Every registered business must identify its tax liability and pay taxes to the relevant authorities. The government uses the tax collections from businesses and income-earning individuals to deliver necessary public goods and services including provision of social amenities, security, and maintaining law and order. If you are looking to start your own business, it is important to have information regarding the amount of taxes you expect to pay to the legal authorities to avoid falling on the wrong side of the law. This article discusses the amount of tax a small business is expected to pay and how to determine your tax rate.
What Determines the Tax Rate?
The tax rate is primarily determined by the legal structure of your business. Since your company was registered legally, it probably falls between three business categories, which are a sole proprietorship, a partnership, or a corporation. The tax rate within each category may also vary depending on the classification of your business. For example, a partnership can be either limited or general, while a corporation can be classified as limited liability, C Corporation, S corporation, an LLC and a non-profit organization. This means that the tax rate of each type of business will be calculated based on its legal structure and profits made over a certain duration.
How Are Businesses Taxed?
Your business may be taxed in a pass-through manner if you chose an appropriate legal structure when registering your business. This means that your company will not be paying taxes on its income rather it will be deducted as personal income taxes from you as the owner every time you take money out of the business. This setup allows some small businesses to grow since you will not be taxed if you are not taking any money out of your business. However, if you take money out of the economy for your personal use, then you will be taxed on it. This only works for certain legal structures like a sole proprietorship, partnerships, and a limited liability corporation as they are considered pass-through legal structures. If you are registered as a corporation, then you will be charged a flat rate of 21% on taxes on your non-deductible income.
Small Business Tax Rates
Businesses pay different amounts in taxes depending on their entities. Pass through entities may be required to pay salaries to officers for reasonable compensation and sole proprietors pay self-employment taxes with a flat rate of 15.3%, which includes 2.9% for Medicare and 12.4% for Social security.
Although this may sound too much for an entrepreneur who is just getting started, small businesses are taxed differently compared to corporations and other big businesses. It is important to have a good idea of your deductions and taxable income for the year to figure out the amount of taxes to pay quarterly. Your tax return for the previous year can be useful in determining what you are required to pay in your current year. A taxpayer can avoid IRS penalties by making estimated tax payments that equal 100% tax liability for the previous year or at least 90% of the total tax liability for the current year.
How Much Should You Set Aside for Taxes?
You can cover your federal and state taxes by setting aside 30 to 40 percent of your income. It is important to set aside funds regularly since you will be paying these taxes quarterly. The type of business you own also determines the amount of money you can save after paying taxes. If it is your first time venturing in the entrepreneur business then have a separate business bank account to put funds set aside for your taxes.
It is important to understand how the tax liability of your business is determined since different business entities have a different tax rate. Paying taxes in time allows the government to provide social amenities, security, and other public goods and services to all citizens. Even if you are sustaining losses, it is still important to file your taxes to avoid legal issues and take advantage of deductions down the line.