Between keeping track of expenses and estimating your future income – managing your taxes as a small business owner was already tough enough.
Unfortunately, small business tax rates in 2021 aren’t likely to make your job any easier. Federal laws are changing and there’s a lot of uncertainty for small business owners.
Use this guide to understand how small business tax rates in 2021 will affect your bottom line and the best ways to stay prepared.
What Is the Federal Small Business Tax Rate?
The federal small business tax rate ultimately depends on how your business is structured. Some business types are subject to different tax laws than others. Here’s a quick recap of the different types of business structures.
With sole proprietorships, there’s no legal separation between you and your business. In other words, your business’s income is taxed as your own personal income.
You’ll report all business income on an IRS Form Schedule C for your personal tax returns. Business owners who have a sole proprietorship must also pay self-employment tax, including Medicare or Social Security taxes.
Limited Liability Corporation
In terms of taxes, an LLC is similar to a sole proprietorship. You’ll have to report your LLC’s earnings on your personal income tax return. But you’ll also have the benefit of liability protection you wouldn’t have under a sole proprietorship.
With an LLC, you have the option to choose whether to be taxed as a sole proprietor, C Corp, or S Corp. In other words, LLCs are an inherently flexible business structure.
Unlike a sole proprietorship, a C corp is a separate legal entity. It maintains many of the same rights as individuals. Your C corp can enter contracts, sue or be sued, own assets, and more all in its own name.
However, as a business owner, you’ll be required to file both personal income taxes and business income taxes. C corp profits are currently taxed at 21%. You’ll also have to pay taxes on the income you receive from your C corp, which can lead to a double taxation scenario.
Thankfully, there are some ways to avoid or mitigate double taxation. Learn more here.
S corps are similar to C corps, the main difference being that S corps aren’t subject to taxes on business profits. Instead, earnings are directly passed over to owners and shareholders, who then pay personal income taxes on their distribution.
Even though S corps are appealing because they’re not subject to double taxation, they’re more difficult to establish. There’s a lot more paperwork involved and additional regulations to adhere to.
Estimating Your Tax Rate
Even though the IRS publishes small business tax rate adjustments every year, you shouldn’t use the current rates to estimate what you’ll owe for the 2021 year. That’s because the new administration has made several promises to raise taxes – and business owners, in particular, are likely to be affected.
It’s typically recommended to look towards your revenue to estimate how much taxes you’ll have to pay at the end of the year. Even then, this strategy isn’t perfect. Many business owners simply don’t know what their revenue will look like in any given year.
If the 2020 pandemic has taught us anything, it’s that market conditions are always subject to change. It’s still important to maintain projections, but there’s always going to be some level of uncertainty.
If you own a C corp or an S corp, you’ll have to take on less guesswork because you’ll have the option to set up a payroll system. This allows you to pay yourself a salary and have your payroll provider take out estimated taxes from each paycheck.
It’s an entirely different process for sole proprietorships and LLCs. With these business structures, income flows directly to you, which means you’ll have to pay estimated taxes quarterly.
The IRS inflicts penalties if you fail to pay estimated taxes. Your estimated taxes should add up to at least 90% of your 2021 tax bill or 100% of your 2020 tax bill. Keep in mind you’ll have to pay estimated taxes to both the IRS and your state’s division of taxation.
Staying Ahead of Your Taxes
Running your business day-to-day and keeping track of your estimated taxes can be exhausting. Thankfully, there are a couple of strategies you can implement to make the process easier.
For starters, look at your previous year’s tax bill to understand how much you’d have to pay each month to avoid owing a large lump sum all at once. If possible, set aside extra money just to be safe.
It’s also important to update your business financial statements at least once per quarter. This will make it easier to stay on top of your revenue and understand how much taxes you’ll owe at the end of the year.
While saving for taxes is incredibly important, your main priority should be growing your business. You don’t want to miss out on a potential opportunity or lose vendors, employees, and customers just because your cash flow is going towards saving for taxes.
Even if you do find yourself strapped for cash come tax time, you have options – the IRS offers installment plans, you could take out a small business loan, or use cash from a business line of credit to pay your tax bill.
Credits and Deductions
As you keep track of your income, make sure to track your expenses as well. Come tax time, your expenses can turn into tax credits and deductions you can use to lower your tax bill.
Food, travel, rent, car mileage, internet expenses, employee salaries, and more, are all tax-deductible. Investing in new equipment or purchasing commercial real estate can also bring about tax benefits.
Overlooking your eligible expenses can leave you shelling out more cash than necessary. If you end up overpaying taxes, you’ll have to wait until your taxes are filed to get your refund – which means you’ll have less access to cash throughout the year.
Ultimately, you have two choices – to pay less during the year and risk a larger tax bill all at once, or potentially overpay during the year and have a greater chance of a refund. The best strategy ultimately depends on your business and your goals.
That said, overpaying taxes during the year in order to get a larger refund later on, can harm your business’ liquidity. You’re more likely to run into potential cash flow issues, miss out on growth opportunities, or even hurt your ability to secure business financing.
Where an Accountant Can Help
Managing your small business taxes can be stressful – but you don’t have to go at it alone. There’s a host of resources available for small business owners.
For starters, check in with your accountant at least two or three times a year. They’ll keep you updated on changes to the federal small business tax rate and can even help you find extra tax benefits throughout the year.
It’s also worthwhile to work with a lender. There’s a ton of speculation about tax increases for small business owners in 2021. If you’re worried about meeting your 2021 tax obligations, the last thing you want to do is sacrifice your business’ growth.
National is a top business financing marketplace with over 75 different lenders. We can help you get the financing you need to grow your business and improve cash flow. Our specialists work with you to discuss personalized solutions based on your credit score and business needs.
Learn how extra financing can make small business taxes easier to manage! Get in touch with our Business Financing Specialists here.