base limit, and 2.9% for Medicare. An additional Medicare tax may apply at higher income levels.

Self-employment tax generally applies if your net self-employment earnings are $400 or more for the year. You can deduct the employer-equivalent portion of self-employment tax when calculating your adjusted gross income, which reduces your income tax.

Self-employment tax surprises many new business owners, since it’s in addition to regular income tax.

Estimated taxes

Because no one withholds taxes from business income, the IRS generally expects you to make quarterly estimated tax payments if you expect to owe $1,000 or more when you file your return. These payments cover both income tax and self-employment tax.

Estimated payments are typically due four times a year. Missing them or paying too little can lead to penalties, even if you pay the full amount when you file. The IRS provides worksheets and the Form 1040-ES to help calculate estimated payments, and you can pay online through IRS Direct Pay or your IRS online account. Many states also require estimated payments for state income tax.

Sales tax

Most states charge sales tax on certain goods and, in some states, certain services. If you sell taxable items, you may need a permit from your state to collect sales tax from customers and send it to the state on a regular schedule. Sales tax rules, rates and what’s taxable vary significantly by state and sometimes by city or county.

Online sellers may owe sales tax in states where they reach certain sales thresholds, even if they don’t have a physical presence there. Many online marketplaces collect and remit sales tax on behalf of sellers in many states, but requirements vary, so check your obligations.

Payroll taxes

If you hire employees, you’ll need to withhold federal income tax, Social Security and Medicare taxes, and applicable state and local taxes from their pay. You’ll also pay the employer share of Social Security and Medicare taxes and federal and state unemployment taxes. Payroll taxes must be deposited on a set schedule, and you’ll file regular payroll tax returns and provide W-2 forms to employees. Many small businesses use payroll services to handle this.

Deductions

Ordinary and necessary business expenses can generally reduce your taxable profit. Common deductible expenses may include supplies, equipment, software, advertising, business insurance, professional fees, rent, business travel, a portion of business meals and vehicle expenses for business use. A home office deduction may be available if you use part of your home regularly and exclusively for business.

Rules for some deductions, such as vehicles, meals, travel and home offices, are detailed. Keep receipts and records for everything, including the business purpose of expenses. Good records support your deductions if the IRS has questions.

Other taxes

Depending on your business and location, you may also face other taxes, such as state franchise taxes, local business taxes, property taxes on business equipment or excise taxes for certain products.

Get help early

A tax professional can help you choose a business structure, set up estimated payments, identify deductions and avoid costly mistakes. Getting advice early, before problems arise, is usually more cost-effective than fixing mistakes later. The IRS website also offers a Small Business and Self-Employed Tax Center with free resources and guides.