How Much Can Your Small Business Make Before Paying Taxes?
This is a very complex question. For one, the answer varies from state to state. Second, it depends on the type of entity you use for your business. Third, different types of businesses are eligible for different kinds of deductions against their taxable income.
Most small business are owned by one individual or within a family unit. With a few exceptions, this makes them eligible for pass through tax treatment. In other words, business income gets taxed only once as long as you do business as an S-Corp, partnership or sole proprietorship.
To an individual business owner, any income that exceeds the standard deduction from taxable income, is taxed to the owner. So the standard deduction itself is very important in determining how much you can earn before paying taxes. As the simplest rule of thumb, the standard deduction is the amount you can earn before paying taxes on your small business, but this rule has many exceptions.
Effective Tax Rates for Small Business Owners
On average today, the Small Business Administration estimates the effective tax rate for small business owners is approximately 20% of taxable income. Due to available deductions,
SBA estimates show effective rates of 13.3 percent for sole proprietorships, 23.6 percent for partnerships, and 26.9 percent for S-corporations. This is probably a reflection of the reality that as businesses make more money, they tend to form more sophisticated business entities, so the very small company will naturally pay less in taxes.
However, sole proprietors are also taxed on “self-employment” income at 15.3% of their income from self-employment. S corporations are exempted from this tax for income distributions and dividends, but there is tax exposure for what the IRS considers to be ordinary, earned income in the business. Many advisors thus recommend that a
A tax advisor may be able to help you with all of the factors involved in estimating your taxes and when you will start having to pay. There are also tools and calculators available online from resources like, the TurboTax Taxcaster that can estimate them for you.
The Qualified Business Income Deduction
Think of this deduction as a bit of a gift from the IRS, if there is such a thing, for your small business. If you qualify for the Qualified Business Income Deduction, or QBID, you can use it to your advantage and essentially reduce your taxable income by 20%. Unfortunately there are many exceptions of businesses that do not qualify for the deduction, so take care to be sure, you are qualified in your own business.
The deduction is not calculated on your Schedule C, 1120S or other form of tax return. The deduction actually goes directly onto your 1040, which can be a little confusing. The tradeoff is that, in general any income that qualifies for the QBID must be self-employment income, subject to the 15.3% tax on that income. While this might seem like it leaves you with only a net, 4.7% deduction, if you are already earning self-employment income you would pay taxes on anyway, you are actually receiving the full benefit of the 20% deduction.
Eligibility for the deduction, as mentioned above, is dependent on the type of business you operate as well as level of business income you earn. The small business must be a “pass-through” tax entity and C-corps do not qualify for the QBID. There are separate forms you must file in order to qualify for the QBID, so you should consult your tax advisor to ensure it’s dome properly and you receive the full benefit of the deduction you are entitled to.
As you decide what kind of business entity you want to have, Landmark Legal Services, can help guide you through the maze of regulations, filing requirements and governance issues you will face. Landmark is a full service provider of business legal services, affiliated with Landmark Advisors, an advisor to investors, owners, buyers and sellers of small businesses like yours. To get started answering all the questions you have, schedule a Zoom consultation with one of Landmark’s team of experts today.