Business Tax Basics
All U.S. businesses must pay federal taxes on their income, just like individuals. However, companies must also pay many other federal, state, and local taxes that often make business taxes more complex than personal taxes. This section contains information on the taxes that must be paid by businesses and their owners, as well as the possible penalties they may face for failure to pay.
Income Taxes for Businesses
Not all U.S. businesses are directly taxed on their income. Many small businesses are set up as pass-through entities where the company is ignored for tax purposes. Any income or losses are reported on the owners' personal federal income tax returns.
The most common types of pass-through business entities include:
Traditional corporations are known as C-corporations, and they pay the corporate income tax on any income they earn. That income is taxed again when it is distributed to their owners as dividends. This is often called "double taxation" and is a big reason that most small to mid-sized businesses avoid organizing as C-corporations.
The federal self-employment tax is levied on individuals who work for themselves. It covers the portion of Social Security and Medicare taxes that an employer usually pays. When a person is an employee, the business usually picks up half of those taxes while their employer pays the other half. Since the self-employed have no employer to pay the tax on their behalf, they are responsible for both halves.
The self-employment tax rate is 15.3%, which breaks down to 12.4% for Social Security and 2.9% for Medicare. However, you can deduct half of that amount (7.65%) from your adjusted gross income on your individual federal return.
The Federal Insurance Contributions Act (FICA) requires all employers to withhold Social Security and Medicare taxes from employee wages and pay it over to the Internal Revenue Service (IRS) on their behalf. However, the withheld amount only represents half of the FICA obligation for that employee, and the employer is required to pay over the remaining 7.65% of the employee's total 15.3% FICA obligation.
Employers are also responsible for paying the federal unemployment tax for each employee. That tax amounts to 6% of the first $7,000 you pay an employee every year but often drops to 0.6% because most states receive a 5.4% credit. States also impose their own unemployment tax at rates that usually run between 1% and 8% on the first $10,000 to $15,000 an employee earns annually.
Most states and many local governments require businesses to charge and collect sales taxes on certain transactions with a nexus or connection to the state or municipality. The nexus requirements often vary from state to state and take into account physical presence, economic nexus, type of goods sold, and whether the goods are for resale.
To collect the sales tax, a business often must obtain a license to sell or a sales tax permit. Unfortunately, each state and municipality has its own rules and exemptions for their sales tax, so check with your state and local governments to be sure you are charging the proper amount.
Excise taxes are imposed by the state or federal government on purchasing specific goods, including tobacco, alcohol, and fuel. These taxes are primarily paid by the businesses selling the products, but most merchants pass the tax on to their customers through higher prices.
Excise taxes generally fall into two categories: ad valorem and specific. Ad valorem excise taxes are assessed on particular goods and services at a fixed rate. Specific excise taxes are imposed at a set amount on certain purchases.
The items and activities subject to federal excise taxes include:
- Gasoline and jet fuel
- Tanning salons
Many states also impose their own excise taxes on tobacco products, alcohol, motor fuel, and other items and services. While not generally considered excise taxes, some states have what is known as "selective sales taxes" on such things as amusements and insurance premiums.
Like individual property owners, businesses are usually required to pay a property tax assessed based on the value of the real estate or property they own. Property taxes are regulated at the state or local level, and you will receive an annual property tax bill letting you know how much you need to pay.
The amount of property tax your business must pay is based on the assessed value of the property it owns. The local tax authority places this assessed value on your property, which may be higher or lower than its fair market value. If you disagree with the assessment, you can file a challenge with the tax authority.
What if I Don't Pay My Business Taxes?
If your business fails to file a tax return with the IRS or does not pay the total amount due, it could be subject to a penalty of from 10% to 15% a month. The penalty tops out at a maximum of 25% of the tax due, but the IRS may still add a $135 fine and interest to that amount.
The most powerful tool that the IRS has to force businesses to pay their taxes is its right to levy your business assets. That means it can seize the business's equipment and property for unpaid taxes. The IRS may also place liens against your business, which will keep you from selling its assets without the government's consent and take priority over other creditors in bankruptcy.
Finally, the IRS has the power to withhold certain federal benefits provided to the business owner, such as military retirement benefits, Social Security payments, Medicare provider payments, and some federal salaries.
Questions About Business Taxes? A Tax Attorney Can Help
Business taxes can be complicated, and the penalties for non-compliance may result in significant financial damage to your company or even put you out of business. That is why it is often a good idea to consult with a local tax attorney to ensure you are fulfilling all of your federal, state, and local tax obligations. In addition to ensuring that you are tax compliant, an experienced tax attorney can help you structure your operations and finances in a manner that minimizes your tax bills.
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