Businesses, like people, have to pay taxes. But, unlike people, most businesses have to pay a lot more types of taxes. Keeping track of and paying these taxes on time can get pretty complicated, pretty fast. This is why we wrote this tax guide for small businesses. In this series of articles, we’ll dive into the types of taxes you may have to pay, and we’ll show you some software that can help you keep track.
As a reminder, most of our readers are in the US, so our articles will focus mostly on US tax laws and regulations. If you’re reading this from another country, be sure to check your local laws instead.
Let’s start with an overview of the different types of taxes you might have to pay.
Types of Taxes Covered by Our Tax Guide for Small Businesses
As a business, you’re responsible for paying lots of different taxes to several different government entities. The major business-related taxes include:
- Income tax: pay to the federal government, states, and, sometimes, local governments
- Sale/use/VAT/excise tax: typically paid to or collected on behalf of the state or local government and not applicable to every business
- Payroll taxes: catch-all term for lots of different taxes paid by employers to the federal, state, and maybe local governments
- Property taxes: paid to the local government by businesses that own real estate
- Import tax: a tax on goods imported from other countries and paid by the importer
- Franchise tax: yearly tax often based on net worth or capital of a business and charged by some states for the privilege of doing business in that state
For this tax guide for small businesses, we’ll break each type of tax into its own section.
All Businesses Have to Pay an Income Tax
Every business has to pay an income tax. This is why we start our tax guide for small businesses with the topic of income taxes.
The Type of Business Entity Determines How the Business Pays Its Income Taxes
How and when your business pays its income tax depends on whether you run your business as a sole proprietorship, a partnership, an LLC, or a corporation. Not only do you have to worry about the federal income tax, depending on your state, you might have to pay a state and local income tax too.
Sole Proprietorship
With sole proprietorships, you and your business are taxed together. You report your business’s income tax with your personal income tax on your yearly personal tax return, Form 1040. Your business’s expenses are listed on Schedule C of your Form 1040.
You also file your business’s state (and local, if applicable) income tax along with your personal tax.
Partnership
If your business is a partnership, the partnership typically files an informational return with the federal and state tax authorities. No tax is paid at this point. Instead, the profits pass through to each partner. The partners typically pay their portion of the partnership income on their personal tax return.
Of course, there are several flavors of partnerships such as the general partnership, the limited partnership, etc. The precise way you’ll have to pay your and the partnership’s income tax will depend on which flavor of partnership the business is set up as.
LLC
With an LLC, you can pick how you want to be taxed—as a sole proprietorship, as a partnership (if the LLC is a multi-member LLC), or as a corporation.
If you’re a single member LLC, then, by default, you’re taxed as a sole proprietorship. If you’re a multi-member LLC, then, by default, you’re taxed as a partnership.
But if you wish to be taxed as a corporation, you’ll have to file Form 8832 with the IRS and, sometimes, a similar form with your state. And if you wish to file your taxes as an S corporation, you’ll have to file one more form—Form 2553.
Corporation
Corporations file their own taxes with the federal and state governments. By default, a corporation is treated as a C-corporation. A C-corporation pays an income tax on the corporation’s profits before it distributes what is left to its shareholders as dividends. Each shareholder then pays an additional income tax on the dividends. In other words, profits from C-corporations are taxed twice.
You can avoid this double taxation problem by asking the IRS to treat your corporation as an S-corporation. To qualify, you have to:
- Be a US-based corporation
- Shareholders must be US citizens or resident aliens (here’s the IRS’s definition) and cannot be partnerships or corporations
- Have no more than 100 shareholders
- Have one class of stock
- Not be a financial institution, insurance company, or a domestic international sales corporation
An S-corporation doesn’t pay its income tax at the corporation level. Instead, it passes the income to the corporation’s shareholders. Each shareholder then reports the income on their own personal tax return and pays the income tax.
To elect to be an S-corporation, you file Form 2553 with the IRS. Most states will also treat you as an S-corporation once you make the federal filing, but some require additional filings. So, if you wish to be taxed as an S-corporation, don’t forget to find out the proper procedure from your state government.
No Matter the Entity Type, You Have to File Quarterly Estimated Taxes
When you’re an employee, your employer will withhold a part of your paycheck for federal, state, and maybe local income taxes. When you’re the business, you have to do a version of this type of withholding. But, instead of filing this every month, you have to file every quarter.
The rules and the amount of the withholding are different depending on the type of business entity you operate under. Calculating the amount can get quite complex. So, we broke the details into a separate article, which you can find here:
How to Calculate Quarterly Estimated Taxes, for Small Businesses
At the End of the Year, Use a Tax Software to Help You File Your Year End Taxes
At the end of your business’s fiscal year, you’ll need to file a formal income tax return for your business. If you overpaid in your estimated taxes, you’ll get a return. But if you underpaid, you’ll have to pay the rest. In essence, this part works just like a personal tax return.
If you have a CPA, they can prepare all the tax filings for you, of course. And, technically, you can file the taxes by hand, if you wish. But there’s really no need to file your taxes by hand these days. There are lots of software you can use. Some are even free. We go over a few for you, in this article:
Tax Software for Small Businesses
Some Businesses Have to Collect or Pay a Sale/Use/Excise Tax or VAT
The income tax is only one of several types of taxes a small business may have to pay. Since this article is a tax guide for small businesses, we will cover other types of taxes too.
Let’s next look at the sales tax, use tax, excise tax, and value-added-tax (VAT). These taxes are paid by the end user, either directly or indirectly. Only those who buy the goods or services pay the tax. Folks who do not buy won’t have to pay.
As a business, you must collect the tax and then, from time to time, send the collected amount to the proper taxing authority.
To avoid confusion, let’s start by defining each type of tax.
What Is a Sales Tax?
A sales tax is a tax added to the purchase price of goods and, sometimes, services. It’s collected one time, from the final purchaser. So, if you’re a manufacturing business, you might not have to pay a sales tax when you buy raw materials. (You do have to show your supplier your resale certificate.)
Sales taxes are imposed by a state or a local government. Each state and local government decides which items are taxed and at what rate. So, if you sell into several states, you’ll have to deal with the sales tax of each state.
There is no federal sales tax.
What Is a Use Tax?
A use tax is similar to a sales tax. But, unlike the sales tax, the use tax is paid by the seller.
Sometimes, if you fail to collect sales tax, the tax is turned into a use tax. Then, you, the merchant, will have to pay it from your own pocket. Often, though, even though the use tax is paid by the business, the tax is passed down to the consumer as a part of the cost of the purchase.
This is why the sales tax and the use tax tend to be mentioned together and used interchangeably.
What Is an Excise Tax?
Most of our readers won’t have to worry about excise taxes, but we add it here for completeness.
An excise tax is paid by the manufacturer but ultimately passed to the consumer. Examples of excise tax include gasoline tax, alcohol or tobacco tax, and, sometimes, taxes on cruise ship tickets. Some excise taxes are paid to the federal government but others are paid to the state government.
What Is a Value-Added Tax?
The value added tax (VAT) is yet another type of tax on certain goods and services. In the US, you usually see a sales tax instead of a VAT. But VATs are common in the EU and other countries like Canada and UK.
VAT works like the sales tax in that the consumer pays the tax. The tax is first collected by the business and then remitted to the government periodically.
How a Small Business Can Deal with Sales/Use Tax and VAT
If you’re a small business that operates in one state only, then it’s not very hard to deal with sales or use tax. Typically, you won’t have to worry about VAT. And, because you’re operating in the same state and in one or just a few other cities, you only have to know a few tax rates at most. You’ll follow one schedule on when to send the tax to your state’s tax collection agency.
But sales tax and VAT can get quite complicated for businesses that sell over the internet. You’re selling all over the country and maybe even internationally. So, you might have to deal with the sales tax rules for all 50 states and the country you agree to sell into.
If you’re a small business using an online marketplace like Amazon, Etsy, and eBay, they’re required to collect and remit the sales tax and VAT for you. So, you won’t have to worry about keeping track of the taxes. But, if you have your own online store through, for example, Shopify, you’ll need to worry about collecting the proper amount of sales and VAT taxes and remitting them to the correct authority at the appropriate time.
For more details, here’s our article on how to handle sales and use taxes and VAT for small online businesses:
A Small Business’s Guide to Collecting Sales Tax, Use Tax, and VAT
Payroll Taxes is a Catch-All Term for Various Federal and State Taxes
A tax guide for small businesses wouldn’t be complete without mentioning payroll taxes. If you’re a small business that has employees, then you have to pay various employment-related federal, state, and sometimes local taxes. Such taxes include Social Security, Medicare, unemployment, and worker’s compensation related payments. The requirements and amounts can vary by state.
We already covered these taxes in our employment laws and regulations series of articles. If you need a refresher, be sure to look through this article:
How to Hire Your First Employee, for Very Small Businesses (Scroll down to the section entitled Calculate the True Cost of Hiring Your First Employee)
Note that if you’re a sole proprietor, a partner in a partnership, or a single-member LLC and you have no employees, you account for your Social Security, Medicare, etc. taxes a little differently. You pay these taxes as a part of your estimated quarterly taxes. We go into this in our estimated taxes article, which we already linked to earlier in this article.
Small Businesses that Own Real Estate Will Have to Pay Property Taxes
Not every small business owns real estate, but those who have physical locations might. The law treats businesses like people, so businesses can own real estate under their names. And, if your business owns real estate, it’ll have to pay yearly real estate taxes.
Your local government will valuate your real estate and notify you of your tax amount. You pay the amount by the due date. This one is pretty straightforward.
If Your Business Buys from Another Country, You’ll Likely Have to Pay Import Taxes
Next in our tax guide for small businesses, let’s look at import taxes.
If your business imports goods for resale or for your own use, you’ll have to pay a customs duty or tariff when the goods enter the US. We don’t expect most of our readers to have to deal with import taxes, so we’re mentioning these taxes for completeness. We’ll only go over the concepts very briefly below.
What is an Import Duty or Tariff?
While there technically is a difference between duty and tariff, these words are often used interchangeably. For consistency, we’ll use tariff in this section.
A tariff is a tax on goods imported into a country. This tax is paid at customs. There are no import tariffs on services (but the term tariff is sometimes used to refer to taxes on services provided across state lines inside the US).
The Tariff on Specific Goods Depends on the Country of Origin
The amount of tariff you have to pay depends on which country the goods are coming from and the type of goods that’s being imported. It’s possible for different types of goods from the same country to have different tariff rates.
But, generally, some countries have favorable trade statuses with the US, so the goods from these countries have lower tariff rates. Other countries have neutral trade statuses, so the goods have “regular” tariff rates. And there are a few countries with unfavorable trade statuses, so the goods from these countries have the highest tariff rates.
As an importer, you’ll need to have at least a rough idea of the tariffs you’ll have to pay when importing the items. This way, when you add the tariffs to the cost of the goods sold, you’ll know if you’re selling at a market-competitive price.
The best way to figure out the tariff is simply to look up the tariff rate. You can find additional information about tariffs and links to rate tables in this article from the US International Trade Administration.
Note that US businesses never have to pay export taxes. Article I, Section 9, Clause 5 of the US Constitution forbids it. But, depending on what you export, you might have to pay certain inspection fees. And there are certain items important to national security (e.g. nuclear know-how) that you’ll never be able to export.
In Some States, Businesses Must Pay a Yearly Franchise Tax
Some states require all businesses in that state to pay a yearly franchise tax. This is what we’ll go over next in our tax guide for small businesses.
The Franchise Tax Applies to All Businesses That Do Business in the State
Even if you didn’t form your business in a state that charges a franchise tax, if you do business there, you might have to pay the franchise tax. What counts as “doing business” in the state? If you formed your business in the state, then for sure you’re doing business in the state. But, even if you didn’t form your business in the state, if you sell a lot of goods or services into that state, have a physical location in that state, or have employees in that state, then you’re also “doing business,” in that state.
The legal jargon for “doing business in the state” is called having a nexus with the state. Different states have different rules on what constitutes a nexus. So, if you’re beginning to do a lot of business in a particular state, be sure to find out the nexus rules so you understand if you need to pay a franchise tax. You’ll usually find this information at the state’s secretary of state’s office’s website.
Franchise Taxes are Typically Percentage Based
Franchise taxes tend to be based on a percentage of revenue or the total worth of the business. But, sometimes, there’s a threshold below which you won’t have to pay the tax. For example, in Texas, businesses that have a yearly revenue of less than about $1.2 million do not have to pay a franchise tax.
Some states have a franchise tax but not an income tax. Other states have both a franchise tax and an income tax. So, when you think you do have a nexus with a particular state, be sure to check if the state has franchise tax requirements.
Not Every Type of Business Must Pay a Franchise Tax
Not every type of business entity will have to pay a franchise tax, even when a state has one. Typically, if you’re a sole proprietor, you won’t have to pay a franchise tax. Some partnerships—usually the ones with only natural persons as partners—tend not to have to pay a franchise tax either.
LLCs and corporations tend to have to pay franchise taxes. But, ultimately, each state makes its own rules. So, always check with the state to determine if you have to pay a franchise tax.
Failure to Pay Taxes Can Bring Harsh Penalties, so Always Check with Your State and Local Authorities
In this tax guide for small businesses, we’ve gone over the broad categories of taxes you need to check or think about when running a business. While these are the taxes most types of businesses will run across, there might be other obscure, local taxes you’ll have to be aware of too.
For example, on one internet forum we read, we learned that, sometimes, very specific occupations must pay additional taxes. The one that we saw was a local city tax in Oregon on adult dancers. So, always check with your city and state governments on the types of taxes you have to pay, to make sure you haven’t missed any.
Tax penalties are unpleasant, expensive, and, ultimately, inescapable. The best way to avoid the penalties is to ask ahead of time. And pay the taxes.
Next Up
It’s taken us over two years, but we’ve come to the end of our guide on How to Start a Small Business. We’re definitely not going away, but we will be changing our publication schedule a little bit. We also have exciting new things planned. See what they are:
DISCLAIMER: This article does not constitute legal or accounting advice. Instead, it contains general information. The information gives you the background you’ll need to hit the ground running when you do go get advice from a lawyer or accountant. Only lawyers and accountants properly licensed in your state/country are qualified to give you legal or accounting advice.
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