Navigating ecommerce business taxes in the U.S. can be daunting. There are several types of taxes, and they vary based on factors like your business structure and where you’ve chosen to incorporate. Learning the basics of business taxes is an important part of ensuring you can focus on what you do best — running your business.
This article covers everything you need to know to get started.
How are businesses taxed?
Every business is required to pay taxes. Your tax rate depends on the legal structure of your business, while how much you pay depends on factors like the structure of your business, how much you earn in personal income, and where you’ve chosen to incorporate.
We’ve outlined common business structures and their taxation below.
- Sole proprietorship: A sole proprietorship is the simplest and most common type of business legal structure. As an owner, you will assume all financial and legal obligations of your business, and report your business’ income on personal tax returns.
- Partnership: A partnership is formed when two or more people come together to run a business. Depending on the specifics of the business, partners can either assume all or some financial and legal obligations of their business and, in certain structures, offer limited liability protection to their partners. Like sole proprietorships, partners report their share of business income on personal tax returns.
- C-corporation: C-corporations, known commonly as corporations, are separate legal entities from their owners, and consist of shareholders, a board of governors, officers, directors, and employees. Corporations pay income tax on their profits. Corporations are taxed twice — first when the business makes a profit, and again when shareholders are paid dividends on their personal tax returns. This is known as double taxation.
- S-corporation: S-corporations are popular among business owners because they offer the same advantages as traditional corporations but with more tax flexibility. In an S-corporation, profits and certain losses can avoid corporate taxes and instead pass through to owners’ personal income tax.
- Limited Liability Company (LLC): Your LLC’s tax rate depends on whether you’ve chosen to operate as a sole proprietorship, a partnership, an S-corporation, or a C-corporation. LLC members must pay self-employment taxes, and in some states, must pay additional annual taxes to operate. However, if these structures are carefully set up, members can ensure that their profits and losses are passed through to their personal taxes.
Did you know?
In the early stages of your startup, it’s easy to make decisions that seem like they’ll save you time and money, like paying for business expenses with personal bank accounts or neglecting to set up payroll systems because your team is too small. However, some of these decisions can be costly in the long run.
Pilot covers five common financial pitfalls that all startups should avoid, along with tips on how to navigate the complexities that lead to these mistakes.
What types of business tax do I pay?
We’ve outlined six types of taxes you’ll likely have to pay as an online business owner. This list is not exhaustive — depending on your business, there are many more business taxes that may also apply.
Income tax
Income tax covers federal and state taxes, as applicable. While LLCs, partnerships, S-corporations, and sole proprietorships do not pay income tax as businesses, their owners still pay tax on the income they take home from their businesses at their individual tax rate.
- For example, if you make $50K a year from your business, you will fall into the $38,701 to $82,500 income tax bracket. You’ll be taxed $4,453.50 plus 22% of your income over $38,700. By adding the $4,453.50 base fee plus $2,486 (22% of $11,300), your income tax will be $6,939.
Self-employment tax
Self-employment tax covers social security and Medicare and applies to businesses profiting more than $400 annually.
- To calculate your liability amount, multiply your business income (after expenses) by the amount subject to self-employment tax, 92.35% (0.9235), then multiply this number by the self-employment tax rate, 15.3% (0.153).
Payroll tax
If you are an employer, you’ll have to pay payroll tax. Payroll tax covers federal income tax withholding, social security and Medicare taxes, and federal and state unemployment taxes. These taxes are paid at a rate of 7.5% of your employees’ wages.
Capital gains tax
You will pay capital gains taxes on any profit you might make off selling your business assets. Rates vary depending on whether assets are categorized as short or long-term.
Sales tax
Sales taxes on businesses are determined by factors like the state you’ve chosen to incorporate in and where you warehouse your goods. In most states, if you sell taxable products or services to customers, you’re required to pay sales taxes.
Dividend tax
Dividend tax covers the investments made by a business. Since dividends are considered income, they are either taxed according to the owner’s tax bracket or the corporate tax rate, depending on the company’s structure.
How to file taxes as a business owner
As a business owner, you are required to make payments throughout the year to various local, state, and federal tax authorities. Stay on top of your records, know what details you need for different forms, and be cognizant of deadlines. These steps will help make paying these taxes easier — plus, your bank account will thank you in the long term.
We’ve outlined the steps you need to follow below.
1. Collect your records
Before filling out any tax forms, you’ll need to collect and organize records summarizing your tax year transactions (January 1–December 31). Complete records will reflect your business earnings, the expenses you can deduct, and the tax credits you may be eligible to claim. All of this information can save you money.
You’ll also need:
- Last year’s tax returns (if applicable)
- Your Employer Identification Number (EIN)
- Your Social Security Number (SSN)
- Financial statements (balance sheet and income statement)
- Receipts (required to account for business expenses)
2. Find the right form(s)
While Form 1040 is the standard tax return for most personal income tax purposes, business owners have a host of new income tax returns to remember. Additionally, don't forget about using Form 1040-ES to make your quarterly estimated tax payments. Most business owners are required to pay estimated income and self-employment taxes throughout the year.
The forms used by the most common structures include:
- Sole proprietors: Owners file their personal income tax return (Form 1040) using the Schedule C (Profit or Loss from Business) and Schedule SE (Self-employment tax) attachments.
- C-corporations: Owners file a personal income tax return and use Form 1120 for business taxes.
- S-corporations: Owners file a personal income tax return and use Form 1120S for business taxes.
- LLCs: Owners can file in a few ways:
- Single-owner LCCs: Owners file their personal income tax return (Form 1040) using the Schedule C and Schedule SE attachments
- Co-owned LLCs: Owners do not pay separate business incomes taxes unless they choose to file as corporations, but must file a personal income tax return and Form 1065 (Return of Partnership Income) for information purposes.
- LLCs that elect to be C-corporations: Owners file their personal income tax return and a Form 1120 for the business.
- LLCs that elect to be S-corporations: Owners file a Form 1120S.
3. Fill out the tax form(s)
Most businesses report earnings on the Schedule C form, which subtracts expenses from business earnings to arrive at a number that determines your net profit or loss. Once you have this number, you can transfer it to your personal income tax form and include it with all other personal income tax items. Forms can be found on the IRS website or through a tax software.
4. Be hyper-aware of tax deadlines
The types of taxes you pay are just as important as when you pay them. However, the number of unique tax obligations for business owners can make it easy to miss a tax filing or due payment. A comprehensive calendar of the tax year’s deadlines can help avoid penalties.
These deadlines are a key difference between individual and business taxes. While most individuals pay taxes once a year on a date set by the IRS, most business owners pay estimated income and self-employment taxes throughout the year. For example, business owners must make quarterly estimated tax payments on January 15, April 15, June 15, and September 15. If you have employees, you might also be responsible for monthly payroll tax filings.
How much does the average business pay in taxes?
Owners of pass-through entities pay personal tax rates on their self-employment income, which range from 10–39.6%. This sum does not include self-employment, payroll, property, dividend, and capital gains taxes. If you are the owner of a corporation, you may also incur special corporate tax rates on income, which vary just like personal tax rates.
Generally, the more money your business generates, the higher the tax rate will be. If you own a corporation, corporate taxes paid to the federal government will not necessarily be your total corporate income tax liability. A number of U.S. tax credits exist to help small businesses reduce the amount of taxes they owe or to receive the largest refund possible.
How much should a business set aside for taxes?
You should regularly set aside 30–40% of your income in a separate business account for budgeting to cover federal and state taxes. This amount may be more than you end up using, but it’s best to overestimate until you’ve established a routine for paying taxes. This routine will let you accommodate changes, like the annual adjustments the IRS publishes for the business tax rate.
Tax deduction tips for business owners
There are a few ways to save money on taxes as a business owner, including business deductions. The key to claiming business deductions is good bookkeeping. Record every business expense, and save and organize your receipts. The IRS often requires proof that you actually qualify for the write-offs you are claiming.
There are many deductions available to businesses come tax season, including:
Business write-offs
- Vehicle expenses
- Wages
- Business travel
- Contract labor (i.e. hiring freelancers and independent contractors)
- Supplies and equipment
- Depreciation of assets
- 50 percent of business-related meals and entertainment
- Rent and utilities on business properties (even if you work from home)
- Insurance (i.e. property, business, health insurance, etc.)
- Repairs
- Other out-of-pocket expenses
Qualified business income write-off
- Sole proprietors and S-corporations can deduct 20% of their business’ net income from their taxable income.
Startup cost write-off
- Businesses can deduct up to $5,000 used to get their companies off the ground.
Another way to save money on taxes is to keep up with your tax deadlines. You can avoid interest or penalties paid on those amounts by paying estimated taxes quarterly.
Don’t forget to use the many resources available to you along the way, from high-quality business tax software to tax professionals. If you take the steps to ensure that you understand the business tax framework, the various rates involved, and the many deadlines they require, your business will be one step closer to success.
Mercury