Managing a small business involves juggling multiple responsibilities, and tax compliance is one that demands particular attention. Staying compliant not only helps you avoid penalties but also ensures you’re keeping up with the various taxes your business is required to pay.
Small businesses are subject to various taxes, including income tax, employment tax, self-employment tax, sales tax, property tax, and excise tax on certain products. This is why effective tax management is non-negotiable. It’s the only way to ensure compliance and maintain control over your finances.
Our team at Victory Tax Lawyers has been committed to helping small businesses manage their tax obligations with confidence and success for over 10 years now. We offer personalized tax relief services and a comprehensive approach to resolving our clients’ tax problems. If you need help with staying on top your taxes, consider scheduling a free tax attorney consultation with one of our experienced tax attorneys today.
This post will break down the different taxes that small businesses must pay at both the federal and state levels. If you’ve been looking for ways to reduce your tax bill as a small business owner, we’ve shared some smart strategies to help you save money.
Types of Taxes Small Businesses Must Pay
Small businesses are subject to several types of taxes, some at the federal level, others at the state or local level. Knowing which taxes you have to remit will help you stay compliant and plan your finances properly. Here’s a list of some of the taxes small businesses must pay:
Income Tax
Income tax is imposed on a business based on its income, including profits and losses. The amount of income tax a business pays depends on its profit and the applicable tax rate, meaning businesses with higher profits pay more tax than those with lower profits.
Your business structure determines how you file your taxes. Individual proprietors and partners report business earnings on their tax forms using Form 1040 or 1040-SR, together with Schedule C, which details profit or loss from the business. On the other hand, partnerships submit an informational tax return using Form 1065 and provide each partner with a Schedule K-1 to report their share of the income or loss.
The filing process for corporations is much different. C corporations (standard corporations taxed separately from their owners) must file Form 1120, while S corporations (which pass income, losses, deductions, and credits through to their shareholders) file Form 1120-S.
Although income taxes are filed annually, many small businesses are required to make estimated payments quarterly throughout the year to avoid underpayment penalties.
Self-Employment Tax
Self-employment tax is a federal tax made up of Social Security and Medicare taxes. It primarily applies to individuals who work for themselves, such as freelancers, sole proprietors, and independent contractors. It functions similarly to the payroll taxes withheld from regular employees’ paychecks, but with one key difference: self-employed individuals are responsible for paying the full amount themselves.
Unlike traditional employees who split these contributions with their employers, self-employed individuals pay the full 15.3% tax rate (2.4% for Social Security and 2.9% for Medicare), based on their net earnings. This tax is calculated using Schedule SE, which is filed along with Form 1040 or 1040-SR. It’s important to note that even if you don’t owe income tax, you’re still required to pay self-employment tax if your net earnings are $400 or more in a given year.
Employment Taxes
All small businesses with employees must pay employment taxes, regardless of the business structure. Employers are responsible for withholding and paying several taxes on behalf of their employees, including federal income tax withholding, Social Security and Medicare taxes, and Federal Unemployment Tax Act (FUTA) taxes. Depending on the company’s payroll schedule, they must file and remit payroll taxes either quarterly or monthly.
Sales Tax
Several states and many local jurisdictions require businesses to collect sales tax from customers on taxable goods and services. However, exemptions may apply depending on factors like the type of product and point of sale.
Small businesses that collect sales tax must register with their state taxing authority, which often involves obtaining a sales tax permit or license. It’s important to ensure you’re charging the correct state rate, plus any applicable local or specialty rates, as sales tax rates vary depending on the state and sometimes even the city. Sales tax returns are generally filed monthly, quarterly, or annually, depending on the state.
Excise Taxes
Excise taxes apply to specific products and services such as fuel, tobacco, alcohol, airline tickets, and certain types of manufacturing. If your business operates in an industry subject to excise tax, you must register, calculate, and remit the appropriate tax to the IRS or your state taxing authority.
These taxes can be imposed at the federal and state levels, and rates vary depending on the product or activity. In some cases, businesses may need a special permit to collect and remit excise taxes, as they are responsible for reporting and paying these taxes on all applicable products.
State and Local Tax Considerations
States and local governments may also impose additional taxes on small businesses, such as income, property, and franchise taxes.
For instance, the federal, state, and local governments require certain types of businesses to obtain licenses and pay corresponding fees, which can also be considered a tax. However, for a state to legally tax a business, that business must meet a certain legal threshold known as “Nexus,” based on its activity within the state, as outlined in the U.S. Constitution.
Each state defines its criteria for sales tax nexus, which may include:
- Having a physical presence in the state or jurisdiction
- Reaching a certain level of economic activity in the state
- Having a relationship with another business that has a physical presence in the state
- Partnering with a third-party seller or referral agent within the state
Understanding sales tax nexus helps small businesses determine where they are required to collect and remit sales tax. It also enables them to calculate the costs of expanding into new jurisdictions accurately while staying compliant with tax laws.
Business Structure and Its Impact on Taxes
Choosing the right form of business entity is one of the most important decisions you’ll make when starting a business. Your business structure not only determines how the business operates but also how you file and pay taxes. Each structure has its pros and cons when it comes to taxation, so it’s important to carefully weigh your options before deciding.
Sole Proprietorship
A sole proprietorship is owned and managed by a single individual who is also responsible for the debts and liabilities incurred by the business. Legally, the owner and the business are not separate, so all income or loss from the business is reported on the owner’s tax return.
The business’s profits are taxed at the individual’s income tax rate, with eligibility for a 50% capital gains tax discount on business or capital asset sales, such as goodwill and trademarks. A sole proprietor must pay self-employment taxes on their income, including Social Security and Medicare taxes. However, if the business incurs a loss during the year, the owner will neither owe self-employment taxes nor earn Social Security or Medicare credits for that year.
Partnerships
In a partnership, two or more people come together to share ownership, responsibilities, profits, and losses. There are two types of partnerships: general partnerships and limited partnerships.
A general partnership involves all partners sharing equally in the responsibilities, profits, and liabilities of the business. A limited partnership allows for “silent partners” who invest capital but are not involved in daily operations. This setup includes at least one general partner and one limited partner. General partners have unlimited liability, meaning personal assets can be used to cover business debts. Limited partners, however, are only liable up to the amount of their investment.
Both types of partnerships are considered pass-through entities. The business itself isn’t taxed; instead, each partner reports their share of the income, losses, deductions, and credits on their tax return. In general partnerships, all partners are responsible for an equal share of the taxes. In limited partnerships, each partner is taxed based on their share of the profits.
Corporations (C-Corp and S-Corp)
Corporations are separate legal entities from their owners (shareholders) and offer limited liability protection. There are three main types: C corporations, S corporations, and non-profit corporations.
C corporations are the most common and are subject to double taxation: the business pays taxes on profits, and shareholders pay taxes on dividends. However, corporate owners don’t pay taxes on profits until those profits are distributed as dividends. S corporations offer pass-through taxation similar to partnerships, allowing profits and losses to flow through to shareholders’ tax returns, thereby avoiding corporate-level taxation.
Non-profit corporations are generally tax-exempt since they are established for charitable, educational, religious, or similar purposes and do not operate for profit.
Limited Liability Companies (LLC)
A Limited Liability Company (LLC) is a flexible business structure that combines the liability protection of a corporation with the tax advantages of a partnership. Since LLCs are governed by state law, the specific rules and requirements for formation and operation can vary by state.
LLCs can be taxed like corporations, but they may also elect to be treated as pass-through or disregarded entities. A disregarded entity operates similarly to a sole proprietorship, with income, expenses, gains, and losses reported on the owner’s tax return. In such cases, a single-member LLC can be taxed either as a sole proprietorship or a corporation.
Tax Deductions and Credits for Small Businesses
Tax deductions help individuals and businesses reduce their taxable income, ultimately lowering their tax bills. Unfortunately, many small business owners miss out on these savings simply because they’re unaware of the deductions and credits available to them. Here are some of the most common tax deductions and credits available to small businesses:
Common Deductions
These deductions can help reduce your taxable income and increase your savings. Knowing which ones apply to your business is the first step to making the most of your tax return.
1. Home Office Deduction
If you use part of your home for business purposes, you may qualify for a home office deduction. To be eligible, you must regularly and exclusively use a specific part of your home for business. Also, your home must be your principal place of business (or where you meet clients or perform administrative tasks).
2. Business Travel and Meals
Travel expenses for business purposes are deductible. These include transportation (airfare, train tickets, car rentals, mileage on personal vehicles used for business), lodging, and meals while traveling for business purposes
3. Employee Wages and Benefits
Small businesses can claim deductions for certain employee-related expenses, provided that these costs are deemed necessary for business operations and are part of the typical expenses incurred in the ordinary course of business. Examples include wages and salaries paid to employees, employer contributions to Health Savings Accounts (HSAs), vacation pay, sick leave, employee assistance programs aimed at supporting mental health and wellness, the cost of life insurance coverage provided to employees, meals and lodging offered during work-related travel or overnight stays, and expenses related to job-specific education or training that helps employees improve their skills.
4. Depreciation on Equipment and Property
You may claim depreciation deductions on business assets that lose value over time. These assets include things like tools, machinery, manufacturing equipment, office furniture, fixtures, technology, buildings or improvements, vehicles that are used solely for business, and intangible assets such as copyrights, trademarks, and patents.
Tax Credits
In addition to deductions, tax credits offer small businesses a powerful way to lower their tax liability. Unlike deductions that reduce taxable income, credits directly reduce the amount of tax owed, dollar for dollar. Here are some valuable credits worth exploring:
1. Research and Development (R&D) Tax Credit
This credit rewards businesses for engaging in innovation, experimentation, or improvement of products, processes, or technology. It’s a valuable incentive to invest in R&D activities.
2. Small Business Healthcare Tax Credit
If you provide health insurance through the Small Business Health Options Program (SHOP), you may qualify for a tax credit worth up to 50% of the premiums you pay on behalf of your employees.
3. Work Opportunity Tax Credit (WOTC)
This federal tax credit is available to employers who hire individuals from certain targeted groups that face significant barriers to employment. These groups may include long-term unemployed individuals, veterans, ex-felons, and SNAP (food stamp) recipients.
Who Needs to Pay Estimated Taxes and When
Estimated taxes are periodic advance payments made to the IRS to cover income that isn’t subject to regular withholding, such as income from self-employment, interest, dividends, rent, and more. Estimated quarterly taxes are most frequently paid by;
- Self-Employed Individuals: If you’re a freelancer, contractor, or small business owner, and you expect to owe $1,000 or more in taxes after subtracting withholding and tax credits, you’re generally required to make estimated tax payments. This is because no tax is automatically withheld on their income.
- Corporations: C corporations typically need to pay estimated taxes if they expect to owe $500 or more in taxes for the year. S corporations usually don’t pay taxes at the corporate level, but shareholders must pay estimated taxes on their share of income.
- Partners in Partnerships: Although partnerships themselves don’t pay taxes, partners are required to report and pay taxes on their share of the income. If a partner expects to owe $1,000 or more after credits and withholding, they must pay estimated taxes individually.
Estimated tax payments are due quarterly. Although dates could vary, they typically fall in the middle of a month, around the 15th of January, April, June, and September. If a due date falls on a weekend or holiday, the deadline is moved to the next business day. Here’s a table outlining the income periods and corresponding estimated tax payment deadlines for the year 2025:
|
For Income Earned |
Due Dates for Estimated Tax Payments |
|
Jan. 1 – March 31, 2025 |
April 15, 2025 |
|
April 1 – May 31, 2025 |
June 16, 2025 |
|
June 1 – Aug 31, 2025 |
Sept. 15, 2025 |
|
Sept 1 – Dec 31, 2025 |
Jan. 15, 2026 |
How to Calculate Estimated Tax Payments
It’s important to stay on top of your estimated tax payments. Neglecting to make these payments or underpaying during the year could lead to IRS penalties and interest, even if you settle the total amount by the tax deadline. Now, there are two methods you can use when calculating your estimated tax payments: one is based on prior year taxes, and the other is annualizing based on what you’ve already earned during the year.
The prior year method is simpler and works well if your income is fixed or predictable. Here, you’ll divide the amount you owed for the previous year by four, then send a part to the IRS. Let’s say you owed $20,000 in taxes the previous year; you’d send a fourth of the amount, which is $5,000 each quarter. To avoid penalties when using the prior year method, make sure your payments meet one of the following:
- Pay 100% of last year’s tax liability (if your AGI was $150,000 or less).
- Pay 110% of last year’s liability (if your AGI was over $150,000).
The annualized income method is better for individuals and businesses with fluctuating or seasonal income. In this case, rather than assuming even income throughout the year, you simply calculate your tax liability based on what you’ve earned in each quarter. So, for instance, if you earn significantly more in Q2 than Q1, you increase your Q2 payment to reflect your increased earnings. This method helps those with growing or inconsistent income stay accurate in their tax disbursements. It also helps you stay penalty-free while improving cash flow throughout the year.
Whichever method you choose to adopt, you can follow the steps below to get your estimated quarterly tax payments right:
Step 1: Estimate Your Annual Income: Include all taxable sources: self-employment, interest, dividends, rental income, etc.
Step 2: Subtract Deductions and Credits: Deduct allowable business expenses, the standard deduction, or itemized deductions, and apply available tax credits.
Step 3: Calculate Your Total Tax Liability: Use current IRS tax brackets to calculate your estimated federal income tax.
Step 4: Divide by Four (or Use the Annualized Formula): If you use the prior year method, divide your estimated tax by four. If you’re using the annualized method, simply estimate your tax liability for each quarter individually.
Top Tax Tips for Small Business Owners
If you’re a small business owner looking for a way to reduce your tax bill, here are some smart strategies to help you:
1. Invest in Health Insurance
Paying for healthcare coverage may seem like a costly burden, especially when you’re a small business trying to manage funds, but it does come with significant tax advantages once you move beyond the immediate cost concerns.
If you’re self-employed and pay for your health insurance, you may qualify for the self-employed health insurance deduction. This allows you to deduct part or all of your premiums for medical, dental, vision, or long-term care insurance. The deduction isn’t just limited to you. It may also apply to your spouse and other family members (including children under 27 at the end of the tax year), even if they aren’t claimed as your tax dependents.
2. Save for Retirement
Not only do retirement savings plans prepare you for the future, but they also provide meaningful tax advantages today. Small business owners can choose from several tax-advantaged retirement options, including Savings Incentive Match Plan for Employees (SIMPLE IRA), Simplified Employee Pension (SEP IRA), Solo 401(k) (also known as an Individual 401(k) or Self-Employed 401(k), Traditional IRA, and more.
These retirement savings plans provide benefits that include tax-deductible contributions for you and your employees, as well as potential tax credits to help offset the costs of setting up a retirement plan. Choosing the right one would ultimately depend on your business structure, whether you have employees, and your income level.
3. Defer Income and Accelerate Expenses
Timing matters when it comes to taxes. Actions such as deferring your income or accelerating your expenses can help you manage your taxable income more effectively. Deferring your income or accelerating deductions can put you in control of how much income you’re taxed on and when you’re taxed, letting you save more money. When you defer expenses, you’re essentially holding off that cost as a deductible from your taxable income for a future tax year.
In other words, you’ll use that expense to reduce the amount to pay in the future. If you expect to be in a lower tax bracket next year, you might delay some payments or invoices until the following year. This postpones the tax liability and gives you breathing room and potential savings.
On the other hand, you can reduce your current year’s tax bill by accelerating your expenses. This means that you make early payments on deductible expenses like rent, supplies, utilities, or even employee bonuses. The idea is that you increase your deductions now but also potentially lower your tax liability for the current year.
4. Hire a Tax Attorney
Tax planning is complicated. A single misstep could lead to falling out of compliance with IRS regulations. And while there are lots of resources and advice out there that promise to offer help, none is as effective as working with a tax attorney. A tax attorney will help you identify overlooked deductions and credits, structure your business for optimal tax efficiency, make sure you’re staying compliant with changing tax laws, and represent you before the IRS and in tax court if you’re audited or facing litigation.
A tax attorney doesn’t only step in when there are tax implications; they can help you prevent them through long-term tax planning. Like most businesses, cutting costs may be a priority. While hiring a professional may seem like an added expense, it can save you thousands and spare you the headache of costly errors or missed opportunities.
Need Legal Help With Your Small Business Taxes?
Taxes might not be the most exciting part of running a business, but managing them properly is essential for keeping operations smooth and avoiding issues.
The best way to stay on top of your taxes and save more money is to take tax planning seriously. This involves making smart decisions throughout the year, including knowing the deductions and credits you qualify for, planning for large expenses, staying updated on tax laws that apply to your business, and automating your financial reporting. When you take tax planning seriously, you avoid last-minute scrambles and costly mistakes, and you free up capital that can then be used to reinvest in your business.
You don’t have to wait until it’s tax season to start planning your taxes. Start today by booking an appointment with one of the best small business tax lawyers. We’ll help you protect your finances, minimize liabilities, and plan for long-term success. Book a free consultation to get started.
FAQs
How Much Income Can a Small Business Make Without Paying Taxes?
The amount of income a small business can earn without paying taxes depends largely on the legal structure of the business (i.e., whether it’s a sole proprietorship, LLC, S-Corp, or C-Corp) and whether it’s been able to claim all deductions, credits, and exemptions available to it.
Are There Tax Benefits to Owning a Small Business?
Absolutely. Owning a business opens you up to a wide range of tax-saving opportunities that W-2 employees (formally employed individuals) simply don’t have. Some of these tax deductions include home office expense deductions, business equipment purchases, travel expense deductions, health insurance premiums, and much more.
How to Avoid Taxes as a Small Business Owner?
You can’t completely escape paying taxes. The good thing, though, is that you can take advantage of tax-saving opportunities to reduce them significantly. Just like we explained above, contributing to a retirement plan, investing in health insurance, tracking your business expenses, and deferring or accelerating your expenses are all legal strategies you can employ to reduce your tax burden.
