Everything you Need to Know About US Business Taxes
How do you keep more of what you make?
How do taxes impact our business structure?
How do small businesses manage?
Solopreneurs are often confused by how to structure their business organization. We hear categories like LLC, S Corp, and C Corp and they wonder, “why can’t people just send me checks for the work I do?”
First, you CAN just accept money for the services you provide. That means it is counted as personal income, and you pay taxes on that personal income based on your total income.
In the US, we have seven tax brackets for most ordinary income: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent.
The U.S. has a progressive tax system, which means that as our income increases, the percentage of taxes we pay also increases.
Our personal tax filing status also impacts the percentage we pay for taxes. You have seen the boxes on your tax forms – are you legally single, married filing jointly, or qualifying widow(er), married filing separately, or head of household?
Here’s an example: Let’s say you are single. You made $100,000 in 2020, after deducting your expenses and everything else you can legally deduct.
The first $9,875 you make is taxed at 10%, so you pay $987.50 on that chunk of income.
Then for every dollar you make starting with dollar $9,876, up to $40,125, you are taxed at 12% on that amount. $40,125-$9,876= $30,249, so since you made $100,000 (above the $40,125), you are taxed at 12% on $30,249, which is $3,629.88.
For every dollar you make from $40,126 to $85,525, the tax rate jumps to 22%. $85,525-$40,126=$45,399. Multiply 22% by $45,399 and you pay $9,987.78 on that earned income.
For every dollar you make from $85,526 to $163,300 the tax rate is 24%. We assume you made $100,000. Subtract $85,526 from $100,000 and you get $14,474. Multiple that by 24% and you get $3,473.76.
The tax rate that identifies the percentage of tax you pay on the last dollar you make is called your marginal tax rate. In this case, your marginal tax rate is 24%. That does not mean that you are paying 24% of $100,000. That would be $24,000. You are not paying that.
Now, add up all of the numbers in bold. That is $18,078.92, equal to about an 18% total tax rate.
The highest tax bracket if you are single kicks in when you make over $518,401. That puts you in the highest income tax bracket, at 37%. You are taxed at 37% for every dollar over $518,401.
This prompts many solopreneurs and small business owners to wonder, should you incorporate your business? What do the numbers say?
The US corporate tax rate for 2020 is 21%, according to Deloitte. It was lowered in 2017, to align with other countries. 21% is a lot less than 37%!
However, you have to remember that US states also add in taxes on corporate income. Of the 44 states that tax corporate income, North Carolina is the lowest at 2.5%. Iowa is the highest at 12%. California is at 8.8%, and Delaware is at 8.7%. This is on top of the 21% federal corporate tax, so in Iowa the total is 33%.
Four of the states that are considered “friendly” to corporate taxation are Nevada, Ohio, Texas, and Washington impose gross receipts taxes instead of corporate income taxes. A gross receipts tax or gross excise tax is a tax on the total gross revenues of a company, regardless of the source of the revenue. A gross receipts tax is similar to a sales tax, but it is levied on the seller of goods or service consumers. Don’t be confused. It is still a tax.
South Dakota and Wyoming are the most corporate friendly states in the US. They are the only states that do not have either a corporate income or gross receipts tax.
Still, you might be wondering whether or not to incorporate, and if so, what kind? The best person to advise you is your accountant, who knows what you make and where you might benefit, and your lawyer, who can tell you what type of corporate structure to consider.
The biggest difference between C and S corporations is taxes. C corporations pay tax on their income, plus you pay tax on whatever income you receive as an owner or employee. This is called the double taxation of income. The income your organization makes is technically taxed twice on the same income. An S corporation doesn’t pay income tax. Instead, you and the other owners report the company revenue as personal income.
S Corp Taxes
The IRS tends to watch S Corp tax filings more than C Corps. Even though you’re not subjected to double taxation, S Corp taxes are more heavily scrutinized. If the IRS discovers a mistake, your S Corp status can be canceled.
C Corp Taxes
The double taxation is the biggest deterrent for C Corps. Your company’s revenue is taxed, and then you’re taxed again for personal returns. It means you’re losing money twice on the revenue you’ve earned. This is especially hurtful for smaller businesses that don’t have enough big profits. When you pay taxes at the corporate level, it cuts into your earnings.
C Corps also don’t allow tax write-offs for owners on their personal income tax returns. This is usually a step that’s taken to offset other income.
There is a lot to consider. Please talk with your accounting and legal advisors and make the right financial decisions for you and your business.