A tax return is an official government document that indicates the amount of money your business earned during a fiscal period. It also shows expenses incurred and allows you to write off any losses.
Your business type determines what types of taxes you must pay. You must complete specific categories with special rules, qualifications, or IRS forms.
State Income Tax
Many states levy a state income tax. In addition, many states impose property and sales taxes levied on the sale or use of certain goods or services. Regarding sales and property taxes, business owners are responsible for registering and collecting them in the states where they do business.
Individuals in states that do levy an individual income tax pay their share of business profits in the form of state-level personal income taxes. However, the other eight states that do not levy an individual income tax levy other taxes such as consumption, sales, and property.
ITEP’s state business tax models analyze the revenue yield and incidence of a variety of state business taxes, including both the individual income taxes, which are levied at the entity level on pass-through businesses, and consumption taxes, as well as property taxes, a significant source of state revenue in most states. In addition, the models evaluate the impact of a state’s business property tax structure and policies on distributional fairness.
For state income tax rates, ITEP’s model calculates the average rate paid by individuals in each state after accounting for federal taxes and deductions—as opposed to the average statutory rate). It also considers whether the tax is regressive or progressive, as evidenced by its effect on the bottom 20 percent of income earners versus the top 1 percent.
Federal Income Tax
The federal income tax is imposed on people and businesses at the federal level. It is based on taxable income, which is calculated using a taxpayer’s method of accounting. Taxable income includes business, rental, and investment income. Individuals also pay taxes on corporation dividend distributions, and investors may deduct net capital gains from selling securities and other property.
The tax rate varies by entity type. C corporations have been taxed at a flat rate of 21% since 2018 due to the Tax Cuts and Jobs Act (TCJA). Pass-through entities are taxed on a tiered basis, with top rates ranging from 37% to 39.6% depending on the types of income a pass-through entity generates.
Businesses can deduct certain expenses in computing taxable income, such as interest paid and operating expenses. However, the TCJA limited the deductions for net business interest to 30 percent of business income beginning in 2022, though there are exceptions. Generally, a corporation can only deduct interest expense to the extent it is a “qualified business interest.”
The federal income tax system has several credits, including the foreign tax credit, which reduces the amount of foreign taxes paid. In addition, the United States has income tax treaties with more than 65 countries, which help mitigate double taxation by allowing each country to tax only its residents and citizens.
State Excise Tax
The states impose state excise taxes on specific goods and services. They are usually levied at the wholesale or retail level and are distinct from a sales tax. Like other taxes, they fund government initiatives and projects. As a result, most states rely on excise taxes more than any other source of revenue.
As the name suggests, excise taxes are not considered income or consumption-based and therefore do not impact the taxes you pay as a business owner. Typically, they are applied to a specific good or service, such as fuel, tobacco, and airline tickets, and are included in the final price of that product or service. Merchants pay the taxes to wholesalers and then include them in the cost of each sale to consumers. Consumers, therefore, don’t see the cost of most excise taxes, and studies have shown that low-income taxpayers disproportionately bear these taxes.
Federal, state, and local excise taxes are usually based on an ad valorem formula according to value. This tax is imposed on quantities like gallons of fuel, gallons of wine or beer, packets of cigarettes, airline tickets, and trucks, for example. A similar type of tax, which is more broadly based, is the value-added tax, or VAT. It is a tax pre-baked into the price of a product or service, and, in most countries, it is not deductible as an expense for businesses.
Local Taxes
Local taxes are levied by municipal entities such as cities, counties, and school districts. They are often based on property but may include income and sales taxes. In addition, many localities levy income taxes on residents, with the funds used to operate services such as police and fire protection, parks, sanitation, and streets. Other forms of local taxes that municipalities may levy include capital gains taxes on the sale of corporate investments and dividend taxes on company earnings sent to shareholders.
Local income taxes are usually levied on individual taxpayers, with the rates and definitions varying from state to state. Some localities piggyback their income taxes on the state income tax so that the taxpayer only files one return and claims all available state deductions and exemptions.
