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How is business income tax calculated?
The method for calculating business income tax is primarily determined by your specific business entity.
Pass-through entities—including sole proprietorships, partnerships, single-member LLCs, multi-member LLCs, and S corporations—are taxed at individual income tax rates.
When determining your tax liability, avoid the mistake of simply multiplying your total income by your highest tax rate. The IRS utilizes an incremental tax system, meaning each rate only applies to the specific portion of income that falls within that designated bracket.
For instance, consider a sole proprietor with $55,000 in taxable income:
- How is self-employment tax calculated?
- Excise tax: Levied on specific products such as tobacco, fuel, or alcohol.
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Employment tax: Required for businesses that hire employees.
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Local tax: Some states allow cities or counties to impose local income taxes. States with such provisions include Alabama, Delaware, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan, Missouri, New Jersey, New York, Ohio, Oregon, Pennsylvania, and West Virginia.
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April 15
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June 15
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September 15
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December 15
Business owners (excluding those in S and C corporations) who earn at least $400 must pay self-employment tax to fund Social Security and Medicare.
This tax is calculated at a steady rate of 15.3%, applied to 92.35% of your self-employment income.
To illustrate, a sole proprietor earning $55,000 in taxable income would pay self-employment tax on $50,792.50 (calculated as $55,000 x 0.9235). This results in a total tax owed of $7,771.25 ($50,792.50 x 0.153).
Additionally, single filers earning over $200,000 are subject to an extra 0.9% Medicare tax. For married business owners filing jointly, this threshold is $250,000.
What other taxes may apply?
The calculations mentioned above do not encompass all potential business tax liabilities, which vary based on your industry and location.
Common additional taxes include:
- Sales tax: Applicable to retail businesses selling physical goods.
A comprehensive small-business tax guide can help identify specific requirements, filing deadlines, and necessary documentation.
Are taxes paid in a single annual payment?
No. The IRS operates on a “pay-as-you-go” system, requiring most businesses to make multiple federal income tax payments throughout the year.
Most entities follow a quarterly schedule. For sole proprietorships, partnerships, LLCs, and S corporations, payments are generally due on:
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How can you estimate quarterly tax payments?
A simple method is to divide your previous year’s total tax liability by four, a process aided by IRS Form 1040-ES.
Alternatively, you can estimate your liability based on the current quarter’s earnings. Consulting with an accountant is recommended for accurate estimations.
Strategies to reduce tax liability
One of the most effective ways to lower your tax burden is by deducting legitimate business expenses to reduce your overall taxable income.
It is vital to coordinate your deduction strategy with a professional accountant to ensure you are maintaining the necessary documentation to support your write-offs.
You may also benefit from business tax credits. Unlike deductions, which lower taxable income, credits reduce your actual tax bill dollar-for-dollar. Examples include credits for pension plan startup costs, paid family and medical leave, and certain employee tip-related taxes.
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About the author
Hillary Crawford is a small-business writer at NerdWallet, specializing in business software products. Her background includes roles as a news writer and associate West Coast editor at Bustle Digital Group, where she covered technology and news. Her journalism has been featured in The Associated Press, The Washington Post, Yahoo Finance, and Entrepreneur. She is based in Traverse City, Michigan.
