Most small business owners pay taxes on their business income at the personal income tax rates, which range from 10% to 37%. But if you operate as a C corporation, you’ll pay a flat 21% tax on your business income.
Several variables, such as your business structure and where you operate, are likely to determine your actual tax rate.
The first variable to take into account is the type of entity you’re running. If you’re not operating as an S or C corporation, you’ll have to pay the self-employment tax, which is an additional 15.3% that’s tacked onto the regular tax rate.
Location, location, location is the rule in real estate, and it applies to taxes too. Most states tax income of some kind. Some cities (in more than a dozen of the states) do too. Rates vary by place and income level.
Whenever you hire an employee, the new hire will trigger employer taxes, which come to a grand total of 13.65% of the employee’s gross pay. The employer pays all of it; the taxes aren’t withheld from employees’ wages.
The taxes you owe as a retailer depend in part on what exactly you sell. Retailers may owe sales tax; for fuel, tobacco, and alcohol, there may also be excise taxes. Tax rates vary by state and by product.
Your Federal Tax Rate as a Business Owner
The type of entity you’re operating will determine your federal tax rate as a business owner. If you run an S corp or another pass-through business, you’ll pay the personal rates, which range from 10% to 37%. For a C corp, the tax rate is a flat 21%.
There are a variety of pass-through businesses, including:
- Any sole proprietorship counts as a pass-through business.
- Partnerships work as pass-through businesses too.
- S corporations pass through to their shareholders, just like partnerships do.
- As long as your LLC hasn’t opted to file taxes as a C corp, then the personal rate applies for federal tax purposes.
A pass-through business is called that because its income “passes through” to the owner’s personal tax return.
One common misconception about the IRS tax rates is that your bracket’s rate is charged on every dollar you earn. It isn’t. It’s a progressive system.
Imagine the tax brackets as buckets. Your income fills the buckets one by one. Say the lowest tax rate is 10%. You won’t pay 10% of every dollar you earn, just the dollars you make up to the top of that bucket’s limit.
The IRS’ 10% tax rate applies to the first $12,400 of taxable income. That can include your pass-through business income. From $12,401 to $50,400, your tax rate is 12%.
Say you’re a sole proprietor, you’re single, and after deductions you earn $150,000.
You pay the 10% bracket only on the first $12,400 you earn, so that’s $1,240 in taxes for a pass-through business owner.
Any income in the $12,401 to $50,400 range gets taxed at 12%. You earn $150,000, but only $38,000 falls into this bracket. That comes out to a tax bill of $4,560 on your pass-through income.
The next bucket is the 22% bracket. The cap for this bracket is $105,700, so the tax owed here is 22% of $55,300 ($105,700 minus $50,400). That’s another $12,166 due in taxes.
Your remaining income, from $105,701 to $150,000, lands you in the 24% bracket. The amount of income in this bracket is $44,300, which will cost you $10,632 in taxes.
Your total tax bill for $150,000 in income is $1,240 + $4,560 + $12,166 + $10,632, or $28,598.
Common Write-offs
Deductions shrink the amount of taxable income, so the right ones could drop you down into a lower bracket.
A lot of small business owners miss common write-offs, which may be easy to overlook when tax time rolls around. The home office deduction is a popular one, and vehicle and travel expenses count here too.
One caveat here is that for anything you deduct, you’ll need proof.
Saleh helps clients sort through IRS audits. When it comes to deductions, the bottom line is that everything should make sense.
To support your deductions, your business records should line up with the paperwork. Bank and card statements aren’t enough on their own.
If you deduct vehicle expenses, changing the oil at the beginning and end of the year is a good way to keep track of your miles. Make sure you keep the service records, since they’ll show the odometer readings.
Another way to lower your taxes is available to some LLCs and sole proprietors. If you qualify, then you may elect S corporation status, which eliminates the 15.3% self-employment tax. But it also adds a layer of complexity to your finances and tax situation.
Watch out if you’re electing S corp status. Many owners don’t follow the rules correctly, and that can lead to trouble with the IRS.
A common pitfall with S corporations is that owners don’t pay themselves reasonable compensation. Unfortunately, the IRS doesn’t give a specific definition for “reasonable,” so mistakes can happen, which may bring penalties.
Even if you have no idea how to reduce your taxable income, it’s better not to wait until the last moment. Talk with a tax adviser before the start of filing season about legal ways to decrease your taxable income, and put a plan in place.
According to Standberry, it’s best to make tax moves before December 31 so you have time to map out a strategy.
It’s always a good idea to work with your accountant to identify potential deductions and stay on top of the tax code year round. You don’t have to be an expert, but you do have to be involved.
Marginal Tax Rate and an Effective Tax Rate
If you’ve ever had an argument with a friend about how much tax you both owe, then it may have boiled down to the distinction between a marginal tax rate and an effective tax rate. Your marginal rate is the highest rate of tax applied to your income; your effective rate is the share of your total income that you actually pay in tax.
When CPAs work to cut your tax bill, they focus on the marginal rate.
Target deductions that can be used to cut taxable income that’s taxed at your top bracket. If you’re in the 37% bracket, every dollar you cut saves you 37 cents.
Still, knowing the effective rate does give you a sense of how much the government is actually taking in taxes on your income.
Having a real-world estimate of what you should set aside for taxes is one thing, but this number is also helpful when it comes to budgeting and financial planning.
If your business is earning roughly the same amount now as it did last year, you can apply your previous year’s effective tax rate to your current quarter to figure your estimates. Don’t forget to check with Form 1040-ES, which you can use to double-check your estimates.
To figure your effective tax rate, divide your total federal income tax by your taxable income.
Remember our single sole proprietor who earns $150,000? In 2026 the 24% bracket covers income from $105,701 to $201,775, so the marginal rate is still 24%.
If you divide the total tax bill, which is $28,598, by your taxable income, which is $150,000, you get a rough figure of 19%, which is your effective tax rate.
About Delancey Street
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