Understanding Business Tax Rates By Entity Type
Understanding taxes as a new business owner can feel like learning a new language.
There are complicated rules, and they apply differently to businesses based on entity type, size, and a number of other variables. The good news is that, like a new language, it is possible to pick up enough basic tax knowledge to get by on a day-to-day basis and ensure your business is tax compliant.
A good place to start is to learn how business tax rates apply to different business entity types. If you are still in the beginning stages, this information may help you choose which entity type is best for your business and goals. If you have already established your business’ entity type, this will help you understand your tax responsibilities.
Here is a summary of 5 tax rate scenarios based on entity type, and the important facts to keep in mind about each.
C corporations are the only entities that pay corporate income taxes. If your business is a C corporation, you will pay a flat 21%income tax rate. C corporations are also subject to “double taxation.” This means that even though they’re taxed at a corporate level, all shareholders still have to pay income tax on any profits they make on their individual returns.
While this double taxation may seem like a disadvantage, the benefits of being a C corporation — such as having unlimited shareholders, access to limited liability, and the ability to go public — often make up for the tax obligations.
An alternative to the double-taxed C corporation entity is a “pass-through” entity in which the business does not pay any taxes, and any profits or losses are passed along to shareholders — who either pay the taxes, or deduct the losses from their individual returns. With anA specific example is the S corporation, which is popular for startups and small businesses,. In this case, the tax rate depends on each person’s individual’s net income. While this entity type is limited to a maximum of 100 shareholders, the vast majority — 97% of S corporations — have fewer than three.
A partnership is another pass-through option, which refers to a businesses owned by several individuals. In a partnership, any business profits (or losses) are passed along to the owners based on their share in the company. Each owner then files their income on their individual tax returns and are taxed based on their net income
If you are one person running a small business and have not registered as one of the previous entities, you have probably defaulted to sole proprietorship. In this case, there is only one owner, and all of the business’ profits and losses are included in that person’s individual return — which is taxed at a rate based on their net income.
The final entity type is an LLC, or Limited Liability Company. For tax purposes, an LLC is much like an S corporation. Profits and losses are passed along to shareholders who file them with their individual returns and are taxed, once again, based on their individual net incomes. However, LLCs can actually register as S corporations, partnerships, or even sole proprietorships.
No matter what entity type your company is, there are some common requirements for all businesses: good record keeping, a working knowledge of what needs to be tracked, and clear agreements when there are partners or shareholders involved. When finishing your taxes, you will want to partner with a qualified CPA to ensure your tax return is done by the book.
For advice on legal tax matters or reducing your risk of a tax audit, seek legal guidance from a professional tax attorney.
For more details about business tax rates or any other tax questions, book a free consultation with San Diego’s top tax attorneys at Milikowsky Tax Law.
The information contained on our website and in blogs is provided for information purposes only and does not constitute legal advice.