Types of taxes in the United States
"Taxes are the price we pay for a civilized society", said U.S. Supreme Court Justice Oliver Wendell Holmes. Whether you agree with this statement or not, it’s no secret that Americans do pay quite a lot of tax, around 25% of their income goes to Uncle Sam if they earn between $37,950 and $91,900.
You might know which taxes you have to pay personally, but it’s a whole other ball game when it comes to the taxes you have to file as a business owner. These come in several varieties: federal, state, and local. Not every company pays the same types of taxes because it depends on what services or products they offer. With so many different taxes, you’d be forgiven for being a little confused: this article aims to cover the basics of businesses taxes so you have more of an idea of which apply to you.
The most important taxes for businesses
You might have an idea of how personal taxes work, but it’s a very different story when it comes to business tax. Single entry accounting and double entry accounting form the basis for taxation. They record all operating incomes and operating expenses that the tax office needs in order to work out whether the company is paying its taxes correctly. The amount of income tax a company pays, depends on how much profit is made. These are the basic types of taxes you have to pay as a business owner:
- Income tax
- Employment tax
- Property tax
- Excise tax
- Sales and use tax
- Estimated tax
- Self-employment tax
- Gross receipts tax (in some states)
- Franchise tax (in some states)
All businesses (except partnerships) must file and pay taxes on any income earned or received during the year. Practically every state imposes a business or corporate income tax although it differs from state to state. This article on state corporate income tax rates goes into more detail about taxing in the different states. Partnerships, on the other hand, must file an annual information return so they can report income, gains, losses, and other important tax information.
If people work for you, there are federal tax requirements that you have to stick to regarding what you pay the government and which forms need filing. Social Security and Medicare taxes must come out of the employees’ paychecks as well as federal income tax withholding, and federal unemployment (FUTA) tax. In each state, it’s mandatory that companies also pay compensation insurance for their workers and unemployment insurance taxes.
Not all of the states think the same when it comes to what property is taxable. Some states collect property tax from businesses in commercial real estate locations whereas others also collect tax for assets used by the business e.g. IT equipment and vehicles. The IRS website tells you everything you need to know about property taxes in your state.
Excise tax is also known as sin tax and is usually imposed on products or services that are deemed unhealthy for people or the environment e.g. tobacco and gasoline. If you sell a product or service that falls into this category, you have to collect and pay excise tax to the relevant federal and state authorities. The two agencies of the federal government that regulate excise taxes are the Internal Revenue Service & Alcohol and Tobacco Tax and Trade Bureau (TTB).
Sales and use tax
Some states charge tax on the sale of good and services, but there are some exceptions such as if your company sells clothing, medicine, food, etc. Sales tax is a consumable tax placed on retail sales, leases, or rentals. Use tax comes into effect in relation to the sales tax and is applied when goods are purchased from other states. There are only five states that don’t impose a sales tax and use tax together.
Federal tax needs to be paid on income that is not subject to withholding or when the amount of your federal income tax that’s being withheld isn’t enough. This can include income from self-employment, business earnings, interest, rent, dividends, and other sources. Estimated tax is not only used to pay income tax, but other taxes such as self-employment tax and alternative minimum tax.
As a business owner, you have to pay Social Security and Medicare taxes to be covered under the Social Security system. Those self-employed are taxed on their net income rather than their gross income, like most employees. Several businesses expenses can be deducted against income e.g. money spent on advertising, equipment, and office supplies. Read our article on tax tips for the self-employed for more detailed information on the matter.
Gross receipts tax
Gross receipts taxes might look like sales taxes, but they actually tax the sellers, rather than the retail buyers. This tax is a state tax applied to a business’ gross receipts (sales) and is sometimes imposed instead of a corporate income tax or a sales tax.
This is a tax levied at state level against businesses and partnerships within the state. It could be that some companies are liable for the tax even if they do business in another state. The amount of franchise tax depends on the tax rules within each state with some calculating the amount based on assets or net worth, and some based on the company’s capital stock.
What happens if a business does not file its taxes correctly?
Taxes are something that shouldn’t be taken lightly. All businesses must file tax returns on Form 1120 with the IRS even if the owner believes that no taxes are owed. You could expect a late penalty for returns filed more than 60 days late. In this circumstance, the minimum penalty has increased from $135 to $205 or the amount of tax owned, whichever is smaller.
If the IRS decides that your business needs to pay taxes that you didn’t know about, you could be subject to late-filing and late-payment penalties and maybe even be charged interest. You could also be prevented from using the company’s new operating loss on your tax return since this loss needs to be reported on a filed 1120, which it won’t be if you abstain from filing taxes.