Owning a small business requires courage and resilience. As Chief Everything Officer, you must handle everything from managing staff and customer satisfaction to tax submission. Tax season can feel like an overwhelming stretch on uncharted waters, even more so when all you want to do is focus on growing your business.
In this article, we will cover the federal, state and local taxes that small businesses must pay and discuss the different deductions and credits for which small businesses may be eligible.
Start with an EIN
An employment identification number (EIN) is often referred to as a federal tax identification number (FTIN). Assigned by the Internal Revenue Service (IRS), it's a unique nine-digit number that identifies your business — it's kind of like your business's Social Security number.
Applying for an EIN is free and relatively simple through the IRS website.
Types of small business taxes
Small businesses may have to pay different federal, state and local taxes, including the following.
Federal tax
Income tax
Incomes tax is the government's share of your business profits.
- In sole proprietorships and partnerships, the profit is passed through to the individual partners, and they are taxed on it individually.
- C corporations pay corporate income tax on their profits, regardless of whether the profits are distributed to shareholders.
- In S corporations, an information return is filed instead of an income return, as the profits pass through to the owner's tax returns.
Self-employment tax
If you're self-employed (a sole proprietor or partner), you're responsible for paying Social Security and Medicare taxes, similar to what traditional employees have withheld from their paychecks.
Employment tax
Any business that pays employees is subject to employment taxes. Employment taxes include the federal income tax that's withheld from the employee's wages and their Social Security and Medicare taxes. The employee and the employer each pay a matching portion of these taxes.
Employers also pay the Federal Unemployment Tax Act(FUTA) tax for their employees. This tax is paid from the employer's fund, is separate from federal, Social Security and Medicare taxes and isn't withheld from the employee's paycheck.
Excise tax
Companies that produce or sell certain types of products may be subject to an excise tax. Excise tax targets specific items like tobacco products, alcoholic beverages, fuels, vaccines, transportation services, etc. It can be levied to generate substantial revenue for the government or discourage people from buying certain items such as tobacco and alcohol products.
Other state and local taxes
While federal taxes provide a national framework, state and local tax landscapes vary significantly across regions. Here are some common state and local taxes you might encounter as a small business owner:
State sales tax
Except for Alaska, Delaware, Montana, New Hampshire and Oregon, every state imposes sales tax on businesses. If you sell taxable goods or services, you'll likely be required to collect and remit sales tax to your state. This tax is added to the sale price of goods and services and is paid by the consumer.
State income tax
Most states levy income or franchise tax on businesses operating within their borders. It's similar to the federal income tax but is applied at the state level and based on the net profits of your business. Tax rates can vary significantly depending on the state and can range from a flat rate to a graduated scale based on income level.
Local property tax
Just like individuals, businesses are subject to property tax on the state and local levels for owning buildings, land or other real estate. You might also have to pay taxes for owning tangible property such as heavy machinery, office equipment or inventory.
Tax deductions and credits for small businesses
Tax deductions and credits can be your golden ticket to reducing the tax burden as a small business owner. Among those deductions are the following.
Business expenses
Ordinary and necessary expenses used to operate the business are generally deductible. These expenses include office rent; utilities such as electricity, internet and water; office supplies; equipment and software used in business operations; marketing and advertising expenses; and salaries, bonuses and employee health insurance.
Home office deduction
A dedicated workspace in your home, used regularly and exclusively for business purposes, can qualify for a deduction on a portion of your rent or mortgage, utilities and even internet expenses.
Credits
Tax credits are dollar-for-dollar reductions in the amount of tax you owe, offering a more direct benefit than deductions. Some of the critical credits include Employee Retention Credit (ERC), Work Opportunity Tax Credit (WOTC), Research and Development (R&D) credits and Disabled Access Credit.
Keeping track: The importance of records
Meticulous record-keeping allows you to approach filing with confidence. Good records bring peace of mind and streamline the tax filing process. Hold onto receipts for all business purchases, from office supplies to marketing campaigns. Invoices provide additional details to verify more significant expenses.
Maintain records of employee wages, benefits and payroll taxes withheld. Document your business income and expenses flowing through bank accounts. This documentation is crucial for filing payroll tax forms and ensuring employee tax compliance.
Simplify your tax journey
Gallagher is committed to empowering small business owners with the knowledge and resources they need to thrive. Our team of experts is dedicated to providing personalized guidance on your business insurance needs. Consult your Gallagher Small Business Insurance advisor to learn more about how we can protect your business and help you achieve long-term success.
In the meantime, you can read the IRS Tax Guide for Small Business* to learn more.
Source
*"Tax Guide for Small Business," Internal Revenue Service, 2 Feb 2024. PDF file.
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