Business Finance 101: Your Complete Guide to Different Types of Taxes in the US

As there are many types of taxes in the US, you might know which taxes you have to pay personally, but things are much more complicated when you file your business taxes. 

If paying taxes has the potential to cause you a lot of headaches, you may want to change your approach. That could mean enhancing your knowledge about taxes, starting filing your taxes earlier, using professional tax solutions, or consulting with a financial advisor. 

In this article, we’ll cover the most common types of taxes in the US and the specific taxes in each category. Let’s find out! 

The most important types of taxes in the US for businesses

Different companies pay different types of taxes because it depends on their products and services. However, most types of taxes in the US fall into three main categories: what you earn, what you buy, and what you own. 

Taxes on what you earn

  • Income tax (individual income taxes, corporate income taxes)

Income tax is a direct tax that a business pays based on its income or profit during the year. Though every state of the US imposes a business (also called corporate) income tax, the tax rates differ from state to state.

Partnerships don’t have to pay income taxes. However, they must file an annual information return to report income, gains, losses, and other important tax information.

  • Employment tax

Employment taxes are levied on employees’ wages and salaries to fund social insurance programs. In the US, the largest employment taxes are a 12.4 percent tax to fund social security and a 2.9 percent tax to fund Medicare, for a combined rate of 15.3 percent. Half of the employment taxes (7.65 percent) are remitted directly by employers, with the other half withheld from employees’ paychecks. Employment tax also covers employees’ federal income tax withholding and federal unemployment (FUTA) tax.

  • Self-employment tax

Self-employment (SE) tax is a social security and Medicare tax primarily for individuals who work for themselves. Your SE tax contributions ensure your coverage under the social security system. This package includes retirement benefits, disability benefits, survivor benefits, and hospital insurance (Medicare) benefits.

In general, you must pay SE tax and file Schedule SE (Form 1040 or Form 1040-SR) if either of the following situations applies.

  • You made $400 or more in net self-employment earnings.
  • You work for a church or a qualified church-controlled organization that elected an exemption from social security and Medicare taxes, and you receive $108.28 or more in wages from the church or organization.
  • Estimated tax

Estimated tax is a quarterly payment of taxes for the year based on the filer’s reported income for the period. This type of tax usually applies to small business owners, freelancers, independent contractors, sole proprietors, partners, and S corporation shareholders, those who do not have taxes automatically withheld from their paychecks as regular employees do.

You can calculate your estimated tax based on Form 1040-ES’s worksheet. You’ll need to estimate how much money you plan to make this year. If you overestimated your earnings, you can recalculate your estimated tax for the next quarter using a new Form 1040-ES. You need to estimate your income as accurately as possible to avoid penalties. 

Taxes on what you buy 

  • Sales and use tax

Some states charge sales tax on goods and services. However, there are some exceptions, such as if your business sells clothing, medicine, food, etc. Sales tax is a consumable tax that applies to retail sales, leases, and rentals of certain tangible personal property and services. Use tax applies when you buy tangible personal property and services from other states.

  • Gross receipts tax

Gross receipts taxes (GRTs) 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) regardless of profitability and without deductions for business expenses. Gross receipts tax is sometimes imposed instead of a corporate income tax or a sales tax.

Because gross receipts taxes are imposed at each stage in the production chain, they result in “tax pyramiding,” The tax burden multiplies throughout the production chain and is eventually passed on to consumers.

Gross receipts taxes are particularly destructive to startups and businesses with long production chains, which often lose money in their early years. Despite being dismissed for decades as a wasteful and unsound tax policy, politicians have recently reintroduced GRTs as a source of additional revenue. 

  • Excise tax

An excise tax, (or a sin tax), applies to goods and services that are regarded as harmful to people or the environment, like tobacco, alcohol, and fuel. If you’re doing business in this field, you have to collect and pay excise tax to the relevant federal and state authorities. The Internal Revenue Service (IRS) and the Alcohol and Tobacco Tax and Trade Bureau (ATFTB) are the two federal agencies that control excise taxes (TTB).

Taxes on what you own

  • Property tax

This type of tax, which is generally levied on immovable properties such as land and buildings, is an important source of revenue for state and municipal governments across the United States. Property tax supports local governments in funding public services (e.g., schools, roads, police and fire departments, and emergency medical services.)

However, the property tax is different in each state. Some states collect property tax from businesses in commercial real estate locations, while others collect “tangible personal property tax,” such as vehicles and equipment owned by businesses.

Overall, taxes on real property are relatively stable, neutral, and transparent, whereas taxes on tangible personal property are more problematic.

  • Franchise tax

A franchise tax is a government levy (tax) that some US states apply to certain business organizations such as corporations and partnerships that do business in another state. A franchise tax doesn’t depend on income but the tax rules within each state, with some calculating the company’s assets, net worth, or capital stock. 

What happens if you don’t pay your business taxes on time

Taxes are a serious matter that every business owner needs to pay close attention to. You must file tax returns on the IRS’s Form 1120, even if you believe that there are no owed taxes. Otherwise, you could be subject to late-filing and late-payment penalties and even have to pay interest. In this case, you could encounter a minimum penalty ranging from $135 to $205 or the amount of tax owed, whichever is smaller.

You may also be unable to claim the company’s net operating loss on your tax return since it must be recorded on Form 1120, which it will not be if you do not file taxes.

You might also be interested in: 

How Shoeboxed can help you prepare for tax season

Shoeboxed is a painless receipt scanning and expense management solution for small business owners and freelance accountants. By using an OCR (Optical Character Recognition) engine and human-verified feature, Shoeboxed helps users scan their receipts precisely and create clear and comprehensive expense reports from their digitized receipts. You can rest assured that the digital versions of your paper receipts are “audit-ready” and approved by the IRS in the event of an audit. 

Sign up today and get yourself prepared for tax season with Shoeboxed

Understanding the IRS’s Tax Underpayment Penalty and How to Avoid It

Whether you are a freelance worker or an owner who earns money from your business, if you didn’t pay the estimated tax properly, you could end up paying an Internal Revenue Service (IRS) tax underpayment penalty. 

This article covers what can trigger a penalty and what you can do to avoid penalties in the future. 

What is a tax underpayment penalty and how does it work?

Though you only file one tax return each year, federal income tax is technically a pay-as-you-go system. You’re expected to pay tax on your income as you earn it throughout the year. Ordinarily, your employer does this for you through income tax withholding. However, if you are a freelancer, you must make your own tax payments throughout the year.

A tax underpayment penalty is a fine imposed by the IRS on individual or corporate taxpayers who don’t pay enough of their estimated taxes, don’t have enough withheld from their wages, or who pay late. The purpose of this penalty is to promote on-time and accurate estimated tax payments from taxpayers. 

The IRS may charge the tax underpayment penalty if you owe more than $1,000 in tax when you file your tax return. They may also apply this penalty if the payments you made add up to less than 90% of the tax you owe. For example, suppose that you owe $10,000 worth of tax on your 2020 tax return, but you only made $8,000 in estimated tax payments. In this case, since your tax payments only amounted to 80% of the tax due, the IRS could apply a penalty. 

The tax underpayment penalty isn’t a static percentage or flat dollar amount. Suppose the taxpayer realizes that they have underpaid taxes. In that case, they must then pay the difference plus a penalty calculated based on the remaining balance owed and how long the amount has been overdue. 

The failure-to-pay penalty that applies to tax underpayments is 0.5 percent of the amount owed for each month (or another time frame) the tax is not paid. This underpayment/failure-to-pay penalty won’t exceed 25% of the unpaid amount. 

Along with a penalty, tax underpayments (as well as overpayments) generate interest. The IRS sets the interest rate every quarter for most individual taxpayers, based on the federal short-term rate plus 3%.

The interest payment rates for Q4/2021 (announced on Aug. 25, 2021) are:

  • 3% for individual underpayments
  • 5% for large corporate underpayments (exceeding $100,000)

Exceptions for underpayment penalties

There are certain exceptions when the underpayment penalty doesn’t apply, which are: 

  • A taxpayer’s total tax liability (after withholdings and credits) is less than $1,000
  • The taxpayer paid a minimum of 90% of the total tax from the current year’s return or paid 100% of their tax liability from the previous year. (*See below for a more detailed note)
  • The taxpayer missed a required payment due to an unforeseen, uncommon, or noteworthy event (such as a casualty or disaster)
  • The taxpayer retired at age 62 or older during the prior or current tax year 
  • Estimated payments were unfulfilled because the taxpayer became disabled during the tax year or the preceding tax year
  • Any other situation in which the underpayment was due to a reasonable cause, not willful neglect. 

(*Note: In this case discussed in this second point, the rule changes a bit if your annual income increases. If your adjusted gross income for the current tax year exceeds $150,000 ($75,000 if married filing separately), you must pay 110% of your previous year’s tax liability.

However, those who don’t qualify for the above exceptions may still qualify for a reduced tax underpayment penalty in certain circumstances. For instance, individuals who change their tax filing status from “single” to “married filing jointly” may be eligible for a reduced penalty because of the higher standard deduction.

What you can do if you received a tax underpayment penalty

Generally, if you fail to pay a sufficient amount of your taxes owed throughout the year, the IRS can issue a tax underpayment penalty. However, suppose you have already paid enough and still receive a tax underpayment penalty. In that case, you may request to have it waived by showing a reasonable cause or proving that you were unable to calculate your estimated income. 

In some cases, you may successfully reduce or eliminate your tax underpayment penalty if the IRS provided you with incorrect information. For example, if you called the IRS to address a question and got the wrong advice from an IRS agent, you might succeed in avoiding a tax underpayment penalty. To be eligible for this, make sure you always note down the date and time of your call to the IRS as well as the name of the person you spoke to. If you encounter an agent who is hesitant to give you a firm answer to your question, try to be patient with them. Many agents are cautious to answer anything that could be regarded as tax advice for fear of misspeaking or giving you wrong information.

How to avoid tax underpayment penalties in the future?

No one likes ending up with a tax underpayment penalty, so here are some steps you can take to avoid this penalty in the future. 

1. Be aware of when your payments are due

For starters, adequately paying quarterly taxes by the dates shown below will help save you from incurring the underpayment penalty: 

  • Apr. 15
  • Jun. 15
  • Sept. 15
  • Jan. 15 of the following year

If a due date falls on a weekend or holiday, the payment is due the next business day.

2. Annualize your income

Generally, you don’t need to wait and pay all your tax liability at the end of the year. Especially if your income is unpredictable or seasonal, you may want to annualize your income, which basically means you will pay your tax payments based on a reasonable estimate of your income during each quarterly period. 

If you own a seasonal business and most of your annual earnings come from three consecutive months, annualizing your income can help you better estimate your tax payment. Calculating your estimated payments and making quarterly estimated payments can help you avoid the tax underpayment penalty. To use this method, you need to complete Form 2210 and attach it to your return.

For example, your business makes $30,000 per year, but all of that money comes in from June through September. When determining your estimated payments, take the $30,000 you expect to make and divide it by 12 months. This way, you can spread the amount of your estimated tax payments evenly across the year and make sure you don’t break the IRS’s pay-as-you-go rule.

3. Adjust your W-4 withholding

Generally, employers must withhold taxes from employees’ paychecks based on their earnings and employees’ information on their W-4s. If your employer isn’t withholding enough tax, you can make up the difference by revising your W-4 and requesting that they withhold more.

You can use the IRS withholding calculator to estimate how much your employer should withhold from your paychecks. Then fill out a new Form W-4, indicate how much you want to be withheld, and submit it to your employer. This can reduce or even eliminate the need for making estimated payments on your own.

The bottom line

To pay the right amount of your taxes owed throughout the years, you can ask your employer to withhold more from your paycheck. Otherwise, you can calculate and make your quarterly estimated tax payments if you’re a freelancer.

Submitting tax payments on time and filing paperwork can seem daunting, but it’s all part of developing a disciplined, well-organized documentation process. The Shoeboxed app can help your business stay efficient and organized!

Shoeboxed is a painless receipt-tracking and expense-managing app that helps get you ready for tax seasons. After scanning your receipts with the Shoeboxed app, you can create clear and comprehensive expense reports that include images of your receipts. You can then export, share or print all of the information you need for easy tax preparation or reimbursement, all within a few clicks. Shoeboxed ensures that the digital versions of your receipts are legibly scanned, clearly categorized, and accepted by both the Internal Revenue Service and the Canada Revenue Service in the event of an audit. 
The Shoeboxed app is available on iOS and Android. Try Shoeboxed for free and get yourself prepared for tax seasons!

Business Owners: Are You Forgetting This Sneaky Tax Due Date?

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Did the title freak you out a little? Sorry about that, but we thought ripping the band-aid off would be the way to go. After all, it’s the truth – if you own your own business, freelance or generally work for yourself, quarterly estimated taxes are due to the IRS and, likely, to your state’s taxing authority right around the corner.

Did you forget about them, or have never dealt with them before? Don’t worry, we’re here to help. We’ll go over what QETs are, why you have to deal with them, and some of the basics of the process to get you started.

The Basics of Quarterly Estimated Taxes

Remember back when you had a 9 to 5 or even when you worked at that fast food joint downtown while you were in high school? At the end of the pay period your boss took out a certain percentage from every paycheck to pay taxes to the government. Afterwards you got to take home what was left.

Now that you own your own business, you don’t have a boss to do this for you. This means you have to do it yourself. However, it doesn’t quite work the same as it did back then. You don’t submit your taxes every two weeks or even every month.

If you own an (for example) online coffee cup shop, every time you sell a coffee cup you might think you need to submit taxes. But that would get even more complicated than it already is, which is why the QET system was set up.

Every quarter you send in a payment to the government to take care of your tax responsibilities. January, April, June and September become your “buckle down and take care of business” months from now on.

How QETs Work

So if you don’t remit tax payments every time you make a sale, how do QETs work? If it’s your first time ever doing them it can be extremely confusing, but once you get the hang of it everything will fall into place.

The biggest thing to remember is the word “estimated.” This is precisely what these payments are – estimations, as in you’ll hardly ever run into a payment that’s 100% accurate the first time. This is because you basically take your profit from the year (that’s income minus business expenses), figure out what you would owe on taxes on those sales, and then divide by four to get your quarterly estimated tax payment.

You can probably see how this would cause unbalance. You may make most of your profits in the 4th quarter, or you may shut your business down over the summer. Therefore, this “estimate” may be a little off.

Fortunately, there’s the “Safe Harbor Rule” the IRS has put into place. As long as you submit the same amount in taxes as you owed the the year before, you won’t be charged any fees or penalties. As an example, if you accumulated a $5,000 tax bill last year, but business boomed and you owe $10,000 this year, you’ll be fine as long as you pay at least $5,000 over the year in quarterly estimated tax payments. However, you’ll have to pay up the remaining $5,000 when all is said and done and you file your annual taxes on April 15th.

The good thing about this mess, though, is that it can help you get your finances in order as well as prepare you for tax season. When the time rolls around, you’ll be so used to figuring out this kind of stuff that it’ll be a breeze.

Here’s a calendar to keep you up to date:

Q1 – April  15, 2014 (you should have already paid this one on income made from January 1 -March 31, 2014!)

Q2 – June 16, 2014 (pay on income made between April 1, 2014 and May 30, 2014; this due date falls on the 16th because the 15th is on a Sunday)

Q3 – September 15, 2014 (pay on income made between June 1 and August 31, 2014)

Q4 – January 15, 2015 (pay on income made between September 1, 2014 and December 31, 2014)

What questions do you have about QETs?