business income tax federal state

The United States has a multi-level income tax system whereby taxes are imposed on people who are filing for a business by federal, state, and local governments. The amount of both federal and state income taxes due is determined by applying a tax rate to the business’s taxable income. These rates differ between federal and state and also from state to state.

Federal income taxes are progressive; the higher the income, usually the adjusted gross income (AGI), the higher the tax. Most states also have progressive taxes, although some have a flat rate. Lets take a quick look at only the state level income taxes across of the country (2016).

Top Marginal Income Tax By State

Top_State_Marginal_Tax_Rates

As you can see, if you are lucky enough to live in one of the following states: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming there is no income tax at all. While New Hampshire and Tennessee only tax interest and dividends only (no ordinary income). Not bad at all. For those of you in states with high state income taxes it may sound appealing to move to state where you pay 0% in income taxes. Think about the savings if you are in a high income state and you re-establish your business in a 0% income state. As a valid example, you are talking up to 13.3% increase in profit just from going from California to Texas or FL. This is just simple income for your individual taxes but the benefits are significant.

Look at the taxes in California, Oregon, Minnesota New York and New Jersey. We can give Hawaii an honorable mention but hey at least you are living in Hawaii!

Other Business Taxes

The IRS collects two additional types of business taxes:

  1. Employment taxes including FICA taxes (Social Security and Medicare), federal unemployment tax (FUTA), and the taxes a business withholds from its employees’ pay.
  2. Self-employment taxes for those persons who are self-employed, work as independent contractors, or are owners, shareholders, or partners in a pass-through business like a sole proprietorship, partnership, Limited Liability Company (LLC), or Subchapter S corporation.
  3. There is another business tax that may do not consider and often misunderstood. The dreaded local tax on income. There are cities across the country that will charge you for working in their city even if you do not directly live there. There is a range depending on the city. An example is if you work in Kansas City or St. Louis, Missouri you must pay a 1% “earnings tax” on top of your federal and state taxes. Note this is based on your pre-tax income. So if you made $100,000 that would be equal to $1,000 straight to the local government.
  4. Remember as a business owner you are responsible for your share of taxes as well and you should consult an accountant to determine the impact on your business.

On top of the federal and state taxes you also need to consider FICA, FUTA, and business withholdings as an employer. Take a long look at the right business structure for you as it can also determine your liability and have a significant impact on your taxes. Various states collect various additional business taxes such as franchise taxes, alternative minimum taxes (AMTs), and employment taxes like unemployment insurance, state disability insurance, and/or employee training taxes.

Which Taxes Your Business Pays

Pass Through active Shareholders

Now take a look at this graphic from the Tax Foundation. It shows how different structures of businesses are taxed different by state. You can see the various range from ~48.9% in California to a tie at 39.6% for various states that also offer no income tax (FL, TX, AL). The lesson to learn is that the type of business you are and the state in which you are located determines which business taxes you will pay.

A pass-through business does not pay its own income taxes. They are, however, required to file an annual informational tax return using their own Employer Identification Number (EIN). Your business can apply for an EIN from the IRS or use a third-party provider like Gov Doc Filing that often simplifies and expedites the process.

A pass-through business entity’s income taxes are recorded and paid by its owners, shareholders, or partners via a Schedule C attached to their individual tax return. It also impacts your tax refund.