Your tax liability is just how much you owe in taxes. For individuals who are employed, it’s usually a simple matter of consulting the tax tables for the year, and calculating your income tax on Form 1040.
For those who are self-employed or run a business, it’s a bit more complicated.
In this article, we’ll guide you through the tax calculation process, according to your business entity type. We’ll just focus on federal tax, but you can calculate your state tax burden with a state tax calculator.
A 20-second summary of how to calculate your tax liability
Figuring out how much federal income tax your business owes starts with knowing your entity type. If yours is a C corporation, it will be taxed twice, at both the corporate and shareholder levels. Your income tax rate will be a flat 21%.
How to calculate tax liability from taxable income
Your taxable income minus your tax deductions equals your gross tax liability. Gross tax liability minus any tax credits you’re eligible for equals your total income tax liability.
But before you can start crunching numbers, you need to understand your entity type. That will affect how you calculate your taxes.
What’s your entity type?
There are many business “entity types” out there (C corp, partnership, sole prop, etc.). But for the purposes of figuring out how much tax your small business owes, there’s only C corporations, and everything else. If you’re not sure what your entity type is, ask your accountant. If you have a small operation, no accountant, and you’ve never thought about entity type before, chances are the government is automatically classifying you as a sole proprietor.
C corporations are the only type of business that pays corporate income taxes. If your business is not a C corp, then it’s known as a “flow-through” entity because profits and losses flow through the business to owners and shareholders, who pay taxes at their individual tax rates.
How to figure out your tax rate if you’re a C corp
The Tax Cuts and Jobs Act greatly simplified tax calculations for C corporations by replacing the graduated corporate tax rate schedule that included eight different tax rate brackets with a flat 21% tax rate.
In other words, if you own a C corporation, no matter how much taxable income your business has, your income tax rate will be 21%.
Double taxation for C corporations
With the way the tax system is structured, C corporations are taxed twice: at the corporate level and then again at the shareholder level when profits are distributed to owners as dividends. So if Charlie’s Chocolates Inc. distributed all or part of its $1 million in income to owners, the owners would have to pay taxes on it again when they file their individual tax returns.
One way for corporations to avoid this double taxation is to incorporate as an S corporation instead of a C corporation. S corporations are flow-through entities so income isn’t taxed at the corporate level. However, there are certain drawbacks to choosing S corporation status that may outweigh the tax savings. We recommend asking your CPA about this one.
How to figure out your tax rate if you’re not a C corp
If your business is not a C corporation, that means it’s a flow-through entity, meaning you’ll pay the taxes yourself, instead of the business paying them.
Your tax rate will depend on the amount of the business’ taxable income and your tax filing status.
If you’re single and:
|Your total taxable income is:||Your taxes are:|
|$0 - $9,700||10% of your taxable income|
|$9,701 - $39,475||$970 plus 12% of any income you made above $9,700|
|$39,476 - $84,200||$4,543.50 plus 22% of any income you made above $39,475|
|$84,201 - $160,725||$14,382.50 plus 24% of any income you made above $84,200|
|$160,7265 - $204,100||$32,748.50 plus 32% of any income you made above $160,725|
|$204,101 - $510,300||$46,628.50 plus 35% of any income you made above $204,100|
|$510,301+||$153,798.50 plus 37% of any income you made above $510,300|
If you’re married and file a joint income tax return with your spouse and:
|Your total taxable income is:||Your taxes are:|
|$0 - $19,400||10% of your taxable income|
|$19,401 - $78,950||$1,940 plus 12% of any income you made above $19,400|
|$78,951 - $168,400||$9,086 plus 22% of any income you made above $78,950|
|$168,401 - $321,450||$28,765 plus 24% of any income you made above $168,400|
|$321,451- $408,200||$65,497 plus 32% of any income you made above $321,450|
|$408,201 - $612,350||$93,257 plus 35% of any income you made above $408,200|
|$612,351+||$164,709.50 plus 37% of any income you made above $612,350|
An example makes this clearer
Let’s look at an example to see how a hypothetical flow-through entity would determine the amount of federal income tax it owes based on these tax tables. Suppose Wally’s Widgets ends up with taxable income of $300,000 in 2018, and that Wally files a joint tax return with his wife, Wendy.
Wally’s tax owed would be:
$28,765 + 24% of the amount over $168,400 (or $31,584).
The calculation: $28,765 + $31,584 = $60,349 total tax due for our friend Wally.
Reduce your taxes with credits and deductions
You may be able to reduce the amount of tax your business pays by taking advantage of targeted tax breaks, including both tax credits and deductions.
For tax deductions, you can choose to either itemize your deductions (add them all up) or take one standard deduction (a single lump deduction of $12,000 for single taxpayers, $18,000 for heads of households, or $24,000 for married filing jointly).
If you don’t have many deductions to claim, you’ll probably want to claim the standard deduction.
If you’ve got lots of deductions, you’ll probably want to itemize. To claim every deduction you possibly can, check out The Big List of Small Business Tax Deductions.
To see what tax credits you might qualify for, check out The Big List of U.S. Small Business Tax Credits.
Making estimated tax payments
Many business owners think that the income tax payment deadline is on “tax day,” which falls in mid-April. However, federal income taxes must be paid as they are incurred. This means that most small businesses must make estimated tax payments throughout the year based on an estimate of their total taxable income at the end of the year.
Further Reading: How to Calculate and Pay Estimated Quarterly Taxes
Paying employment taxes
In addition to income taxes, your small business may also have to pay employment taxes on wages paid to employees and yourself. This is true regardless of your entity type and whether or not you have employees. These taxes typically include the following:
Social Security tax: This equals 12.4% on wages paid up to $132,900 (for 2019). You will pay half of this for each employee and the other half will be deducted from their wages.
Medicare tax: This equals 2.9% of wages paid with no wage cap. Again, you will pay half of this for each employee.
Federal unemployment tax (or FUTA): This generally equals 6% of the first $7,000 of each employee’s wages. You may be able to reduce this by the amount of money you pay into your state’s unemployment fund, which can reduce your unemployment tax rate to just 0.6%.
While a portion of these taxes is actually paid by your employees, your business is responsible for withholding the money from their pay and passing it on to the IRS.
Note that if you’re a self-employed solo business owner, you will have to pay a self-employment tax. This is equal to the total amount of your Social Security and Medicare tax liabilities, since you don’t have a separate employer to pay half of the tax for you.
The next step: paying your taxes
Determining how much money your small business owes in taxes is just the first step. Once you’ve figured this out, you’ll need to actually pay the taxes. If you’re stressed about saving enough money to cover your next tax bill, we have a few ideas that will help.