Business Income Tax—How Does It Differ From Personal Income Tax?

Under U.S. tax law, both individuals and businesses must pay tax on earned income. The way in which personal and business income are taxed, however, is very different. Here we’ll look specifically at business income tax, who must pay it, how tax rates are determined, and how business income tax differs from personal income tax.

What is Business Income Tax?

Business income tax is assessed on all businesses, based on the annual reported earnings, profits, and losses for the business. Under U.S. law, businesses have to pay income tax, self-employment tax, employee payroll tax (if you have workers other than yourself), and local property tax (if you own land, buildings, etc.).

How Does a Small Business Pay Taxes?

If you own a business, you are responsible for filing tax returns for the enterprise. The type of form you use will depend on the nature of your business and your business structure.

  • Sole Proprietors (self-employed) — use Form 1040.
  • Pass-Through businesses (where business income is considered as the personal income of the proprietors) — use Form 1040
  • C Corporations — use Form 1120
  • S Corporations — use Form 1120S
  • Partnerships — use Form 1065 (information form)
  • Non-Profits — use Form 990 (information form)

Your business might be required to pay payroll taxes, sales and use taxes, and any other state or local taxes. As a business, you may also be required to file quarterly estimated income tax on Jan 15, April 15 June 15, and Sept 15. Lastly, be aware that some business tax filing requirements may include monthly filing of payroll taxes, while others have return filing deadlines in March, April, and May. Note that estimated personal quarterly taxes can be filed using Form 1040-ES.

How is Personal Income Tax Calculated?

In California, the Franchise Tax Board (FTB) is responsible for collecting income taxes. Just how much you will pay depends on a variety of factors including your filing status (single, married filing jointly, married filing separately, head of household or qualifying widower), your taxable income, and any qualified deductions and exemptions. The personal income tax brackets in California are progressive, which means the higher your adjusted gross income (AGI), the higher your tax rate. The personal tax rate in California varies between 1% and 12.3% of your AGI. Keep in mind that you do not have to be a resident of California to pay California state taxes.

How is Business Income Tax Calculated?

Small businesses are taxed depending on their structure. So, when your business was established, you chose a specific legal structure for your company. Each structure carries its own legal stipulations, as well as its own tax advantages.
In the state of California, many businesses are taxed based on gross receipts. For those business tax classifications, the tax rate is a specified amount per $1,000 of taxable gross receipts for each tax classification. Some business taxes are based on a flat rate per tax period and others are based on the number of vehicles, machines, devices or equipment used, the number of employees, square footage of the area, seating capacity, or the scale of fees collected. Laws vary by state, so check with an experienced business tax professional to fully understand the laws in your area.

Business Tax Offers More Opportunities for Deductions

If all this sounds like a lot of work, don’t panic—there is some good news. Depending on their structure, businesses possess a wider array of potential deductions than do personal filers.
Here are a few common types of deductions taken by small businesses…

  • Startup costs
  • Unreimbursed Personal Expenses incurred while conducting business.
  • Home Office Deduction (for those working from home)
  • Use of your personal vehicle for business (you may be able to write off some travel and auto expenses if you use your vehicle for work)
  • Salaries and benefits provided to employees, subject to certain requirements
  • Professional service fees
  • Depreciation

Section 199A Deductions
Remember to record all deductions and to keep copies of all receipts.

Don’t Forget About Employment Taxes

While not considered a business income tax, if you own a business and employ workers other than yourself, you’ll have to budget for employment tax. These taxes are in addition to the taxes you pay based on business income. Most common employment taxes include:

  • Social Security taxes: The Social Security tax rate for small businesses is presently 15.3%. However, this is split 50/50 between the employee and the company, with each expected to pay 7.65%.
  • Medicare taxes: Small businesses are also required to pay 1.45% for Medicare.
  • Federal income tax withholding: Small businesses are required to pay a FICA tax rate of 15.3%.
  • Federal unemployment taxes (FUTA): Small businesses must pay a rate of 6% of the first $7,000 paid to each employee annually. Be sure to check with your tax advisor to see if your business qualifies for a tax credit of up to 5.4%.
  • Other CA employment taxes: In addition to the employment taxes noted above, California businesses may also need to pay state unemployment insurance, disability insurance and employment training taxes.

Confused by your tax obligations? Want to learn more on how to reduce your business and/or personal income tax liability? Our experienced attorneys, CPA’s and enrolled agents are waiting to hear from you! Contact Moskowitz LLP today to arrange a complimentary consultation.