Figuring out how much federal tax you owe is so complicated, most small business owners ask a CPA to do it for them.
But even if you work with a CPA, it’s still worth knowing the mysterious art of calculating your own taxes. You’ll be able to plan ahead, save money on CPA billable hours, and never enter tax season blind.
We’ll guide you through the tax calculation process, according to your 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 small business owes starts with determining 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%. If your business is not a C corporation (aka a flow-through entity), your tax rate will depend on your taxable income and your filing status.
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.
Here are the 2018 individual tax brackets, according to the finance site NerdWallet:
If you’re single and:
|Your income is…||Your tax will be…|
|$0-$9,525||10% of taxable income|
|$9,526-$38,700||$952.50 + 12% of the amount over $9,525|
|$38,701-$82,500||$4,453.50 + 22% of the amount over $38,700|
|$82,501-$157,500||$14,089.50 + 24% of the amount over $82,500|
|$157,501-$200,000||$32,089.50 + 32% of the amount over $157,500|
|$200,001-$500,000||$45,689.50 + 35% of the amount over $200,000|
|Over $500,000||$161,379 + 37% of the amount over $600,000|
If you’re married and file a joint income tax return with your spouse and:
|Your income is…||Your tax will be…|
|$0-$19,050||10% of taxable income|
|$19,051-$77,400||$1,905 + 12% of the amount over $19,050|
|$77,401-$165,000||$8,907 + 22% of the amount over $77,400|
|$165,001-$315,000||$28,179 + 24% of the amount over $165,000|
|$315,001-$400,000||$64,179 + 32% of the amount over $315,000|
|$400,001-$600,000||$91,379 + 35% of the amount over $400,000|
|Over $600,000||$161,379 + 37% of the amount over $600,000|
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:
$28,179 + 24% of the amount over $165,000 (or $32,400).
The calculation: $28,179 + $32,400 = $60,579 total tax due for our friend Wally.
Reduce your taxes with credits and deductions
Of course, 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. Our recent article, A Strategic Guide to Maximizing Your Small Business Tax Return, explains these tax breaks in more detail.
Making estimated tax payments
Many business owners think that the income tax payment deadline is on “tax day,” which typically 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 $128,700 (for 2018). 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.